Thursday, November 12, 2009

Vertical Integration at Samsung

The Wall Street Journal has a good article today about Samsung's vertical integration strategy. By vertical integration, I mean that Samsung produces consumer electronics items, as well as many components that go into such products.

Vertical integration, of course, does pose some risks. Let's identify three key risks. First, the firm finds itself competing with its customers and/or suppliers. The article states that, "About one-third of Samsung's revenue comes from companies that compete with it in producing the TVs, cellphones, computers, printers and cameras where it gets the rest of its money." Second, vertical integration can create dulled incentives. In other words, if you produce your own components, then a high level of "guaranteed internally generated revenue" may cause the component production unit to be less efficient than it should be. Finally, vertical integration can lead to wasted time and effort associated with internal transfer price battles.

The article suggests that Samsung does face some challenges associated with competing with key customers. However, it also suggests that Samsung mitigates all three of these risks by forcing each of its businesses to clearly demonstrate that it can compete successfully in the external market. Internal and external competition seems to be key to Samsung's culture and strategy. According to the article: "People look at our businesses and see vertical integration. It really isn't," says David Steel, a Samsung senior vice president and marketing strategist. "It's a portfolio of component businesses and consumer-product businesses and, within that, we don't compromise on the idea that each business is charged with its own success." Of course, it is vertical integration, but what Mr. Steel is saying is that they treat each business as a stand-alone entity that must show it can compete effectively... no guarantees that a component production unit will be able to operate at capacity simply because the company could use all those components in finished products. The components unit must prove it's doing a better job than external players that could be suppliers to the finished product divisions at Samsung.

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