- Peloton announced blowout earnings last week, and has joined an elite club that includes Apple, Netflix and Tesla. These companies not only delight their customers and create enormous shareholder value, but they also operate a highly vertically integrated enterprise. The success of these companies is rewriting some outdated rules on what drives effective business strategy.
- Startups should be particularly open to building vertically integrated capabilities when appropriate as soon as funding capacity and management talent and bandwidth permits. Vertical integration can give companies more control over delivering superior products and better experiences at every customer touchpoint. For example, it is now generally recognized that Apple’s tight control over hardware and software design, as well as operating its own company stores, have contributed to superior product performance, customer satisfaction, and price realization, more than offsetting the increased costs and complexity of managing a vertically integrated enterprise.
- Companies should give careful consideration to three pivotal questions to guide their strategic decisions on vertical integration.
- Does owning or controlling assets and capabilities across the value chain significantly improve product performance and customer experiences?
For companies like Apple, Netflix, Tesla, Ikea, Allbirds, and Peloton, vertical integration has proven to be a key driver of superior company performance, while also building barriers to competition.
- Can the requirements for capability-building capital be scaled to reflect a company’s stage of development?
While early stage ventures are often strapped for capital, they have the advantage of being able to build and launch capabilities in small increments, before committing to large scale rollouts. For example, Peloton tiptoed into retailing, streaming video classes, and white-glove bicycle delivery with small pilot operations in a single metropolitan area before expanding the scope of its operations internationally. In contrast, when Ikea decided to significantly upgrade its ecommerce capabilities, it faced nine-figure investments to build fulfillment centers, webstore infrastructure and new operating processes across its multinational operations prior to launch.
- Are the products and services offered conducive to generating premium returns from superior product performance and customer satisfaction?
The required investments in vertical integration can only be justified if enough consumers recognize and are willing to pay premium prices for superior performance. Not all product categories meet this requirement, but market leaders in businesses with a strong personal and emotive connection to customers — for example in health and wellness, automobiles, mobile technology, and entertainment — have successfully exploited high levels of vertical integration to build powerfully advantaged, profitable and resilient enterprises.