The WSJ is continuing to debate with itself whether vertical integration is the new fad (as blogged by Marty in “Is vertical integration the new black?.”). The last episode in that debate appeared several says ago (“Outsourcing Isn’t Just for Christmas, “h/t for Anuj Kaydan).
The main claim of the article is fairly simple:
Overall, outsourcing is more than a management fad. It fosters rational allocation of capital and growing global trade. That is certainly preferable to vertical integration driven by fear of supply shortages. This not only feeds on itself, as more supplies get “locked up,” but leads to inefficiencies as the competitive dynamic is removed from the supplier-customer relationship.
While I agree with the first statement regarding the fact that outsourcing maybe a rational choice for may firm I cannot really agree (or follow) what comes after it. Supply shortage is definitely a good reason for a firm to decide to take control of its supply market. If this shortage if of strategic consequences – it make a lot of sense to integrate it into the firm. Moreover, I am not sure I follow the logic that vertically integrated chains necessarily lead to inefficiencies in terms of supplier-customer relationship. As long as Apple hasn’t purchased all chip producers and PepsiCo has not purchased all bottlers they cannot leverage their market power to more than what it already is. Moreover, I think there are many inefficiencies that are due to outsourcing (just remember the 2007 recall of toys produced in China for an example of what may happen due to mismanaged outsourcing)
I am not sure that vertical integration should be the new black, but at the same time, there are cases where it makes more sense than outsourcing. In the operations strategy course we discuss several metrics one can employ to make these decisions, such as the Total Cost of Ownership, trying to take into account all related long term aspects. ( Did I mention that I will be teaching the class in the Spring quarter?).