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December 02, 2011

Virtual or Vertical Integration

By Dr. Alan Solheim, VP of Marketing and Business Development, DragonWave Development , DragonWave Inc.

As the ancient Chinese proverb says “we live in interesting times”. European debt crises, global competition, high unemployment rates in the West, hyper growth in Asia – all lead to instability and uncertainty. At the same time, technology evolution and consumer appetite for mobile data seem to continue unabated. How does one deal with the conflicting imperatives to improve cost effectiveness of an organization while simultaneously continuing to invest for the future?

The traditional corporate structure of vertical integration has long since been dissolved on the manufacturing side, with even the largest of global companies employing third party contract manufacturers to do purchasing, assembly, testing, logistics and maintenance and repair. No one today considers this type of outsourcing strategy to be a detriment to the delivery capability or competitiveness of a company. 

However, this was not always the case. When contract manufacturers initial came on the scene there was quite a lot of debate on the merits and cost effectiveness of moving such a core activity as manufacturing outside the control of the “mothership”. These concerns largely went away because it became obvious that the contract manufacturers could be more efficient by leveraging the required investment across multiple product families, and by focusing on doing one thing very well.

In a very similar fashion, as the demands for even greater internal investments continue to mount and the profit margins continue to be challenged by global competition, we are starting to see companies making hard decisions about what they do internally and what they will use third parties to achieve. The logic is clear – if the third party can leverage the investment over several product families they can be more efficient, and can deliver faster and better innovation by focusing on doing one thing very well.

The challenge is for a company to continue to provide a coherent and differentiated product offering when they do not control all the aspects of the key elements. The inability to answer this challenge has left most companies only moving inconsequential or low value-added pieces of the puzzle to the more efficient outsourcing model. When companies have tried to move more substantial pieces of their product offering outside, they face stiff questions from customers and industry analysts alike about their commitment to a particular product space and product family.

The answer to the challenge lies in doing more than a simple outsourcing. Unlike contract manufacturing which has very little interaction with other aspects of the end-to-end customer offering, Research and Development play a key role in both the actual and the perceived value proposition of any company’s future plans. In order to effectively take advantage of the efficiencies of the outsourcing model for R&D there must be a virtual integration (rather than a vertical integration) of the outsourced R&D team, where both companies participate not only on a supply arrangement, but also a technology partnership.

When an R&D organization is vertically integrated into a company there is an opportunity for a cross fertilization of ideas between product lines, as well as an alignment of features and capabilities across product lines. This helps to ensure a smoothly functioning end-to-end product offering, and the ability to develop features that interact between products in such a way as to provide differentiation and added customer value when compared to integration of independent products. When an R&D team is outsourced it is essential to be more deliberate about fostering these interactions that largely happened automatically inside a vertical organization.

When done well, this will result in a virtual organization that can deliver the efficiency benefits of outsourcing without sacrificing the innovation and end-to-end integrity of the customer offering. In fact, the ability to leverage a larger pool of R&D resources that are exposed to ideas and influences outside the vertical integration should lead to faster innovation and the development of better products overall.

Changing times require changing organizations and approaches. The way we develop and build products today is certainly different than it was 25 years ago, and it will be different in the future, as well. With the advent of seamless global communication, visualization techniques and computer modeling, the ability to integrate teams from around the world and across corporate boundaries has become not only possible, but also mandatory. The vertical organization cannot compete with the virtual organization. Moving to a virtual model will allow companies to stay innovative and provide a future-proof, cost-effective business model.

Dr. Alan Solheim, Vice President of Product Management at DragonWave, is author of TMCnet�s The Middle Mile column. To read more of Alan’s articles, please visit his columnist page.

Edited by Jennifer Russell
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