Evolution of Supply Chain Design: horizontal and vertical Supply Chain evolution
We’ve discussed in our latest article how the nature of the product can significantly influence the design of the entire Supply Chain Design and change its overall purposes. The main influence of this kind of evolution was the customer response. We’ve studied also its impact on the demand, decision making, etc…
https://medium.com/y-insights/evolution-of-scd-based-on-the-nature-of-the-product-daa5d47bae47
In this part, we’re going to discuss another type of evolution of SCD that doesn’t only influence the decision-making of a giving company, but it influences the entire architecture of the SCD and all the related companies starting from sourcing down-streaming into the customer service.
Defining a Vertical and a Horizontal/Modular SCD:
We refer to a horizontal Supply Chain Design policy as when a company takes charge in one or some elements of the Supply Chain while it externalizes the other operations to be held by different companies or parties. And so, a company can be charged with the manufacturing process while it collaborates with other parties for raw material sourcing and logistics.
On the other hand, a vertical SCD is when a company takes full charge of the creation of the product/service starting from sourcing all the way to serving the final customer.
As a matter of fact, it’s becoming infrequent overtime to witness a company that has a fully vertical SCD especially in highly competitive industries such as the automobile or the IT sector. Still, many companies try to integrate vertically in their SCD as that offers them better control of the pricing and the overall SC.
The Shift from Vertical SC into a horizontal/modular SC and vise versa:
The switch from a Vertical policy into a Horizontal/modular policy:
We define SCD evolution from vertical to horizontal as the change that occurs when an industry that is used to be held by few numbers of ‘big’ players that control the entire or the most of the SC of a given industry evolve into a horizontal/modular policy.
In other words, the company externalizes some of its functions ( logistics, sourcing) instead of keeping in charge of them internally. Such decisions have a great impact in the overall industry as it creates new opportunities for the rise and the development of small companies that take in charge of these functions.
Causes of the switch from a Vertical policy into a Horizontal/modular policy:
We can divide the causes into two interconnected categories, internal causes, and external causes.
Concerning internal causes, one of the most common reasons for making such a decision is reducing the complexity of the SC. SC complexity is considered one of the biggest factors that are related to higher SC costs. Saying so, the easiest way to reduce complexity and so the costs is to externalize.
On the other side, one of the widely known external causes is that several industries tend to evolve at a higher rate ( clock-speed industries ) and so firms find themselves unable to take fully in charge of the SC while staying competitive. And so they externalize some functions to focus more on their competitiveness.
Other causes that are both classified as internal and external can be:
- The relentless entry of niche competitors hoping to pick off discrete industry segments.
- The bureaucratic and organizational rigidities often settle upon large, established companies.
Consequences of the switch:
Although the switch from vertical to horizontal seems to be a cost-effective method and an effective policy to reduce the complexity within the SC of the product, such a decision can unleash a dramatic change in the entire architecture of the industry and can determine the fates of companies and profits and power. A great example of this is what is known in the SC literature by ‘intel inside phenomenon’. ‘In the late 1970s, IBM faced a challenge from upstart Apple Computer. IBM’s competitive response, the PC, catalyzed a dramatic change throughout the industry, which quickly moved from a vertical to a horizontal structure. To keep costs low and increase speed to market, IBM chose a modular product design with a modular supply chain design, built around major components furnished by two virtually unknown companies: Intel and Microsoft. Still a powerful, profitable, and influential company by the standards of the computer industry, IBM had nonetheless been far outdistanced by its two hand-picked suppliers, who had taken the lion’s share of the profits and industry clout that flowed from IBM’s standard-setting product. IBM’s suppliers also won the allegiance of millions of customers who came to care far more about the supplier’s logo — “Intel Inside” or “Windows 95” — than about the brand name of the company that assembled the components and shipped the final product. The power in the chain had shifted, as had the financial rewards.’
Saying so, we have to highlight that making such a decision should be deeply studied and be considered as a defining strategic decision rather than just a lowering cost policy.
The switch from a Horizontal/modular policy into a Vertical policy:
As we’ve discussed earlier, turning your SC policy from a horizontal-focused one to a vertical one appears to be an unusual decision to make. Still, in many scenarios we observe companies try to integrate vertically their SC. We can give the example of Microsoft where it started as a software company particularly in operational systems, nowadays we see Microsoft taking a considerable market share in multiple software services as well as integrating the hardware market. However, making such a decision like what Microsoft did is not available for every company. The firm needs to be at least big enough to handle the fund of this kind of investment and to be already dominant in its current activity in terms of its market share and its popularity.
A steady and complete study is always needed before stepping into a vertical integration unlike the switch to a horizontal policy that can be seen as a direct lowering cost and complexity decision.
SC stability vs SC sustainability:
We refer to a Stable SC as a predictable and reliable Supply Chain where all the interactions between the SC component are well defined.
For Supply Chain sustainability, on many occasions, is defined as the way the SC interacts with the environment and the safety of its employees. In our context, we interpret sustainable SC as the ability of the SC to be endurable to the changes that occur internally and externally and the capacity to be adaptable to different stages and conditions. We can consider SC sustainability as a broader term of SC agility.
We’ve discussed in our first insight (SCD: A deeper understanding) that SCD is the result of a process that is shaped by three major dimensions that have a hierarchical relationship: influencers, design decisions, and building blocks. In other words, qualifying a Stable SCD or a Sustainable SCD is related to how the company interacts and considers these factors. SC stability is about how the company handles its building blocks (inventory, transportation, etc) whereas SC sustainability is more how the company handle its influences and design decision.
https://medium.com/y-insights/a-deeper-understanding-of-scd-ffa8438dcfdf
Generally, SC is not expected to be stable in the long run. Instead, as we saw earlier, supply chain structures are expected to cycle between integral/vertical and horizontal/modular forms. The reason behind this is the dynamic aspect of the SC. Charles H. Fine introduced in his work “the second law of supply chain dynamics.” This hypothesis states that the industry clock-speed a company faces increases the farther down-stream it is located in the supply chain. As a consequence of this hypothesis, when a company far upstream experience an enhance in technology or the overall service, this creates a rapid change of the entire SC and so all the down-companies face them also changes and evolution. This can let companies externalize some of their functions to benefit from this new technology and to enhance their product attractiveness and so staying competitive in the market. On the other side, this can encourage companies from upstream to integrate new businesses and so increasing their portfolio as long as their market share is growing. Therefore, companies should give permanent attention to sustainability and prioritize it rather than working solely on stability as this case only induces the company’s vision to be myopic and unable to adapt itself to the dynamism of the SC.
Conclusion:
SC is naturally complex, multi-dimensional, and sensible. Working in such conditions makes the smallest decisions suspectable to stimulate radical challenges and opportunities. All things considered, SCD evolution between a vertical policy and a horizontal one is a great example of this sensibility.
Resources:
- Charles H. Fine, Clockspeed-based Strategies for Supply Chain Design1 published in Production and Operations Management, Vol. 9, №3, Fall 2000, pp. 213–221.
