What is vertical integration?

I don’t know how many people know what vertical integration means but it’s important you do for my next entry. I get so annoyed with myself when I get stalled on an entry and have to back track to write a pre-entry.

Loosely defined, vertical integration describes a business that owns its whole chain, from supply to sales. Let’s say you made cornflakes. A vertically integrated cornflake manufacturer would own corn farms, corn silos, corn processing plants and in a perfect world, stores that sell corn based products. Since there’s little sense to dedicated corn based product stores, that last leg is pretty much off the table except for buying coveted slots on grocery store shelves in the cereal aisle. They do that by the way.

In apparel, a vertical manufacturer is one who produces and sells their own stuff. Companies like GAP, Victoria’s Secret, Old Navy, Zara etc are all vertical operations. In a perfect world, vertical integration is considered ideal because it reduces your operating costs. If you don’t have to buy corn from a farmer because you’re producing corn on land you own or lease, your supply costs are lower. Theoretically. Much to my dismay, the term “produce” has been wildly re-interpreted.

The definitions of vertical integration get looser all the time. Some people are vertically integrated but they don’t technically produce it themselves. They buy contracts, much as you do when you hire a sewing contractor. They do not own the enterprise that sews the production. Now sure, they’re running large quantities so they get lower costs with respect to economies of scale and it’s all made to their specs but they have a lot of transaction costs they wouldn’t have if they owned and operated these plants outright. The whole reason one seeks vertical integration is to avoid transaction costs so while these companies may technically be vertically integrated because they sell it, they aren’t necessarily the sanest model for a company concerned about lowering costs through a sustainable supply chain.

A lot of firms claim to be vertically integrated, having stuff made by contract to their specs with time lines stretching from 12 to 16 months in advance of retail sale. There’s a lot of costs in there. I could see these time lines as tenable if one were growing their own corn because corn is a stable commodity tied to earth cycles. Fashion is not stable but trendy. If you try to produce fashion like you would a commodity like corn, that’s exactly what fashion will be, a commodity. Meaning, few people want to pay a premium for stuff you designed two years ago according to suggestions from spendy trend forecasting services.

It used to be that everyone produced their own stuff in house. That allows for a lot of flexibility. Then with outsourcing, it got cheaper to do it overseas so it didn’t make sense to do it all and worry about plant operation, payroll and sewing line fiefdoms. But you know, things are coming full circle. Transaction costs were lower because there was less complexity. When things get complex, we give up freedom of choice (read: settling for a commodity) in exchange for the lowest cost of our time. To reduce the cognitive overload of complexity, we settle for that which is less risky. Now if you only care about becoming the next GAP, have at it. But if not, do read this entry on how the industry has changed forever. C’mon. I know most of you glossed over the earlier hyperlink.

By the way, Zara is the one exception to the list of vertical manufacturers I mentioned because Zara is not a push manufacturer (a whole other host of problems). They are truly mostly vertical. But, that’s due to how sales are driven internally. Totally unlike the other mega corps in their category. GAP et al (sorry to continually single them out, I have no beef with them) design their product lines 12-18 months in advance of delivery, determine how much to make of each style, produce it (via contract) and then have it delivered to stores for sale. Zara doesn’t do that. No no. Zara produces prototypes which are presented to store managers electronically (twice weekly). Each store manager has the autonomy to select whichever styles they want. If a style doesn’t get many takers, Zara doesn’t cut it, meaning less likelihood of markdowns. Most styles are produced in lot sizes of 300-500 units. There is no reordering. Once it’s gone, it’s gone. There is no central office shipping identical products to all the Zara stores. In this way, Zara stores act independently. Most importantly, the company produces very quickly, in three weeks or less from sketch to delivery. That’s the vertical integration model you should aspire to meet.

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