Tom Evslin wrote a great insight on the topic of vertical integration and how it is no longer a sound business strategy (hat tip: Fred Wilson from A VC). It is an excellent article that explains the transition from vertical to horizontal integration. IBM, Tom argues, was in the older days of computing the typical model of vertical integration: it made the hardware, chips, application software, OS, and even peripherals, while also providing instruction, consulting services and accessories. However, with the advent of the microcomputer, a paradigm shift took place, with the business changing to a horizontal model: Intel became the microprocessor king, while Microsoft dominated the OS and applications. IBM had to change itself, and managed to adapt to the new environment thanks to initiatives such as IBM Global Services, although it is not the dominant force it once was.
Tom wonders whether or not SBC will be able to make vertical integration work with its acquisition of AT&T. Clearly, the vertical strategy failed at AT&T, since it lost the opportunity to be an ISP powerhouse and a key local access player. Tom makes it clear which strategy is his preferred one:
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"A horizontal company has a high surface to volume ratio. It sells all of its outputs in a competitive market. It is free to buy all its inputs in a competitive market. Its managers are not isolated from the markets they compete in. A vertical company spends most of its time and energy dealing with itself rather than the external market. Meetings are dominated by esoterica like transfer pricing between divisions because this is what determines internal success. The real marketplace is distant from most of the managers trapped inside the vertical structure. Buy vs. build and capital allocation decisions inside a vertical company are made by office politics in a vain attempt to optimize across the whole vertical organization. Horizontal competitors optimize only for the layer they are competing in and so end up being superior to the vertically integrated company layer by layer." |
Read it all! - This is definitely a great insight.
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