Has Amazon caught the forward integration bug?

Every time I think I’m done with this vertical integration obsession another example pops up.

Rumours are flying around the news sites that the giant of online retailing Amazon might be bringing a portion of its delivery process back in-house.

They are reportedly considering opening old school bricks-and-mortar shop fronts in the UK where buyers can pop past to pick up their purchases.

This would represent a substantial shift in the business model of the firm, and also a convergence back with various other high street retailers (most notably in the UK Argos) who also have a strong online presence.

It is also an interesting example of adaptation to the quirks of infrastructure and custom from location to location. Parcel deliveries may be less practical in the UK given different living arrangements, and customers are more densely situated meaning such distribution points could be viable.

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Is vertical integration sexy again?

Hot on the heels of my recent posts discussing forward integration, Wall Street Journal is reporting an increase in the incidents of vertical integration.

The article in question cites very prominent recent examples of backward integration (General Motors, Boeing, Apple, Nucor, ArcelorMittal and Oracle) and forward integration (LiveNation and Pepsi), and argues that these moves represent a significant shift in corporate mindset. Perhaps vertical integration is back in favour. If so, this would represent a shift away from four decades or so of de-integration (at least in developed markets).

There are valid qualifiers for this assertion:

“The historical view of vertical integration was that you had complete control of the supply chain and that you could manage it the best,” says Bain & Co. consultant Mark Gottfredson.

Today’s approach is more nuanced. Companies are buying key parts of their supply chains, but most don’t want end-to-end control.

Likewise, there are some strong explanations for specific moves:

GM (who bought into a steering systems supplier) “wanted to assure uninterrupted supply”.

Boeing (who similarly reentered the parts and assembly business) is fighting to regain control of the delayed Dreamliner project.

The steel manufacturers are trying to secure guaranteed supply of ore (and/or scrap) in a period of price uncertainty (where hedging becomes difficult).

Oracle are seeking to offer complete IT solutions (i.e. hardware and software).

Apple’s return to the semiconductor business is explained thus

“By developing its own chips for new mobile devices – a departure from the industry trajectory – Apple hopes to tighten control over a key technology and keep it away from rivals”.

Pepsi’s purchase of several key bottling/distribution partners reportedly reflects greater complexity in the product mix:

“…motivated as consumers flock to noncarbonated beverages, Pepsi is keen to gain more control over the distribution of its growing menu of offerings.”

While the motives for vertical integration would appear to vary considerably, much of these could be viewed as transaction cost issues (i.e. the relative greater costs of contracting effectively with other parties for vital inputs/market access are perceived to outweigh any cost advantages said parties might have). Interestingly. no mention is made of the potential that firms are picking up ‘bargains’ in the GFC-scarred world.

Why don’t more producers sell on-line?

Last week, Aussie surfwear giant Billabong announced they had entered the online retail arena via the acquisition of California-based boardsports website Swell.com.

Swell carries a wide range of brands beyond the Billabong stable. Billabong’s argues “the purchase will allow the company to take advantage of higher margins”. This is certainly logical, but it begs the question why more consumer durable producers have not gone down this path.

Firms like Billabong carry an enormous range of products that are distributed in low quantities to a very dispersed (and individually pretty inconsequential) set of bricks and mortar retailers (presumably via margin-eating middlemen wholesalers). Building a front-end in the online world could give firms a much more direct, more responsive and more lucrative customer interface. One can imagine Billabong offering exclusive and limit-edition ranges through the Swell store, and also tapping into more insightful customer preference data.

The challenge resides in the perceived channel conflict. Will other retailers feel threatened by the firm as a competitor (leading to them cutting back purchases)? While Billabong feel restricted in its pricing at Swell?

Likewise, there may be hostility from competitor brands. Will these firms still want to offer product to Swell, given Billabong will be earning a big chunk of their profits?

Billabong have done a smart thing in buying a firm with proven technology, a functioning back-end and known brand rather than going alone with such forward integration.

What are some other examples of such moves in the e-commerce space? And have they worked?