Outsourcing Isn't Just for Christmas


Wall Street Journal

LIAM DENNING

Another Christmas, another triumph for the world’s foremost exponent of vertical integration.

Imagine if Santa Claus outsourced instead. Pinkerton might be hired to keep tabs on how well children behaved. Toys would no doubt be churned out in Chinese factories rather than Polar workshops. Santa could stay home and brainstorm with his elves on brand management, while UPS did the sleighing.

A decade ago, when champions of disintegrated supply chains like Dell were riding high, Santa may have felt under pressure to fit in with the zeitgeist. Consultants had spent years persuading clients to focus on “core competencies” and to outsource everything else.

But vertical integration can sometimes make sense, and it has demonstrated something of a comeback. Luxury watch-maker Rolex, for example, operates its own foundry for precious metals, helping it refine alloys—and allowing it to boast in advertisements that it goes the extra mile. Apple has bought into several chip-makers. This year, Boeing bought a parts supplier to help get a grip on its Dreamliner project, itself a grand experiment in outsourced production. And PepsiCo is buying its two biggest bottlers to increase control over its soft-drink business and increase efficiency.

Yet these are discrete re-linkages, fulfilling specific needs or fixing specific problems. None represents a return to vertical integration à la Henry Ford, whose Ford Motor owned iron-ore mines outright to ensure metal supplies for making cars. Unfortunately, however, that old-school sort of vertical integration has also made a comeback this decade. China, for example, is buying up mineral rights globally, reflecting both fears of supply shortages and a perception industry consolidation has created oligopolies for some raw materials. Steelmaker ArcelorMittal has also been buying up mines.

Overall, outsourcing is more than a management fad. It fosters rational allocation of capital and growing global trade. That is certainly preferable to vertical integration driven by fear of supply shortages. This not only feeds on itself, as more supplies get “locked up,” but leads to inefficiencies as the competitive dynamic is removed from the supplier-customer relationship.

Quite apart from persistent rumors he is a myth, it’s worth remembering Santa’s vertically integrated venture is not in the business of making profits.

Write to Liam Denning at liam.denning@wsj.com

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