Why is vertical integration disrupting vehicle manufacturing?
Firstly, it is simply owning as many aspects of production as possible, from raw materials to final assembly. This is quite opposite to the theories by Adam Smith on specialization & division of labour for individuals, companies & countries. This system was further refined by the Japanese to the Just In Time system. Not only was most of the non core work outsourced, the inventory was kept very lean by having the outsourced inputs arriving at the factory just before they are needed. Toyota became the largest profitable OEM.
However vertical integration has flipped this script. BYD and Tesla for example, own the majority of their input supply chains, rather than outsourcing them. BYD has become the symbol of vertical integration after launching a second ship this year to exclusively export its production units around the world. The ship will reportedly be one of at least eight vessels that the carmaker aims to own or charter within the next two years.
How did the success formula for yesteryears become the stumbling block of the current world?
Well, here are some reasons why vertical integration has become the new secret sauce in vehicle manufacturing;
1. Product life cycles are now shorter – while ICEVs could stay in the market for 10 years without a model change, a 3 yr old EV model is considered old given the rapid pace of change in the industry. The pace of change means production has to have high flexibility, which is limited when you have 100 different vendors.
2. Vehicle parts are fewer – the over 3,000 parts in an ICE passenger car are a far cry from the far less components in an EV, which for example has only about 30 moving parts. Therefore the need for skill & equipment specialization are much less.
3.Safety requirements are higher – given the high voltage and thermal runaway risks in EVs, the quality control aspect is preferably done in house to maintain a closed loop.
4. Less exposure to shocks – when there are fewer or no third parties than can change tone overnight due to a myriad of reasons, internal subsidiaries are unlikely to bring such shocks during production especially in this VUCA world.
5. No middle men – probably the biggest benefit is the removal of middle men who all add their margin to the vehicle cost. This makes the end products much better priced compared to just by virtue of the business model.
However for vertical integration to make business sense, two things have to be in place;
1. The OEM has to have adequate capital to invest in all the diverse but related areas of production.
2. The OEM has to have adequate volumes to enjoy the economies of scale.
If it is so simple, why are the legacy OEMs like Ford, VW & Toyota not doing it to reclaim their shrinking market shares? Well, that discussion needs to join the list of stories for another day.
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VERTICAL INTEGRATION
