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.

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Supermarket hold-up in Belgium – quasi-rents at stake

It is rare that we see public demonstrations of what we verbose academics call the appropriation of quasi-rents. But just such a scenario is playing out in the Belgian retail arena.

In early February Belgian supermarket chain Delhaize (the 33rd largest retailer on Deloitte’s list) ceased stocking around 300 products from Unilever, the world’s 3rd largest fast-moving consumer goods giant (behind Nestlé and P&G). This represents a sizable majority of the 480 products usually stocked (and includes such brands as Dove, Sunsilk and Lipton).

This move springs from Delhaize’s unwillingness to match Unilever’s price demands and also the retailer’s desire to not stock some of Unilever’s less popular brands.

This is exactly the sort of scenario transaction cost economists get all excited about. There are a series of relationship-specific investments in place (in brands and locations) leading to small number bargaining. This means firms are want to hold up the other party in an attempt to extract the quasi-rents from the situation.

Put differently, this is the bargaining power of suppliers/buyers element of Porter’s Five Forces at work.

It is a little unclear who triggered this. Supermarket chains are often chastised for squeezing suppliers and there is a feeling that the current climate is escalating this tendency. On the other side of the equation, giants such as Unilever are typically viewed as less susceptible to such pressures due to the enormous breadth of their offerings. The fact that this breadth is a stumbling block in this standoff is enlightening. Delhaize would seem to be trying to shift the balance.

Currently, the data coming out seems to indicate that Delhaize is been hurt by this decisions with customers showing considerable loyalty to the brands rather than the retailer.

It is worth noting that Delhaize is only pursuing this approach in one national market at the moment, and that market is less than a quarter of their business. Perhaps they are getting some practice (or testing the waters) before trying it on a bigger stage (such as the US which constitutes almost 70% of their sales).