In business, vertical integration means a whole supply chain of the company is controlled and owned by the organization. Thus, making it possible to control each step through customers. in the digital world, vertical integration happens when a company can control the primary access points to acquire data from consumers.
- Vertical integration in the physical world
- Google vertical integration explained
- Atoms vs. bits
- Google and the supply chain of data
- Google business of collecting data
- From the search page to the voice assistant
- Vertically vs. horizontally integrated
- Apple’s Vertical Integration case study
- Why Vertical Integration is a key competitive moat
- Vertical integration examples in the physical world
- Other connected business phenomena
Vertical integration in the physical world
On FourWeekMBA, I discussed the Luxottica business model, which is a great example of vertical integration:
Luxottica controls the whole supply chain, which goes from product development to manufacturing, and logistics.
While this strategy is more expensive in the short-run, over the years can turn into a competitive advantage.
As the Luxottica case shows, the company grew and integrated more brands within its portfolio (iconic brands like Ray-Ban and Oakley are part of the Luxottica Group), by both having Luxottica-owned brands and by producing sunglasses for other major luxury brands.
By controlling the supply chain, and taking a step further in its retail strategy, Luxottica can connect the dots between product development and final customers to make sure quality and customer demand are aligned.
This process is used also in the digital world, by players like Google or other tech giants, that over the years have developed products and distributed them directly to customers to gain control over the whole supply chain.
Google vertical integration explained
In early 2018, Sundar Pichai, Google’s CEO, highlighted how AI for humanity is more important and profound than what fire was.
To keep using an analogy, the real fuel that keeps the AI fire going is data.
Indeed when we go from atoms to bits, the strategic thinking behind an organization changes.
For instance, for a traditional company, one of the long-term success of the organization is based on keeping control of its processes and being able to control the whole supply chain.
While this strategy is expensive, it is also what drives sustainable growth. For instance, traditional companies operating in “slower” sectors (think of Luxottica in the eyewear industry) managed to gain control over the supply chain and also became the world’s leaders in their markets.
In short, the idea is that the closer you get to the customer (in case you’re a manufacturer) or the closer you get to the producer of a good or service (if you’re a retailer) the more control you have over the whole experience.
This, in turn, might allow you to dominate your industry over time and keep tight control over processes, quality, and operations:
While this is intuitive in the world of atoms. It gets a bit trickier in the bits world.
For the sake of understanding how vertical integration and supply chain work in the bits world, we’ll look at how Google is going up – or down (depending on where you look) in the supply chain of data.
Atoms vs. bits
As the web has become so ingrained in the way we interact with the world and with each other, it is easy to forget between companies that operate purely in the atom world, compared to that operating in the bits world.
Just to keep a clear distinction a business based on bits is mostly a software business or any organization that makes money primarily by selling digital goods or services, compared to a traditional atoms business.
It is important to remark that bits businesses are not entirely so, as they rely on massive physical infrastructure (think of Google data centers) which allow the company to operate.
However, a bits company’s mission is to provide goods or services, often at scale.
Where in the world of atoms, a key ingredient for an organization’s success is made of raw materials.
In the bits world, that raw material is even more critical.
That is the crucial ingredient for their success, and the raw material in the bits world is data.
Google and the supply chain of data
Before understanding vertical integration in the bits world, made primarily of data it is critical to understand how it flows to realize how tech companies are trying to gain control of it.
Often the supply chain of data needs to rely on the physical supply chain and vice versa.
Google business of collecting data
Google learns a great deal about a user’s personal interests during even a single day of typical internet usage. In an example “day in the life” scenario, where a real user with a new Google account and an Android phone (with new SIM card) goes through her daily routine, Google collected data at numerous activity touchpoints, such as user location, routes taken, items purchased, and music listened to. Surprisingly, Google collected or inferred over two-thirds of the information through passive means. At the end of the day, Google identified user interests with remarkable accuracy.
This ability to identify users’ interests with “remarkable accuracy” comes from Google investments over the years in creating the proper infrastructure that could support its supply chain of data.
As voice search is approaching Google needs to be on top of the data game, and that explains the next run to dominate the voice assistants devices market.
From the search page to the voice assistant
When you type something on Google’s search box, you’re making its search engine better and better.
That is the power of network effects. In short, the more users keep using Google, the better its search engine can capture users’ commercial intent.
However, even though Google has a high gross margin, people still have to keep going back to its search pages.
As I pointed out in Google’s TAC strategy, the company managed to keep having billion of users each day going back to it thanks to a massive distribution network, both driven by distribution agreements and its networks (like AdWords and AdSense).
Yet that data is precious it is still coming from third parties. Therefore, Google is investing massive resources to make sure that data can get acquired via its devices so that it can finally have control of the overall chain.
As I pointed out in Google’s hardware plans in January 2018, Google completed the agreement with HTC with the acquisition of the team of engineers and a non-exclusive license of intellectual property from HTC for $1.1 billion in cash.
Another example is how Google invested in KaiOS, an operating system, that transforms feature (dumb) phones into smartphones, providing them also of a default voice assistant (KaiOS phones use by default the Google Assistant).
That works as a window into the Indian market, where Google can access voice data, directly from those devices, thus bringing it closer to over a billion consumer base, that in the future might turn into a great business opportunity.
That move is toward creating a vertically integrated supply chain of data!
Vertically vs. horizontally integrated
For instance, in horizontal integration, the companies that take part in it, either merge or acquired the other (the same process can happen through vertical integration). However, in horizontal integration, this usually happens in the same industry and segment of the supply chain.
Therefore, imagine a wholesaler’s leader buying another leading company, to take a bigger chunk of the same market.
An example of horizontal integration might be the acquisition from Uber of Postmates.
An example, instead of vertical integration, in the bits world, as highlighted in Google’s data supply chain, the company is able to integrate its supply chain from upstream (in this case the upstream side starts with customers who become the sources of the raw data), to downstream.
Apple’s Vertical Integration case study
When Apple launched the iPhone, back in 2007, it was a moderately successful product.
Yet what really made it take off, was the combination of hardware, software, and marketplace.
In 2008 that was introduced as App Store, and that is when iPhone sales took off.
Combined with a strong distribution strategy, the iPhone became a business platform, which enabled Apple to keep tight control over the ecosystem built on top of it, while generating revenues, ad high margins.
Why Vertical Integration is a key competitive moat
By 2021, Facebook announced a complete rebrand, and it became Meta.
Why did Facebook, now called Meta, made such a move?
It’s possible to analyze this move according to vertical integration.
Indeed, there is a key distinction to make between Meta and other tech giants like Google or Apple.
Where Google and Apple have built vertical integration, thanks to the control over a whole ecosystem.
Facebook didn’t manage to build that, over the years. And as Apple tightened its App Store’s rules around privacy, that had the potential to crash the whole Facebook Business Model.
Thus, the Facebook move into the Metaverse wasn’t just a strategic move, it was a survival move.
And now Facebook (Meta) is trying to build the same kind of ecosystem and vertical integration that Apple and Google had built, which is what made them thick, in the long run.
Vertical integration examples in the physical world
Here are some more examples of vertical integration to solidify the concept.
Across multiple divisions, Samsung takes an active role in the manufacture of components for use in the company’s various consumer electronics products.
These include camera modules, semiconductors, antennas, and LCDs.
Samsung’s vertical integration is so well established that rivals such as Apple sometimes use the company to source parts.
A network of subsidiaries maintains control over manufacturing, while forward integration is managed by branded stores that sell directly to consumers.
ExxonMobil, BP, and Shell
Oil companies are one of the best examples of vertical integration across the entire supply chain. ExxonMobil, British Petroleum (BP), and Shell have exploration divisions tasked with finding oil around the world.
Independent or part-owned subsidiaries then build the necessary infrastructure to extract it from the ground.
After extraction, these companies transport the crude oil to refineries. Control at this point in the supply chain is maintained via numerous other subsidiaries or joint ventures.
Each company also employs a retail division to market the refined product to customers – whether that be petroleum, diesel, engine oil, jet fuel, or asphalt.
Target is a department store chain that has embraced vertical integration with open arms.
In 2007, Target launched the RedCard – a branded credit card able to be used in the company’s retail stores and on its website.
The RedCard enables Target to control aspects of consumer financing and payment processing.
The card also gives the company access to consumer purchase behavior data that can be used to secure a competitive advantage.
Like Target, Zara leverages this control to collect data on its customers which it then uses to make sales forecasts or guide product development.
Vertical integration also affords several other benefits for Zara. For one, it can maintain the quality of its products over time.
The supply chain itself is also more efficient since communications between the various Zara departments are more fluid.
Ferrero is a chocolate and confectionary company best known for its hazelnut-based spread Nutella.
The company operates 25 factories across five continents near areas where critical raw ingredients such as cocoa, palm oil, and sugar are produced.
Ferrero is a major buyer of hazelnuts on the world stage, acquiring 25% of the total supply.
Around 70% of that amount comes from Turkey, which made the company vulnerable to supply shortages in 2014 after heavy frost damaged crops.
To secure a stable supply of hazelnuts and ensure it would be protected from price rises, Ferrero vertically integrated by acquiring Oltan Gida – the worldwide leader in the procurement, processing, and marketing of hazelnuts with an annual turnover exceeding $500 million.
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