Going Vertical
The business world is prone to fads. Over the decades, nothing has been more faddish than ideas about how broad the scope of a company’s business should be.
Back in the ’60s and ’70s, conglomerates were all the rage. This led to bizarre transactions like electronics company LTV’s acquisition of Wilson and Company, a meatpacker, in 1967, and Mobil Oil’s lustful embrace of mail-order giant Montgomery Ward in 1974. The executives concerned didn’t have good reasons for doing these things, except that Wall Street analysts advised that diversification could bring steadier earnings. When the analysts changed their minds, conglomerates went out of style and most of those mindless mergers were unwound, often at considerable cost to shareholders.
The conglomerate fad was followed by the outsourcing fad. Outsourcing, of course, is the opposite of conglomeration: rather than engaging in all manner of businesses, companies were told to focus on their “core competence” and get rid of everything else. From executive dining rooms to mines and factories, whatever wasn’t a “core competence” was to be obtained by contracting with an outside supplier, leaving the company to do only what it did best. This dictum conveniently suited the needs of leveraged buyout groups that borrow heavily to fund their acquisitions and then dismember them in order to pay down their debts.
The outsourcing fad was one reason big companies began to create long value chains in the late 1980s: if you’re going to purchase raw materials or components or services from others rather than producing them yourself, you might as well try to obtain those inputs wherever they are cheapest. Giant corporations, in this construct, became integrators, putting together pieces created by others, while largely dispensing with factories, vehicles, warehouses, and production equipment of their own.
But the outsourcing fad seems to be over. Vertical integration, which involves companies buying up suppliers or customers — in some cases, the same types of suppliers or customers they sold off years ago — is back in vogue.
You can see this most clearly in the auto industry. Vehicle manufacturers, almost all of which have long since hived off their parts subsidiaries, are now investing in battery plants to control the design and production of batteries for their electric vehicles. Much the same is happening in the aircraft industry, where, after expensive failures to deliver new products on schedule, companies like Boeing and Airbus seem to want to own key suppliers of everything from avionics to fasteners. Cleveland Cliffs, originally an iron miner, last year acquired two major steelmakers hungry for its iron pellets. Pharmaceutical companies are reconsidering their dependence on outside vendors for essential ingredients. Container ship lines increasingly want to own their own terminals to make sure their vessels receive priority service. The global semiconductor shortage has even made some companies consider whether they should manufacture a portion of their chips in house — a practice that most automotive and consumer-electronics manufacturers abandoned years ago.
How far will the trend go? At this point, companies seem to be selective. Microsoft and Google have integrated vertically into designing electronic devices that run on their software, but they continue to outsource the manufacturing process. While Ford Motor wants close control over electric vehicle batteries, it seems less eager to make its own headlights and windshield wipers. Amazon.com owns its distribution centers, but it prefers to purchase transportation services, at least in part to avoid the possible unpleasantness of having to deal with labor unions representing truck drivers or pilots.
Given increased worry about risk management in the business sector, vertical integration seems likely to gather steam. This fad, I’d bet, is just getting started.
Tags: fads, vertical integration