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 muchof the raw materials and inputs from their suppliers. However many
companies buy thesuppliers of most of the important supplies needed to produce the
final product or servicein the company. The more the company produces in-house
or own suppliers, the morevertically integrated the company is. There are several
reasons central to the question of m a k e o r b u y d e c i s i o n o f t h e c o m p a n y . T h a t
i s s h o u l d t h e c o m p a n y b u y m o r e f r o m independent suppliers or should it be
more vertically integrated.
As Myopi andB u l l i n g t o n ( 2 0 0 4 ) s u g g e s t s t h e c h o i c e b e t w e e n v e r t i c a l i n t
egration and independentsuppliers is primarily driven by cost efficienc
y . I f c o s t a s s o c i a t e d w i t h i n d e p e n d e n t supply is high than vertical integration is
better. If independent supply is less costly thanvertical integration is a less efficient solution.
A decrease in vertical integration can resultin a decline of production costs for several
reasons. When a company decreases verticalintegration there will be fewer
production plants combined in one organization. As ar e s u l t p r o d u c t i o n c o s t s
will be low because a company will be dealing with
fewer production plants which will have lower conflicts with other pla
n t s a n d c o s t o f supervising will decrease. Secondly when the company will be in a
business of producinggoods that require differing capabilities from the company’s core
capabilities than therewould be a problem of underutilized capacity and
diseconomies of scale resulting inhigher production costs (Krajewski & Ritzman 1996).
Thirdly when you are buying fromsuppliers where rivalry amongst suppliers is high,
a less vertically integrated firm canbenefit here because the competitive pressure will
bring down the cost from the suppliersand thus result in lower costs of production.
Lowering the level of vertical integration canalso lead to lower inventory costs. If any
process is outsourced than the cost of storing thei n v e n t o r y s u c h a s r a w m a t e r i a l s
w i l l a l s o b e p a s s e d o n t o t h e s u p p l i e r s . M o s t o f t h e Japanese companies
also outsource because the cost of paying their employees for thesame work is
more than it is when outsourced or sub contracted to a supplier. One of thereasons is
that the suppliers pay lower wage rates to their employees than the
Japanesefirms have to pay to their employees at their production plants.

The disadvantages of more vertical integration have been experienced by many

wellk n o w n f i r m s .
F o r d a d o p t e d t h e s t r a t e g y o f h i g h e r l e v e l o f v e r t i c a l i n t e g r a t i o n a n d pr
oduced everything in house because the company’s founder Henry Ford thought
thathis company has mastered the technique of mass production before its suppliers and
thiscould help the company reduced huge costs. The Ford Company also thought that
doingeverything themselves would help them gain greater predictability in their
operationsa l s o . H o w e v e r t h i s d i d n o t w o r k a n d F o r d ’ s
v e r t i c a l i n t e g r a t i o n i s c a u s i n g m a s s i v e problems of bureaucracy with no solutions
(Eisenstein 2000)
with competitors such as Ford, GM and Chrysler in terms of low price for its car whichare
also more fuel efficient. Today Toyota has a larger market share in USA as comparedto Ford
and GM. The other competitive priority of Toyota has been the high quality thatcomes to
the customer at a cheaper price. Toyota’s high quality has come because of itscollaboration
with its suppliers. At Toyota this is referred to as the ‘collaborativeadvantage’. 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 givesuggestions on improvement of
its operations. This is the essence of the TPS which helpsto Toyota in carrying out the
continuous improvement needed in its operation in order togive 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 aremostly internationalizing their
businesses because of the continuous technological changein the world today. Today
companies are taking advantage of other company’scompetitive advantage so that they can
outsource their functions to them and concentrateon their own competitive priorities.
Nokia, which is the world’s largest Finnish mobilephone manufacturer, is one of them. Nokia
competes amongst its rival mobile phonemanufacturers in terms of product innovation and
quality. In order to maintain thiscompetitive edge Nokia outsourced many of its operations
and services to many smalland large suppliers. Within the mobile telecommunication, the
pace of technologicalchange has been very rapid in the last few years. There was a change
from analoguetechnology to digital technology and then software development was
essential in order toprovide new features and functions to customers in order to compete.
Nokia first realizedin 1992 that to respond to increasing technology it has to develop new
competencies andresources in the area of digital mobile technology. By that time the GSM
technology wasintroduced which was based on open interface and provided a high
bandwidth. GSMtechnology was also providing roaming facilities to its customers. However
this newtechnology required a new network system and equipment. Nokia chose to acquire
thetelecommunication 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 costsof
developing new technologies, reduced product-development times and
promotedinnovation (Sadowski, Dittrich & Duysters 2003). During the late 90’s the
newtechnological challenge for Nokia and other mobile manufacturers has been the extent
towhich these companies can provide the technology of personal multimedia. There
havebeen 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
andBluetooth applications. Nokia realized that it cannot produce everything in-house so
ithas outsource most of its multimedia operations used in mobile phones to many
softwarevendors and other organizations such as IBM, Intel, Toshiba, Matsushita and Psion.
In2001, Nokia signed a deal with HP where HP was to manage the IT infrastructure
andoperations for Nokia’s network and for its messaging and groupware systems. Upon
thesuccess of this deal the contract was further contracted in 2004 which is valued at
$100million 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 Nokiaowns a
market share of 35% worldwide compared to its second rival Motorola who has amarket
share of 17.8% (Swartz 2005). The outsourcing agreement with HP resulted in acost savings
of around 25% since 2001 till 2004. The market share of Nokia which alsofell 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 coststhat
it bears. If the company has resources and capabilities to produce all by itself than itis better
off choosing a higher level of vertical integration. Most organizations choose alower level of
vertical integration to take advantage of the core competencies andcompetitive 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 outsourcinginternationally in
order to take advantage of the lower wages and lower cost of operatingbusiness in other
countries. Through outsourcing these organizations have been able togain competitive
advantage over their competitors

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