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Introduction

All organizations buy at least some inputs to their processes in the form of raw material,
professional services or manufactured products from other producers. The more a
company depends on other suppliers and producers to provide it products and services the
lesser the level of vertical integration in the company. Lesser vertical integration leads a
company towards more outsourcing. An organization has to ascertain that while
outsourcing it does not outsource its core competencies or a process that is crucial to it. It
must also make sure that through outsourcing it receives a competitive edge over its
competitors through lower costs and high quality. A company that chooses more vertical
integration tends to produce most of inputs and processes itself and also buys out most of
its supplier. This essay, however, describes how Toyota and Nokia were able to gain
competitive edge as a result of outsourcing most of their operations to independent
suppliers and vendors.
The level of vertical integration in an organization implies how much of the products or
services in the organization are produced in-house and how much of it are outsourced.
Majority of companies in the world do not produce everything in-house. They buy much
of the raw materials and inputs from their suppliers. However many companies buy the
suppliers of most of the important supplies needed to produce the final product or service
in the company. The more the company produces in-house or own suppliers, the more
vertically integrated the company is. There are several reasons central to the question of
make or buy decision of the company. That is should the company buy more from
independent suppliers or should it be more vertically integrated. As Myopi and
Bullington (2004) suggests the choice between vertical integration and independent
suppliers is primarily driven by cost efficiency. If cost associated with independent
supply is high than vertical integration is better. If independent supply is less costly than
vertical integration is a less efficient solution. A decrease in vertical integration can result
in a decline of production costs for several reasons. When a company decreases vertical
integration there will be fewer production plants combined in one organization. As a
result production costs will be low because a company will be dealing with fewer
production plants which will have lower conflicts with other plants and cost of
supervising will decrease. Secondly when the company will be in a business of producing
goods that require differing capabilities from the company’s core capabilities than there
would be a problem of underutilized capacity and diseconomies of scale resulting in
higher production costs (Krajewski & Ritzman 1996). Thirdly when you are buying from
suppliers where rivalry amongst suppliers is high, a less vertically integrated firm can
benefit here because the competitive pressure will bring down the cost from the suppliers
and thus result in lower costs of production. Lowering the level of vertical integration can
also lead to lower inventory costs. If any process is outsourced than the cost of storing the
inventory such as raw materials will also be passed on to the suppliers. Most of the
Japanese companies also outsource because the cost of paying their employees for the
same work is more than it is when outsourced or sub contracted to a supplier. One of the
reasons is that the suppliers pay lower wage rates to their employees than the Japanese
firms have to pay to their employees at their production plants.
The disadvantages of more vertical integration have been experienced by many well
known firms. Ford adopted the strategy of higher level of vertical integration and
produced everything in house because the company’s founder Henry Ford thought that
his company has mastered the technique of mass production before its suppliers and this
could help the company reduced huge costs. The Ford Company also thought that doing
everything themselves would help them gain greater predictability in their operations
also. However this did not work and Ford’s vertical integration is causing massive
problems of bureaucracy with no solutions (Eisenstein 2000).

Toyota however adopted the strategy of lesser vertical integration. It was successful in
this strategy particularly in America while competing with its rivals such as the GM,
Chrysler and Ford. The creator of Toyota Production system Taiichi Ohno believes that
Toyota competes on cost and quality. For both these purposes it has to adopt lesser
vertical integration. Toyota does this successfully through strong relationship and
collaboration through suppliers as against the others who keep their suppliers separate
from the firms operation. Toyota has currently outsourced 70% of its operations
regarding car components to its suppliers and the remaining 30% are done in-house.
Toyota realized the importance of outsourcing very early. In the late 1940’s when Japan’s
economy was suffering, Toyota was also suffering from the poor economy. Its electrical
equipment department ran into difficulties and was contributing losses to the company. In
1949 Toyota decided to take action and separated the electrical equipment department
from the company. However the separated department was made into a separate and
independent company which is popularly known as “Denso” today. Denso is the biggest
supplier of Toyota’s car spare parts and electrical equipment and although it is a
distinctive and an independent company but it has strong relations with Toyota as it is
part of the ‘Toyota Production system’ (TPS). Through the ‘Just in Time’ concept Toyota
benefits highly from Denso and other suppliers in managing the inventory costs and the
overall production costs. Through outsourcing to its suppliers, Toyota has managed to cut
costs across the board for the purchase of all the car parts including air conditioning
equipment, electrical equipment and even windshield wipers to around 30% compared to
its competitors (Anderson 2003). This decrease in cost has assisted Toyota to compete
with competitors such as Ford, GM and Chrysler in terms of low price for its car which
are also more fuel efficient. Today Toyota has a larger market share in USA as compared
to Ford and GM. The other competitive priority of Toyota has been the high quality that
comes to the customer at a cheaper price. Toyota’s high quality has come because of its
collaboration with its suppliers. At Toyota this is referred to as the ‘collaborative
advantage’. Through its relations with the suppliers Toyota evaluates the performance of
its suppliers on regular basis and asks the suppliers also to evaluate Toyota and give
suggestions on improvement of its operations. This is the essence of the TPS which helps
to Toyota in carrying out the continuous improvement needed in its operation in order to
give customers a high quality product without even carrying out most of its operations in-
house.

Many companies have also moved from in-house production to outsourcing and are
mostly internationalizing their businesses because of the continuous technological change
in the world today. Today companies are taking advantage of other company’s
competitive advantage so that they can outsource their functions to them and concentrate
on their own competitive priorities. Nokia, which is the world’s largest Finnish mobile
phone manufacturer, is one of them. Nokia competes amongst its rival mobile phone
manufacturers in terms of product innovation and quality. In order to maintain this
competitive edge Nokia outsourced many of its operations and services to many small
and large suppliers. Within the mobile telecommunication, the pace of technological
change has been very rapid in the last few years. There was a change from analogue
technology to digital technology and then software development was essential in order to
provide new features and functions to customers in order to compete. Nokia first realized
in 1992 that to respond to increasing technology it has to develop new competencies and
resources in the area of digital mobile technology. By that time the GSM technology was
introduced which was based on open interface and provided a high bandwidth. GSM
technology was also providing roaming facilities to its customers. However this new
technology required a new network system and equipment. Nokia chose to acquire the
telecommunication equipment and expertise of installing and maintaining it from other
suppliers in the market. By focusing on its core competencies and purchasing the
remainder from specialist suppliers, Nokia created a network system that spread the costs
of developing new technologies, reduced product-development times and promoted
innovation (Sadowski, Dittrich & Duysters 2003). During the late 90’s the new
technological challenge for Nokia and other mobile manufacturers has been the extent to
which these companies can provide the technology of personal multimedia. There have
been technologies introduced such as TCP/IP and ATM (Asynchronous Transfer Mode)
as well as WAP (Wireless Application Protocol). Another introduction was in the area of
mobile wireless information which gave birth to operating systems such as EPOC and
Bluetooth applications. Nokia realized that it cannot produce everything in-house so it
has outsource most of its multimedia operations used in mobile phones to many software
vendors and other organizations such as IBM, Intel, Toshiba, Matsushita and Psion. In
2001, Nokia signed a deal with HP where HP was to manage the IT infrastructure and
operations for Nokia’s network and for its messaging and groupware systems. Upon the
success of this deal the contract was further contracted in 2004 which is valued at $100
million annually. This is the biggest outsourcing contract on part of Nokia. The fruits of
the successful strategy of lesser vertical integration are there for Nokia. Today Nokia
owns a market share of 35% worldwide compared to its second rival Motorola who has a
market share of 17.8% (Swartz 2005). The outsourcing agreement with HP resulted in a
cost savings of around 25% since 2001 till 2004. The market share of Nokia which also
fell a little few years ago rose to 6% in the span of 2 years only since 2004.
Conclusion

The level of vertical integration a company chooses depends highly on the overall costs
that it bears. If the company has resources and capabilities to produce all by itself than it
is better off choosing a higher level of vertical integration. Most organizations choose a
lower level of vertical integration to take advantage of the core competencies and
competitive edge of their suppliers in order to get a high value and quality product or
service. Most organizations in the world have also adopted the strategy of outsourcing
internationally in order to take advantage of the lower wages and lower cost of operating
business in other countries. Through outsourcing these organizations have been able to
gain competitive advantage over their competitors.
References

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