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Business - Written by on Tuesday, December 15, 2009 11:53 - 0 Comments

Nick Vitalari
Going Vertical: The New Reality of Vertical Integration in the Era of Business Platforms and Ecosystems

A recent article in the Wall Street Journal by Ben Worthen, Cari Tuna and Justin Scheck pointed out a resurgence of vertical integration as a company strategy as seen with Oracle’s recent acquisition of Sun Microsystems, HP’s pending acquisition of 3Com, and Apple’s acquisition of chip maker, P.A. Semi last year. These acquisitions provide these companies with more control over core features and assets in their business models and position them to rely less on others for essential product and service components. Such schemes also intend to protect proprietary advantage, avoid “leakage” of plans, patents, and various flavors of their secret sauce, and add distinctive and differentiated features to their products. Of course such vertical integration plays create new options for product extensions, new service offerings and in some cases afford entry into new markets. But at a deeper level there’s more to this story. This is not your grand-father’s or great grand-father’s brand of “going vertical.”

Vertical integration was popular in the latter part of the 19th century and the first half of the 20th century as a means to assure consistent and predictable supply chains for large-scale enterprises. Andrew Carnegie coined the term in the late 1800s to describe the structure of his company, U.S. Steel, which owned virtually their entire supply and distribution chain — the inputs to production (ore and coal mines), the means of production (steel mills) and the means of product distribution (steamship and railroad lines) – ergo a completely vertically integrated company.

Vertical integration was one of the key inventions used by industrialists to manage the proliferation of transaction costs involved in the orchestration of a scale enterprise. Industrialists at the time did not have the Internet nor did they have well-developed global financial markets or global supply chains. As a consequence these early large producers had to create their own infrastructure and transaction cost deflators through vertical integration. Otherwise the coordination, collaboration, and transaction costs would have overwhelmed their enterprises. As the industrial economy developed, other industries followed suit with other vertically integrated firms in the petroleum, automotive, and newspaper / communications industries. However, as economies matured and suppliers and supply chains became more reliable, the model was largely abandoned in favor of a more distributed model with specialized firms serving segments of the supply chain and many vertically integrated companies divested.

All of that is history: today is different. While vertical integration may be on the rise, entrepreneurs and executives operate with many more tools in their strategic arsenal. Let’s look at two tools that help shed light on the new approach to “going vertical:” the Internet and collaborative business platforms.

  1. The Internet. The Internet is now a euphemism for the reality of a highly-interconnected always-on business environment. More to the point, this highly connected world has radically reduced collaboration and transaction costs. When vertical integration is applied in this context, the purchase of an element of the value chain is not used to corner the market or reduce transaction costs, but rather but rather to solidify the company’s position relative to the business ecosystem. So for example, the acquisition of Sun by Oracle, enables Oracle to embed its software in a hardware platform, similar to the iPhone or to the Google Nexus One, that in turn provides more options to work with others and build growth through an interconnected ecosystem (for commentary on the pending handset war between Google and Apple, see Laura Carrillo’s post). With the hardware, Oracle has the potential to involve more partners and grow the business beyond the bounds of a software provider. Consider also that Oracle can also entice other developers to create add-ons (apps) for the Oracle tool. One other benefit: Oracle potentially opens new markets with smaller companies that desire industrial strength databases.
  2. Collaborative Business Platforms. In a prior post, I noted an emerging “best practice combination” of a collaborative business platform + a business ecosystem. Google needed to remove itself from Apple’s Board and create their own handset and move into head-to-head competition with Apple, RIM and Nokia. Google has the world’s most powerful and extensible collaborative platform with 100′s of millions of users. But, without a handset (i.e. a mobile device) it cannot differentiate itself nor assure its place in the increasingly mobile marketplace. This inability to garner sustained loyalty of its customers was a key threat to Google’s ecosystem. Without a branded mobile device, Google is just another “app provider.” This vertical integration play allows Google to instantiate its brand in a physical mobile device. Why is this better than instantiating its brand in an iPhone or a Blackberry? Because, the device enables Google to offer a more extensive set of apps and offer functionality that is critically dependent on firmware integration. It also creates new options for Google, who has been largely dependent on the hardware manufactures for it innovation model. Now the Google innovation maven can drive innovation in hardware and firmware.

So the new form of “going vertical” is a merged strategy that will operate in concert with collaborative business platforms and robust business ecosystems. In the case of Oracle, Apple and Google, the addition of hardware assets to their respective business portfolios increases their competitive options, extends their brand, provide a closer connection with their customers, provides a new “sandbox” for innovation, and offers new ways for partners to contribute to their business ecosystems. In the new style of vertical integration, the goal is not to go it alone, but rather to set up the game, so that more partners can participate in the supply chain thereby enhancing Oracle’s, Apple’s and Google’s prognosis for growth.

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