The end of outsourcing? Why companies are taking back control

Until fairly recently, corporations did everything in-house rather than delegate activities to others. Now the “vertical integration” model is making a comeback. That spells opportunity, says Richard Beddard.

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Over the past two decades, outsourcing production has been one of the key trends in global business.But it is a relatively new phenomenon. In the early 20th century, manufacturers using the new techniques of mass production had to build their own supply and distribution networks because the alternative – external suppliers and distributors of sufficient scale – did not, on the whole, exist. 

These firms were “vertically integrated”: they performed most, if not all, of the activities required to bring a product to market because they had to. But as technology advanced and the global economy became more sophisticated, the tide began to turn and by the end of the 20th century the fashion was to “de-integrate”. Companies preferred to outsource less profitable activities to specialists who could do them more efficiently and focus on where they could add more value: making distinctive products and services that would be more lucrative. 

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The corporate tide is turning

The poster child for de-integration and global supply chains is Apple, which famously outsources the assembly of the iPhone. A closer look, however, suggests that the story is more nuanced. Though Apple does not assemble its products, it is a vertically-integrated company in many respects. It provides the operating system, App Store, the marketplace for services that make the phone functional and some of those services, such as iTunes. 

You may well have bought an iPhone directly online or from a physical Apple Store, where you can also get support and repairs. Since many of the components in a mobile phone are fairly generic and the capacity to manufacture electronic devices in huge quantities is already established in the Far East, there would be little to gain and much to lose by taking production in-house. But, in common with many of its peers, Apple seeks to control the experience of its customers from design, through software, to sales and service. This is where Apple can add most value.

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When vertical integration works for you...

Today, companies are thinking again about reintegration. Technology giants such as Tesla, which sells electric cars through its own outlets, and streaming service Netflix, which is making films and TV programmes, are behaving like the giants of yore. So-called “fast fashion” suppliers such as Zara take manufacturing in-house to reduce the time it takes to respond to new fashion trends. The risks inherent in lengthy supply chains have become more apparent with time. The more companies a product passes through before it reaches the customer, the more places the chain can be broken or costs introduced, either due to problems at individual suppliers, or because of threats such as trade barriers and Covid-19, which has closed iPhone factories in China. Sometimes managing complex supply chains is more onerous than doing the work in-house.

When customers require very high-quality standards, a company may decide the only way to comply is by taking overall control. When you’re selling trench coats for over £1,000 and handbags for little less, pretty much everything about them must be perfect – the product, the in-store or online experience and the story marketers tell about them. So luxury-goods companies such as Burberry vertically integrate to guarantee quality and justify the price tag. 

If supply of a material required for production is restricted, a more vertically-integrated approach makes sense. Churchill China, a manufacturer of tableware for the hospitality industry, is dependent on a particular type of clay to manufacture hard-wearing plates and bowls. The manufacturing processes it has developed over centuries using this clay enable it to make robust tableware cheaply and distinguish it from competitors abroad, which explains why, in 2019, the company took control of its supplier. 

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