Is Vertical Integration Back in Style?

Yes, according to the November 30^th Wall Street Journal (teaser here, full article requires subscription).  Living for a long time in New England with the likes of DEC and Wang Laboratories, and having read AnnaLee Saxenian’s Regional Advantage: Culture and Competition in Silicon Valley and Route 128, I am dubious.

The article posits that large companies need to be able to better control their supply chain, and rather than outsourcing all but their core competencies, they are bringing more and more of the capability of building their entire product in-house.  It uses an example Oracle’s pending acquisition of Sun Microsystems, and Oracle’s plans to build not just database and business software, but also chips, hardware, and storage systems that runs that software.

On the other hand, fifteen years ago Saxenian, an urban planning professor at Cal-Berkeley who was educated at Harvard, contrasted the vertical integration of Massachusetts bay area high tech companies with the extensive outsourcing model that’s prevalent in Silicon Valley.  Her conclusion (fed by a large dose of cultural and attitude differences among the people in those two locales) was that the focus on core competencies practiced by Silicon Valley was more efficient than the Route 128 focus on vertical integration.

Has anything changed during the past fifteen years to invalidate that conclusion?  Well, during the two economic downturns in this decade, many companies went out of business or discontinued product lines, which undeniably hurt larger systems integrators.  And as the supply chain stretches globally, politics and wars have a way of causing disruptions.

There is something to be said for controlling your supply chain; look at what happens when a key automotive supplier goes under, or its workers go on strike – it can halt one or more production lines, and leave thousands of workers without any cars to build.  Lean manufacturing is all well and good, but it requires that you trust your suppliers absolutely.

But I think there is an even greater danger in vertical integration.  The likes of Wang and DEC got into trouble not because they weren’t technologically savvy, but rather for another reason.  By building everything themselves, they didn’t have to interact with suppliers who likely had different views of the direction of technology.  By establishing their own direction, they were able to ignore the direction of the industry as a whole.  Do that for too long, and you become irrelevant.

And that’s a danger today for the likes of Oracle, IBM, and HP, although all are more open than IBM, DEC, and Wang of the 1980s.  But it does no good protecting your supply chain if you lose sight of broader industry trends.