For example, Research in Motion also bought QNX, a company with an operating system and is trying to assimilate it with the firm’s hardware offerings, like the BlackBerry. But RIM’s QNX-based operating system has been delayed as the company struggled to sell the PlayBook tablet.
Apple’s integration efforts were on display when the company unveiled its third-generation iPad last week. The new version will come with 4G connectivity, a high-definition display and a faster processor. Sterne Agee analyst Shaw Wu said in a research note that Apple had been able to advance features like power consumption precisely because it controlled the parts that make up the iPad. “Our industry checks indicate Apple has made notable progress in improving battery life that has plagued competitors,” said Wu. “This is due to Apple’s ownership of core intellectual property including systems design, semiconductors, battery chemistry and software.”
According to Wharton management professor Dan Levinthal, what Apple’s competitors really envy is the company’s control of its ecosystem. “It is important to distinguish between a motivation to manage the interface between hardware and software and a desire to manage one’s ecosystem. I think many of these moves are really about the latter sort of motivation,” says Levinthal, who adds that Google’s purchase of Motorola Mobility was not only a way to gain control of various patents, but also to fend off Apple’s patent lawsuits.
Google also wants to create a more seamless user experience that will entice consumers to invest in its full line of products, rather than just using one or two, Levinthal notes. Analysts say Apple’s successes in this area led to increased market share. “We believe that Apple’s software ecosystem (including third-party apps, iOS and Apple’s own applications) is the key to driving sales long term,” Barclays Capital analyst Ben Reitzes said in a research note. “There is just too much you can do with an iPad versus other devices.”
The Risk to Innovation
As technology companies push to become more vertically integrated, a few unpleasant side effects could emerge. For instance, Hsu suggests that the advancement and growth of Google’s Android technology may slow if the company is juggling hardware and software efforts. Even though Android is technically open source, Google drives development. “Google integration with Motorola Mobility could make products better, but the risk is that Android may not evolve at the same pace it would under a specialization model.”
Andrea Matwyshyn, a legal studies and business ethics professor at Wharton, has similar concerns. “Vertical integration is desirable for some products, but you need multiple models in the technology industry,” she says. “If every tech company followed Apple, there would be a degree of novelty and innovation lost.” After all, Apple’s success may be largely a function of a command and control structure instituted under former CEO Steve Jobs. If others followed suit, large technology companies would dominate supply chains and innovation, which could make it harder for a start-up to develop a breakthrough product. “In some ways, you can make the case that more vertical integration could mean less innovation,” Matwyshyn adds.
Matwyshyn predicts that many technology companies currently trying to integrate software and hardware will back off in a few years. “In 10 years, these companies are going to look a lot different,” says Matwyshyn. “Every industry has periods where vertical integration looks better. A few years ago, everyone was outsourcing.”
Typically, companies back away from vertical integration as products become more commoditized. It is unclear when that will happen in the smart-phone or tablet markets, but the advent of that period would likely mean trouble for vertically integrated firms. “What Apple has done well is stay ahead of commoditization,” Hsu notes. “Apple is more of a trailblazer and that opens up possibilities.” The catch is that a vertical approach does not provide a significant advantage if a firm is unable to stay ahead of the competition. Indeed, Apple’s integrated approach in the PC market did not work to the firm’s benefit when it was battling Microsoft in the 1980s and ’90s.
In its current form, Apple has found a way to balance vertical integration with an outsourcing model. For instance, Apple focuses on design and integration, but Foxconn, a Chinese contract equipment manufacturer, actually puts together iPads and iPhones. According to Hsu, Apple has deployed a hybrid model, in which it has control over the product and supply chain but uses contractors in many areas. In addition, Hsu says, Apple is so large that it can dictate terms to contractors — a leverage point that other technology companies cannot match.
Republished with permission from Knowledge@Wharton, the online research and business analysis journal of the Wharton School of the University of Pennsylvania.