Investors Business Daily, Monday, April 20, 1998 at 11:56
Sara Lee Corp. contracts out its manufacturing work via computer.
Dell Computer Corp. counts on electronic ties with suppliers for PC
parts. Even Microsoft Corp. leaves vital parts of its online travel
agency up to suppliers that it links with over the Internet.
For many companies, the days of vertical integration, or trying to
do everything in-house, are numbered. The "virtual integration" era
is on the way.
Companies are forging electronic relationships with suppliers in
the form of outsourcing deals, long-term contracts and joint
ventures. And these companies are linking with their suppliers
through computer networks.
"The old business model of vertical integration has broken down,"
said Richard Nolan, professor of management of technology at the
Harvard Business School. "Companies are experimenting with strategic
alliances, networks and relationships . . . trying to figure out a
better way."
Backers say it's not about technology, although tech is the
enabling factor. Virtual integration helps get costly plants,
property and equipment off the balance sheet, cuts management
distractions and wins a better valuation on Wall Street.
"I don't think we could have created a $12 billion business in 13
years if we had tried to be vertically integrated," Dell Chief
Executive Michael Dell wrote in the March/April issue of the Harvard
Business Review.
Of course, technology's not a requirement to form such deep-rooted
arrangements with suppliers.
Even before computers, automakers never made all their own car
parts. And tightly knit networks of Japanese companies have formed
closed "keiretsu" deals with each other for ages.
"Even the Internet and collaborative computing can't substitute
for deep relationships between manufacturers and suppliers," said
Andy Zoldan, supply director for SAP AG in Germany, a maker of
business software that automates back-office tasks. "But without
technology, no one could have imagined the wide-reaching partnerships
we see today without the companies involved losing control."
Vertical integration is far from obsolete. Some industries,
including entertainment, see it in their future.
Music and movie firms view digital networks as a door to gain more
control of how their product reaches consumers, says Steve Abraham,
global managing partner of Price Waterhouse's entertainment and media
practice. They would rather have high-bandwidth networks transmit
their movies directly to consumers than cut video stores in on the
rental market.
Virtual organizations work much better in some industries than
others, says Mary Lou Fox, senior vice president of Manugistics Group
Inc., a software firm that helps companies build electronic
alliances.
Maximizing use of the "noncore" units is the No. 1 motivation, she
says. Companies with underutilized units have the most to gain,
because they can spread overhead costs over more customers, she says.
That's the case with the manufacturing operations of Sara Lee.
President Steven McMillan says he wants to cut costs 25% by setting
up links with suppliers.
Sara Lee designed a meat-processing plant to be opened by '99 in
Mississippi. But the company won't run the plant, McMillan says.
That'll be left to a virtually connected partner.
"Technology wasn't the driver of the decision, but it's one
example of the ways companies have been better able to link with each
other in the past five years," McMillan said.
Virtual arrangements also are fast ways to fill in "expertise"
that the main company doesn't have or want to develop, says Charles
Kalmback, managing partner of Andersen Consulting's organizational
strategy practice.
"I can't acquire Harvard University because it has knowledge I
want," Kalmback said. "But I can have technology-based alliances
(with its staff)."
Dell Computer passes daily production requirements of memory,
drives and monitors electronically to a small group of suppliers.
"We can share design databases and methodologies with supplier-
partners in ways that just weren't possible five to 10 years ago,"
Dell wrote.
And Compaq Computer Corp. digitally sends its yearly demand update
forecasts every week for memory, disk drives and processors to
vendors.
But it's more than just an electronic marriage. Often the
partners build their plants near, if not inside, Compaq facilities.
"If you'd walk down the halls at a Compaq site today, you'd see
suppliers everywhere," one Compaq executive said.
Compaq and Dell officials agree that for virtual integration to
work, the number of supplier-partners must be limited. Compaq, which
now leans on about 500 production partners, wants to cut that number
in half by the third quarter.
Virtual integration wasn't possible until the PC business reached
maturity and components became standard. Earlier, Digital Equipment
Corp. and IBM Corp. had to make their own parts. The vendor network
wasn't mature enough to be reliable.
IBM still makes many of its own chips. But it makes them for
other users, too. That helps it reach its plant capacity, says Paul
Lewis, general manager of IBM Global Services' consulting unit.
Yet, others are trying to get the best of both virtually and
vertically integrated worlds. They're doing it by spinning off
noncore units, but maintaining networked links with the units, as
well as majority ownership.
Sabre Group Holdings Inc. is a perfect example of the virtual-
vertical hybrid. The former flight reservation arm of American
Airlines parent AMR Corp. was spun off as an initial public offering
in '96. So while AMR still owns 82% of Sabre's stock, the unit is
free to service other airlines.
AMR had never utilized 100% of Sabre, says Michael Durham, Sabre's
chief executive. Now it can offer American lower rates, since it
also performs reservation services for other airlines.
But by keeping majority ownership, AMR retains control, the
biggest advantage of vertical integration.
"Technology lets companies outsource to others without giving up
close ties," Durham said. |
