Page 193 - Operations Strategy

168 CHAPTER 5 • PuRCHAsing And suPPly sTRATEgy
decided. Vertical integration is the extent to which an organisation owns the network
of which it is a part. It usually involves an organisation assessing the wisdom of acquir-
ing suppliers or customers. Vertical integration can be defined in terms of three factors.

1 The direction of vertical integration – should an operation expand by buying one of
its suppliers or by buying one of its customers? The strategy of expanding on the
supply side of the network is sometimes called backward or upstream vertical inte-
gration, and expanding on the demand side is sometimes called forward or down-
stream vertical integration.
2 The extent of vertical integration – how far should an operation take the extent of its
vertical integration? Some organisations deliberately choose not to integrate far, if at
all, from their original part of the network. Alternatively, some organisations choose
to become very vertically integrated.
3 The balance among stages – is not strictly about the ownership of the network, but rather
the exclusivity of the relationship between operations. A totally balanced network
arrangement is one where one operation produces only for the next stage in the net-
work and totally satisfies its requirements. Less than full balance allows each opera-
tion to sell its output to other companies or to buy in some of its supplies from other
companies. Fully balanced networks have the virtue of simplicity and also allow each
operation to focus on the requirements of the next stage along in the network. Hav-
ing to supply other organisations, perhaps with slightly different requirements, might
serve to distract from what is needed by their (owned) primary customer. However, a
totally self-sufficient network is sometimes not feasible, nor is it necessarily desirable.

Example Contrasting vertical integration strategies: ARM versus intel 6

Nothing better illustrates the idea that there is more than one approach to competing in the
same market than the contrasting business models of ARM and Intel in the microchip busi-
ness. At one point in 2014, ARM’s chip designs were to be found in almost 99 per cent of mobile
devices in the world, while Intel dominates the PC and server markets. Yet ARM and Intel are
very different companies, with different approaches to vertical integration and, some claim,
very different prospects for their future. They are certainly of a different size. In revenue terms
Intel is around 50 times bigger than ARM. More interestingly, Intel is vertically integrated,
both designing and manufacturing its own chips, while ARM is essentially a chip designer,
developing intellectual property. It then licenses its processor designs to manufacturers such
as Samsung, who in turn rely on subcontracting ‘chip foundry’ companies to do the actual
manufacturing (including Intel, ironically).
Intel’s vertically integrated supply network monitors and controls all stages of production,
from the original design concept right through to manufacturing. Keeping on top of fast-
changing (and hugely expensive – it can cost around $5 billion to build a new chip-making
plant) operations requires very large investments. It is Intel’s near-monopoly (therefore high
volume) of the server and PC markets that helps it to keep its unit prices high, which in turn
gives it the ability to finance the construction of the latest semiconductor manufacturing equip-
ment before its competitors. And, having the latest manufacturing technology is important – it
can mean faster, smaller and cheaper chips with lower power consumption. As one industry
source put it, ‘Intel is one of the few companies left with the financial resources to invest in state-
of-the-art manufacturing R&D. Everyone else – including all the ARM licensees – have to make do
with shared manufacturing, mainstream technology, and less-aggressive physics.’ By contrast, ARM’s

M05 Operations Strategy 62492.indd 168 02/03/2017 13:04