History repeats itself or call it Life has come full circle; we are witnessing a new trend of Vertical Integration in Technology Industries.
Some recent news items (2009)
Cisco’s entry into server market
Apple recruits chip designers
Intel acquires a software company
Oracle acquires Sun
RIM acquires a browser company
Google building Operating Systems
Nokia acquires Payment System Company
Prime View (Kindle Manufacturer) buys E INK
List goes on ...and grapevine says more to come….
Why this is happening?
In early part of the industry evolution, we had vertically integrated industries (like IBM in early mainframe days) with proprietary and interdependent architectures.
Then with time as product functionality and reliability improved, industry shifted to modular and independent architectures and led to the rise of best of breed suppliers like Microsoft (Operating System), Intel (Processors).
Subcomponent industry develops with clear interfaces and best of breed suppliers
New product introduction is fast, one just needs to system design the new product. The components can be easily sourced from suppliers for product assembly.
Cost comes down initially as subcomponent suppliers main focus is cost optimization
Unfortunately party cannot go on for ever and few problems have started emerging
• Limit in component level innovation or cost reduction
• Breakthrough innovation is not coming as there are interdependencies across the subsystems and components
• Even if breakthrough innovation comes, it gets copied very rapidly as getting components from suppliers is easy , like iPhone, or eBook reader
So What Next?
Hence comes rise of Vertical Integration and drivers are more than innovation
• Cost and Profitability- As number of suppliers increase in value chain so is their profits (assume each supplier earns 20-25 % gross margin). So why not integrate companies and work on integrated 25-30% gross margin and pass partial benefit to customers
• Innovation – Product level Breakthrough innovation will need optimization and interdependencies across components and subsystems
• Competition – Raising time and other barriers for entry for the competition. Competitors will need time to understand the product and develop internal capabilities to design and manufacture components
• Regulation and Technology grants – Thanks to credit crisis and government stimulus, government is promoting new investments in creating jobs and facilities and also selectively giving grants for R&D programs in new technologies.
• R&D Economics of Scale – By vertical integration , companies can leverage economics of scale in R&D efforts at product level and interdependencies rather than suboptimal utilization and duplication at component level
What will be the Implications?
I wrote earlier about rise of product companies as result of Obama’s ban on outsourcing.
This goes one step further with rise of Vertical Integrated companies. There will be more levers for M&A for both early stage technology companies and established companies
So on one hand vertical integration will accelerate the pace of M&A and on the other hand it will change game from collaboration to competition, as witnessed in recent Google Voice and iPhone controversy
Earlier leaders had no incentive for vertical integration, as it would have turned their existing partners and customers into competitors and would have led to cannibalization of their existing product line sales. But this is changing now, as evident from Cisco’s bold move…
The best of breed component players will need to think that where they will fit in vertically integration and fierce competition trends. Status Quo will not be the option!!