Vertical Integration vs. Outsourcing “Following the Crowd” Essay Example

the current trend among medium and large companies of outsourcing various components of their supply chain despite potentially sacrificing significant benefits in terms of profit, quality, and communication. It is initially challenging to comprehend why numerous companies act irrationally when their primary goal is profit maximization; especially in today's era where most markets are commoditized resulting in minimal cost advantages (Christopher, Ch.).Please provide the text that needs to beand unified.

1) During the pre-outsourcing era, companies achieved great success in terms of profits. Therefore, there must be more reasons behind the change in strategic policy than simply seeking increased flexibility to compensate for the advantages that have been given up. (Introduction Into the Topic: At the end of the 19th century and the beginning of the 20th century, the global market was mostly favorable to sellers, giving companies significant power as the demand for goods from customers consistently exceeded manufacturers' capacity to supply. Source: M.Christopher, Logistics and SCM, Ch. 10, p. 287)

This advantageous situation allowed several companies with a slight knowledge advantage to experience extraordinary growth rates compared to the present day. The absence of the need for extensive advertising campaigns, which typically incur high costs, played a minor role in this success. The main contributing factor was the significant competitive edge these companies had over smaller competitors. Their early entry into the market gave them an advantage in economies of scale, enabling them to produce much larger quantities of their product than their rivals and gain a lead in both time and quantity on the experience curve. This, in turn, led to lower production costs due to the experience curve effect. As a result, these

companies naturally established a monopoly with strong market positions, as the barriers for new entrants were impossibly high. Consequently, these privileged companies generated substantial profits that greatly increased their cash holdings. (Source: www.partacus. schoolnet.)

The companies in question (source: co.uk) faced challenges in communication and sourcing specialized companies that could meet consumers' needs in terms of quantity and quality. To overcome this, they opted for a strategic approach called backward vertical integration. This involved acquiring all the supplying companies in the supply chain upwards. One benefit of this integration was the elimination of profit margins between the different elements in the supply chain. This was particularly advantageous considering the limited price regulations and competition in the underdeveloped markets of that time (source: W. Sharkey, The Theory of Natural Monopoly). However, market dynamics have since changed. The seller's markets have transformed into buyer's markets with increased competition and market transparency. In other words, market imperfections have reduced, thereby limiting the sales figures of each company.

The pursuit of new markets is essential for a change in corporate strategy, resembling the quest for new colonies witnessed in the early 19th century (source: www.marktwert.ch/downloads/marketing_ueberblick.pdf, p.4, translated from German; source: www.imf.org/external/np/exr/ib/2000/041200).

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htm). Therefore the former multinational and now transnational companies, being independent of where the headquarters are situated, operate now on many markets in terms of countries and products.They maintain subsidiaries or offices, respectively, in those markets to be able to react immediately to changes and to be close to the consumer in geographical terms and to attain a feeling for the consumers’ needs. In the last decades the needs of consumers have become much more diverse and

fast-changing as in the first half of the 20th century. The consumers’ needs are diverse even within the scope of one product, e. g. do many car manufactures offer a variety of several thousands of accoutrements of their cars.The companies are situated in an area of conflicts of quick adjustments to anticipated or already upcoming consumers’ demands and of being able to meet return on investment claims of the shareholders as owners of the companies.

Formerly multinational companies, now transnational companies, operate in multiple markets and maintain subsidiaries or offices in order to respond quickly to changes and be geographically close to consumers. Consumer needs have become more diverse over time, including within individual products like cars that may have thousands of different accessories. Companies face the challenge of quickly adapting to consumer demands while also meeting the expectations of shareholders for return on investment.

The emphasis on responsiveness in the supply chain and creating shareholder value has led to outsourcing becoming the preferred strategy. This is primarily because it reduces the need for investments, thereby enhancing shareholder value. However, companies may have ignored the potential benefits of their outdated strategies as they strive for growth and competitiveness. These obsolete strategies can actually lead to higher profits, increased freedom and competitiveness in different areas, and improved communication within the supply chain. In the following paragraphs, we will delve deeper into these opportunities. (Source: Christopher, Ch. 1; en.wikipedia.org/wiki/Shareholder_value)

Logical Problems and Sub-questions

The main logical problem that occurs is the apparent irrationality of many companies that practice outsourcing. This is because the forgone advantages seem to outweigh the gained advantages. Each of these advantages

can be further explored as sub-questions in section seven of our paper. One notable sub-question is the issue of collaboration quality within the supply chain. It is clear that in-house collaboration, even in today's multimedia age, should be more effective than B2B collaboration. This is because in-house collaboration promotes a shared corporate identity and working towards a common goal, which is often encouraged by management. However, in a globalized world where a significant portion of factories responsible for finished products are located in underdeveloped countries or countries with lax regulations (as seen in textile or shoe companies), it is natural to expect occasional quality issues. These quality issues can lead to out-of-stock problems, as examined by Christopher. Another important point to consider is that outsourcing often requires giving up profit margins, which conflicts with companies' main goal of profit maximization.

Every step that is outsourced requires the company to compensate with a profit margin that exceeds the costs of the product. The number of interferences or "touches" for modern digital products is even higher than in the time of vertical integration in the early 20th century, despite companies attempting to reduce them.

Our methodology for this study involved starting with a shared understanding of the current state of outsourcing, which has become dominant in corporate strategies, replacing vertical integration. This shift in strategy allowed companies to gain significant profit and market share, leading to some being forced to separate in the early 20th century due to antitrust laws like the Sherman Antitrust Act of 1890. We formed this perception from various sources such as newspapers, online news, lectures, and books from university courses we have taken,

particularly Logistics and SCM by Martin Christopher, which we will refer to throughout this paper when appropriate.

In section one, we introduced various issues and terms discussed in the Literature Review section four. These terms are supported by scholarly literature as well as reliable definitions from wikipedia.org, which mainly consist of excerpts from scholarly literature. Following that, we examined specific examples illustrating the main strategies of Vertical Integration and Outsourcing. Carnegie Steel serves as a model for vertical integration and vertical monopoly, while Nike is a successful example of outsourcing, particularly in underdeveloped Asian countries. This allows us to explore the issue of quality in subsection 7. It is worth noting that Nike has faced scrutiny and criticism regarding its strategic policy, providing references from other online presentations. To make it easier for readers, we thoroughly explain the strategies along with their respective advantages and disadvantages in relevant sections. In section eight, we conclude with future outlooks and discuss upcoming trends. To ensure academic credibility, we utilized online sources such as university pages like University of North Carolina and University of Zurich. This was especially important when discussing modern topics like outsourcing to avoid bias from bloggers. When discussing anything regarding Carnegie Steel Company, we made sure to incorporate scholarly literature and pages designed specifically for teachers in the United States.The research on this subject has been widely accepted in textbooks for about 90 years, so there is no need to rely on current sources.

Still, we compared the statistics between the pages to ensure that we are on the right track.

Literature Review

Literature concerning the terminology fast running train, which serves as a metaphor for a trend

resembling a train that may be missed and cannot be caught later. This term is commonly used in connection with an item or fashion that is only available for a limited time but is considered essential. Additionally, Vertical Integration pertains to the extent to which a company possesses its suppliers upstream and its buyers downstream, as previously mentioned.

According to en.wikipedia, backward vertical integration involves owning only the upstream suppliers. Outsourcing, a term that emerged in the 1980s, refers to delegating non-core operations from internal production to an external entity.

According to investorwords.com, a seller's market is when there are more buyers than sellers, resulting in high prices due to excess demand over supply. In contrast, a buyer's market, also known as a soft market, occurs when there are more sellers than buyers, leading to low prices due to excess supply over demand.

com. Natural Monopoly: There are two potential meanings associated with this term. The initial meaning is when a company possesses lower social costs in comparison to its competitors. The second meaning is when one company sustains long-term survival due to possessing a significantly larger market share than its competitors. This is also known as a technical monopoly.

According to W.Sharkey, multinational companies (MNC) are corporations or enterprises that operate in at least two countries. Among these MNCs, there is a specific group called transnational companies (TNC), which have independent headquarters and office locations, enabling them to conduct global operations. The concept of "transnationalism" was introduced by Randolph Bourne in the early 20th century.

Supply Chain Management (SCM) refers to the efficient process of meeting customer requirements through planning, implementing, and controlling supply chain operations. According to Wikipedia.org,

SCM involves the movement and storage of raw materials, work-in-process inventory, and finished goods from point-of-origin to point-of-consumption. The term was coined by Keith Oliver of Booz Allen Hamilton in 1982. Despite varying definitions, all interpretations share a common core concept.

Shareholder Value pertains to a company's objective of enhancing shareholder wealth through dividends or increased stock prices. This notion was introduced by Alfred Rappaport.

Sunk costs are expenses that have already been incurred and cannot be significantly recovered. Further information about this can be found on en.wikipedia.org.

Literature Concerning the Main Theories of Outsourcing and Vertical Integration and the Examples of Carnegie Steel Company and Nike
Literature Concerning Vertical Integration and Carnegie Steel Company
Extensive discussions regarding the Theory of Vertical Integration and its characteristics can be found on en.wikipedia.org.

The websites org and www.quickmba.com provide valuable information on strategic theories. The Carnegie Steel Company is widely regarded as an iconic example of achieving the American dream.

There are excellent online sources available that frequently present similar information, particularly regarding the extent of vertical integration and the specific processes owned by Carnegie Steel. These online sources primarily draw from scholarly works by Bridge, Morris, and Licht, each providing their own unique facts. We discovered these sources at www.evancarmichael.com and www.sparknotes.

com, www.spartacus.schoolnet.co.k, www.u-s-history.

We found the best information from websites such as wikipedia.org and the Swiss webpage www.com concerning the theory of outsourcing and Nike.

The advantages and disadvantages of the theory were elaborated by ifi.unizh.ch very well. The focus is currently on Nike, the most successful sports company with innovative products and advertisement campaigns. Nike also faces attention due to its high percentage of overseas production, attracting criticism and sparking discussion on web

pages. For presenting the bare facts of its business, the official web page is www.nike.

Several online presentations of the University of North Carolina, www.unc.edu, as well as the web pages www.enewsbuilder.net and www.

The website www.lclark.edu/~soan221/96/nike.html can be useful due to its statistical approach rather than providing biased opinions.

Vertical Integration

The Concept



Introduction into the Concept

Vertical integration refers to a style of ownership that determines the extent to which a firm possesses its upstream suppliers and downstream buyers (www. quickmba. com/strategy/vertical-integration). There are three types of vertical integration, including "Backward vertical integration," where the company establishes subsidiaries that manufacture various components of the final product, as exemplified by the Ford Company in the 1920s.

Vertical integration is a form of integration that involves moving up the supply chain. Forward vertical integration occurs when a company establishes subsidiaries to distribute or promote their products to customers. Balanced vertical integration occurs when a company establishes subsidiaries that both supply them with inputs and distribute their outputs (source: en.wikipedia.org). This concept was widely adopted by large companies in the first half of the 20th century because there were not enough companies available to provide real price competition for supplying parts to larger companies. It was more cost-effective and reliable to produce parts in-house, especially when companies required custom products that were not readily available in the market.

Advantages, Reasons, Goals

Vertical integration offers numerous advantages, which serve as the reasons for implementing it as an ownership style.

The company can capture profit margins along the supply chain by owning the individual steps, which only charge the costs

of the unit to the next step. This improves cooperation and collaboration among the steps in the supply chain. While communication may not be significantly limited due to modern forms of communication, employee motivation and corporate identity play a role. Cooperation with other companies can also be time and cost intensive. The company's experience with certain work-steps remains in-house, unlike outsourced divisions, which extends the company's core competencies.

The expertise and results gained by the individual subsidiaries in the supply chain are valuable assets for the company. One advantage that should be noted is the exclusive access to a limited resource, which serves as a barrier for competitors. For instance, if the company owns the only lake in the region with sturgeon for caviar production, competitors would either have to pay a high fee to fish in that lake or be unable to enter the market. Additionally, establishing downstream distributors can provide access to distribution channels that are typically unavailable. The company's control over different steps in the supply chain increases its power. As an example, it can acquire a specialized and costly asset that benefits multiple subsidiaries and the company as a whole.

One option that could be considered is acquiring a large building at a price significantly below market value. This building would have more capacity than what is needed for the marketing division alone, but it would be suitable for two divisions. However, it would not be feasible to partner with an external party to acquire this building due to their lack of financial resources or uncertainty about finding tenants or lessees (source: www.quickmba.com/strategy/vertical-integration).

Disadvantages and Deficiencies

Like any system that offers benefits, vertical integration also

has its own shortcomings and therefore disadvantages.

One major drawback of the company is its inflexibility. Without significant expenditures, the company cannot promptly adapt to market fluctuations. For instance, if a car manufacturer that previously focused on producing limousines decides to enter the SUV market, it will have to make expensive initial investments in new machinery or possibly even entire factories. These investments are fixed costs that are economically justifiable or logical only if the company intends to stay in that market for an extended period.

An example is the attempt of Dell Computers in 1990 to give up direct delivery to the customer in favor of selling through distributors (Christopher, Ch. 1). Dell had to abandon that strategy after several periods with a negative net income since the strategy did not fit the company. If it had bought all the stores and equipped them, those costs would have been sunk costs. Those costs would not occur if the specific work is outsourced to an external company. It is also more difficult to increase the product variety because the development of new products must happen in-house, but today especially small companies (e.g.

In computer programming and mobile phone applications, external companies like Digital Online Media are often hired by Deutsche Telekom to provide expertise and support. However, outsourcing can be disadvantageous in uncertain markets where future demand is unpredictable. In such cases, it becomes necessary to build up buffers to meet unexpected surges in demand. This can result in excess divisions within the supply chain. Additionally, the demand for certain pre-products may decrease over time, leading to a decrease in staff members needed. Furthermore, the costs of

in-house divisions may increase due to a lack of competition and price wars. (Source: www.dom.de)

quickmba.com/strategy/vertical-integration). The costs in terms of bureaucracy and financial resources increase with vertical integration, leading to the need for more subdivisions within the company. The example of the Carnegie Steel Company, which later became the world's largest steel company (www.evancarmichael.com), illustrates the clarity and success of vertical integration.

Andrew Carnegie founded it in the mid-1870s in Braddock, Pennsylvania. As one of the “captains of industry”, Carnegie was the richest man in the world at the turn of the century. He initiated the company by opening a steel furnace in Braddock and proceeded to acquire every single step in the supply chain.

Coal mines supply coal, an ingredient in steel production. Ore mines supply iron, another ingredient. Railroads transport these ingredients to the furnaces. The Pittsburgh Locomotive and Car Works Company provides trains and cars for the facilities. Coke ovens are used to cook the coal. This vertical monopoly includes all the necessary facilities for steel production.

(source: en.wikipedia.org/wiki/Vertical_integration, www.evancarmichael.com)

The website u-s-history.com/pages/h981.html states that the individual made efforts to decrease profit margins throughout the supply chain by bypassing intermediaries and selling the completed products directly to customers. Additionally, this information can be found at www.u-s-history.com.

David Carnegie was a modern businessman who used various strategies to promote his interests. He owned 18 newspaper companies, demonstrating a modern approach to influencing public image-building (www.vancarmichael.com/pages/h981.html). The strategic approach of the Carnegie Steel Company was extremely successful. For example, between 1889 and 1899, the company significantly increased its annual steel production from 332,111 to 2,663,412 tons, improved net profits from $2 million to $40 million, and gained a

25 percent stake in the market (www).

According to spartacus.schoolnet.co.uk/USAcarnegie.htm, Carnegie achieved great success not only in terms of economic figures but also by promoting competition among workers and allowing them to have a share in the company's profits. This approach resulted in improved efficiency and productivity. However, in today's companies that do not own all steps in the supply chain, replicating this process may prove to be impossible (www.evancarmichael).

com).

Outsourcing - The Concept

Introduction into the Concept Definition of Outsourcing

Outsourcing is the delegation of company functions and structures to third-parties, possibly to a provider abroad.It’s the reduction of vertical range or integration of manufacture and concentration on the core business. Thus outsourcing is a special form of external procurement of so far internal adducted activity, where the duration as well as the purpose of the service is contractually fixed (de. wikipedia. org- translated).

According to the English Wikipedia, outsourcing is defined as "the delegation of non-core operations from internal production to an external entity." This trend is particularly prominent among large companies. Outsourcing has been a common practice for many years, with various aspects of a company being outsourced. Typically, logistics and production are frequently outsourced.

Not only manufacturing companies but also service providers engage in outsourcing. These companies are sometimes referred to as "virtual" companies. The rationale behind outsourcing is that companies thrive when they focus on activities where they possess a competitive edge over their rivals (Christopher, Ch., p. 236).

According to "Do what you can do best – outsource the rest" (de.wikipedia.org), a new strategic slogan, each company must determine its core competencies and assess if outsourcing is beneficial. This assessment includes considering cost reduction, gaining additional

capacities, and strengthening existing capabilities.

The re-cancellation of outsourcing is referred to as "insourcing," which involves bringing back parts or processes that were previously outsourced by an organization.

Advantages, Reasons, Goals

The reasons for outsourcing are varied and numerous. One of the most frequently mentioned and significant reasons is the focus on an organization's core competencies. When a company outsources parts of its operations that are not its core strengths, the money saved can be reinvested in the core business, allowing for a greater concentration on competitive advantage and tasks relevant to the business.

The text highlights the advantages of outsourcing, particularly in terms of flexibility and cost reduction. In terms of flexibility, outsourcing allows for better capacity planning. If there is high demand, the burden of providing the necessary amount of products lies with the partner companies. On the other hand, if demand decreases, firms can cancel contracts. This increased transparency in planning leads to more efficient operations. From a cost perspective, outsourcing allows firms to benefit from the economies of scale offered by the outsourcing provider. This means that fixed costs can be transformed into variable costs, which leads to a decrease in working capital and an increase in free cash flows. As a result, profitability and shareholder value can be higher, especially if there is a plan to sell the business. Additionally, outsourcing makes it easier to plan and manage costs due to increased transparency.

Companies that outsource benefit from improved access to specialized knowledge and a potential increase in innovation. Additionally, they can leverage modern technology without the need for their own investments. By outsourcing, companies can reduce the

risks associated with technology development as the outsourcing provider assumes full responsibility.

(Source: http://www.ifi)

unizh. ch/ikm/Vorlesungen /IM3/WS0203/IM3_files/4-outsourcing. pdf).

Disadvantages and Deficiencies

However, there are also some risks and disadvantages concerning outsourcing. We want to further examine those now. One of the biggest points of consideration is the fact that the network of suppliers and partners has to be managed and controlled. A big drawback if an organization sources a part of it out is that it loses a competence completely; and if the outsourcing turns out to have negative impacts the regaining of know-how is immensely difficult - a fully outsourcing decision is hard to reconstruct after a few years.

Another major disadvantage or risk is the reliance on the outsourcing provider. Typically, there is a long-term contract (typically between 3 to 10 years) that provides security to the partner but limits flexibility in cancelling. The geographic distance or reduced contact with the outsourcing provider also poses challenges to collaboration. Additionally, companies should consider the high initial cost of negotiating or restructuring contracts. There will also be communication and coordination costs (transaction costs). Transparency can be affected as the prices organizations must pay to the outsourcing provider may not always be predictable. The outsourcing provider may hold a monopoly, and other competitors may also strive to be the preferred partner. Ultimately, it could end up costing more to obtain products or services from the outsourcing partner.

One critical concern is the potential release of confidential information. Even if an outsourcing partner has been reliable for many years, there is a possibility that they may suddenly decide to support a competitor and share knowledge gained from their partnership with the original company.

It is important to note that there is no guaranteed security measure for maintaining the confidentiality of data (http://www.ifi.unizh.ch/ikm/Vorlesungen/IM3/WS0203/IM3_files/4-outsourcing).

pdf).

The Example of Nike

As stated by Dominique Roux, a renowned economist, "Nike is a highly successful pioneer in the field of outsourcing" (cio. de). Nike, the largest sportswear manufacturer, was established in 1973 by Bill Bowerman and Phil Knight and has maintained its headquarters in Beaverton, Oregon, USA.

Nike manages its global virtual company and employs around 26,000 individuals worldwide. However, Nike products are manufactured by approximately 650,000 people in contracted factories that are not owned by Nike. Nike sources products from 137 factories in America, 104 in EMEA, 252 in North Asia, and 238 in South Asia (nike.com).

The largest portions of its operating costs remain within the U.S. for product design, marketing, and research.