Meritocracy Consulting Blog

For it’s entire history, Apple has essentially stuck with the approach of vertical integration, increasingly controlling every aspect of the value chain. Recently, this model has been hugely successful, encouraging the company to broaden their control to include ownership of chip manufacturers, control over manufacturing, extremely strict software standards, a nearly closed ecosystem and proprietary retail stores.

Historically, vertical integration has been typically bad for companies, and definitely bad for consumers (think of how powerful companies have killed innovation and driven up prices):

• Standard Oil – broken up as a result of anti-competitive practices and price controls achieved through their vertically integrated monopoly
• AT&T – broken into baby bells, allowing Sprint and MCI to enter the market and drive down long distance prices
• Current oil companies – controlling prices and discouraging alternative energy investment
• Cable providers – local monopolies have contributed to the US having one of the slowest broadband speeds in the modern world…not to mention my $120/month cable bill
• Apple – for years their vertical approach and refusal to just detach the OS from their hardware almost drove them out of business
• Microsoft – leveraged their natural monopoly to arguably hurt software innovation for years and delay the potential of the internet
• Mobile phone providers – through vertical integration they delayed the adoption of smartphones, stifled phone operating system innovation and continue to focus on customer lockin rather than on what customers really want…really fast mobile broadband and the freedom to use devices from any manufacturer

In a tandem post, I discuss how the business world has recently shunned conglomerates (once again), but is vertical integration something that finally works? I think that as more companies move toward vertical integration, they are charting a crash course that will eventually end with failure. This belief is entirely unpopular now as a result of tremendous success by Apple, Walmart and the vertically integrated oil companies, but I believe that we are reaching a point where weaknesses are visible in even the “shining examples” of vertical integration.

An impetus for this post and a related post on the failure of conglomerates was Bill George’s article on how the past decade is a lost decade because of an absence of leadership. Bill pointed out some grim statistics and briefly touched on the need for businesses to strive for long-term value. Dead on, but a little vague…immediately I felt like I had something to add in terms of diagnosing this “lost decade”.  Simply put, its cause can be attributed to a return to vertical integration and overemphasis on scale (as was common in the 1800s, and most recently in the late 1960s and early 1970s).

It seems like this past decade was plagued by an overemphasis on blocking competitors instead of differentiating through innovation. While these techniques can be effective for optimizing profits in the short-term, it is not surprising that the US is now struggling to maintain its worldwide leadership and create jobs. When companies place too much emphasis on blocking competition (through vertical integration, local monopolies or other non-innovative techniques) they create a hostile environment where the entire industry fights amongst themselves rather than looking to the future. In the short-term, there certainly will be some winners…like Apple, but in the long-term everyone loses…hence a 10 year period with no real economic growth for the United States.

Not convinced that vertical integration is a second rate strategy?  Check out a detailed look at Microsoft’s trend toward vertical integration as well as 7 more examples of vertical integration gone wrong.

There are literally hundreds of examples to show us why a strategy of vertical integration will ultimately will be bad for most businesses and society. As far as the decade being “lost”, it is my belief that poor leadership results in management’s decision to focus on the “strategy de jour” which seems to be to provide a complete vertical experience that is slightly less expensive. In the short-term this gains market share, but is very unlikely to change the world, improve our lives or spawn the next “unknown” industry. In fact, it seems like a focus on breadth instead of depth actually results in much slower innovation. Would we have been better off if Zappos and Mint stayed independent and continued to innovate with retail and personal finance…I think so. Consumers would benefit more if Quicken and Amazon had viable competitors.  Do I blame those entrepreneurs for selling?  Maybe a little, but it would be nice if late stage VC firms could have provided some liquidity and encouraged them to build standalone businesses.

We’re already seeing a lot of failed efforts and disintegration, but perhaps led by Apple’s relatively recent success as a “total closed system”, I think we will have several more years before this mindset breaks down and true innovation is unleashed.  Do I know what will drive the next phase of growth? No, but if Microsoft had their way back in 1998, the internet would have been used only for allowing customers to download windows applications.

In another post, I advise companies to ignore Apple’s unlikely success and point out several companies that I hope stay focused on just what they are doing.

In summary, working with partners is scary and unpredictable.  The allure of boxing everyone out and doing everything yourself continues to grow as Apple and others find success with this strategy.  If as consumers we can see the benefit of “companies doing less well”, then we should trust history and expect focused companies to win out in the end.  Realistically, innovative companies will probably find a way to leverage partnerships and truly “open platform” strategies will prevail…I do trust markets.  The question, is how long will it take and at what cost to shareholder value and society at large.  Perhaps somehow we can wake up consumers to reward smaller, more focused companies…or MAYBE, the government can empower focused, open and highly innovative companies to thrive faster.

Ironically, if we all put down our iphones and support platforms like Android (and hopefully other new open platforms as they emerge), we’ll actually get better phones a few years down the road.