How Apple Made ‘Vertical Integration’ Hot Again — Too Hot, Maybe

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Google recently acquired mobile-device maker Motorola Mobility and will soon manufacture smart phones and television set-top boxes. Amazon’s Kindle Fire tablet represents its bridge between hardware and e-commerce. Oracle bought Sun Microsystems and now champions engineered systems (integrated hardware-and-software devices). And even long-standing software giant Microsoft now makes hardware for its Xbox gaming system. Technology titans are increasingly looking like vertically integrated conglomerates largely in an attempt to emulate the success of Apple.

Vertical integration dictates that one company controls the end product as well as its component parts. In technology, Apple for 35 years has championed a vertical model, which features an integrated hardware-and-software approach. For instance, the iPhone and iPad have hardware and software designed by Apple, which also designed its own processors for the devices. This integration has allowed Apple to set the pace for mobile computing. “Despite the benefits of specialization, it can make sense to have everything under one roof,” says Wharton management professor David Hsu.

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The tech industry’s success in this type of integration is mixed. Samsung, a large technology conglomerate, has thrived by making everything from LCD panels to processors, televisions and smart phones. But Sony, which has attempted to meld content, TVs and game systems like the PlayStation, has yet to find a way to make the disparate parts gel.

“Companies can emulate the Apple model, but it will not happen overnight,” notes Lawrence Hrebiniak, a Wharton management professor. Although tech companies for now are focusing on entering areas closely aligned with their core businesses, Hrebiniak notes that hardware and software require different competencies and skill sets in areas such as manufacturing, procurement and supply chains. In that respect, the challenges these firms face will be similar to what many diversified multinationals deal with when managing disparate business units.

The technology industry’s rush to vertical integration may be misplaced, Hrebiniak says. After all, there is a reason that large conglomerates tend to trade at a discount on Wall Street — they are harder to manage. “Conglomerates can work if you have one line of business, go into another and then leave that unit alone,” Hrebiniak notes. “If you try to integrate disparate businesses, you become so unfocused that you lose the ability to coordinate.”

Yet, with technology companies under increasing pressure to keep growth rates up, expanding into new areas is an attractive proposition for many firms, according to Wharton new media director Kendall Whitehouse. Google may be getting into hardware today, but it could be Facebook tomorrow. “Haven’t we seen this movie before?” asks Whitehouse, pointing to the rise of multinational conglomerates in the mid-20th century. For example, Vivendi transformed itself from a water company to one focused on media, while GE started as an electric company but later expanded into such disparate businesses as microwave ovens and the NBC television network (which it recently sold to Comcast). “Conglomerates are now refocusing after spreading themselves too thin,” says Whitehouse. “Can expanding tech companies learn the lessons of an earlier wave of conglomerates?”

There are also examples of tech firms that have switched gears and tried to return to a more specialized model. For instance, IBM divested its PC and printer operations to become a more service-focused company. “The fundamental question about efforts to expand is whether there are synergies between these parts,” notes Whitehouse. “If a new product or service dovetails nicely with your core business, then there is something to leverage. If not, focus is better.”

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According to experts at Wharton, markets that are not commoditized, such as mobile computing, smart phones and tablets, benefit most from vertical integration. However, once markets become less differentiated, a specialized approach — where each member of a supply chain has a role — makes sense. Hsu notes that the PC and semiconductor markets were once vertically integrated. Eventually, however, the supply chains reverted to being more specialized. In the case of PCs, a group of companies now makes different parts of the machine that are then put together to create the final product: Microsoft builds operating systems, Intel makes processors, Nvidia provides graphic chips and a series of companies manufactures hard drives.

Looking Beyond ‘Apple Envy’
Google’s plan is to operate Motorola Mobility as a separate business, which is tightly coupled to the Android mobile-operating system for smart phones and home set-top boxes. The trick for Google is making the key hardware-and-software connections to replicate Apple’s success. “Apple does well, but has had top-down integration of hardware and software for more than 30 years,” Hrebiniak states. That integration, which requires centralization foreign to Google and many other companies, is hard to deliver.

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