International Supply Chain Management: Luxury Sector Goes Vertical - Essay Example

International Supply Chain Management: Luxury Sector Goes Vertical Vertical integration pertains to a host of activities and decisions undertaken by large corporations whether they should provide goods and services in-house or purchase them from outsiders. In other words, it is a function of bringing different business activities in a supply chain under the management of a single company (Guan & Rehme, 2012). In order to grow and sometimes, even to survive, companies may have to make these decisions to enhance the efficiency of their supply chains. The forces driving vertical integration could arise from transaction cost considerations, strategic considerations, price advantages and uncertainties in costs or prices. The traditional framework for vertical integration was a response to technological and operational interdependencies but many firms such as in the luxury sector now follow the transactional framework which states that an integrated firm will perform better than its competitors that are not integrated. The supply chain in the luxury sector has undergone tremendous changes, obviously in the interest of the luxury companies. Manufacturers in other sectors have been contracting out the supply of component parts but the luxury sector is moving in the opposite direction (Brooke, 2014). The luxury companies have been acquiring the companies that provide them with accessories and parts as they would like to secure their supplies. For instance, luxury watch companies acquire smaller companies producing sophisticated cases for high-end complicated watches. Thus the luxury companies either own or have a significant financial interest in their suppliers. They own every stage of the process from raw materials to retail, to the extent that they have started buying their retail and distribution partners as well. An effective supply chain strategy is essential for luxury companies because the supply chain strategy could impact the critical success factors of luxury companies, which supports them in achieving competitive advantage (Brun & Moretto, 2014). Some of the critical success factors in luxury companies include high level of quality, heritage of craftsmanship, emotional appeal, exclusivity, and brand association. Apart from avoiding risks and securing supplies (Brooke, 2014), vertical integration increases rivals’ costs or leave the market thin, which restricts the expansion of competitors (Guan & Rehme, 2012). Vertical integration is also a strategic response to monopoly market power. Within the luxury sector several factors impact the supply chain strategy. The company size, selling volume, product complexity, product fashionableness and brand reputation define the supply chain configurations (Caniato et al, 2011). The luxury sector demands high standards to be maintained throughout the supply chain from production to distribution and to retail sales. Besides, the luxury sector is not homogenous and is not regulated either as the consumer electronics and automotive sector are. Within the luxury sector also differences exist in managing their supply chains as in the case of Zara versus The Gap. Driving down costs is not a motivation but this gives the luxury companies control over their supply chain while also helping them uphold ethical standards and their corporate social responsibility goals as in the case of acquisition of jeweler Harry Winston by Swatch group (Brooke, 2014). Sometimes it may be necessary to commit capital to receive regular and assured supply particularly in luxury items such as diamonds. Luxury chains also consider investing in their suppliers as an investment to protect the traditional crafts. This strategy also protects small industries based on traditional skills and large groups are happy to support and promote. Another major advantage that the luxury companies are deriving through such integration and acquisition is that they are able to promote the craft element of their products by putting their artisans on display. Customers can observe the watch makers working or see watches being made or repaired. While these are the advantages that the large companies enjoy, the smaller companies and the artisans are subject to several disadvantages. These niche manufacturers are restricted from producing for or supplying to anyone else in the category. Even if the niche manufacturer stands to gain in the short run because of regular orders, the future of the skill as well as the entire sector is not secure relying on one single buyer (Brooke, 2014). Such companies are unable to attract talent as the focus is on producing for one large company. It has been argued that to avoid such conflicts a group of companies could share ownership of an artisan supplier. Thus a group of companies could jointly invest in smaller firms which would make business sense, apart from fulfilling their CSR, which is an increasingly important consideration for the luxury sector (Brooke, 2014). Supply chain strategies in high volume sectors such as consumer electronics, automotive, and the fast moving consumer goods (FMCG) differ in several ways. The modern supply chain in several industries such as electronics, apparel and automobile industries involve worldwide networks with many tiers with several companies playing various roles (Kumoi & Matsubayashi, 2014). In the last two decades the power balance among the members in the supply chain has changed. In the FMCG industry retailers have started designing their labels and getting them manufactured under contract. Thus retailers such as Wal-Mart and Tesco, through the development of private labels, ensure vertical integration of each process in the supply chain into a centralized system. The situation in consumer electronics sector differs across products. Google for instance, in the smart phone industry, outsources the manufacturing of its Nexus series of phones to leading manufacturers, preferring one manufacturer for each generation of product (Kumoi & Matsubayashi, 2014). Such a strategy enables them to focus on brand development and management instead of engaging on each stage on the chain. In such cases, vertical integration may not appear feasible in consumer electronics. However, Dell in consumer electronics established a direct model wherein it coordinates all stages of the supply chain and ensures vertical integration into a centralized system. The supply chain in the consumer electronics sector is driven by technological, social and environmental changes (Dhekne & Chittal, 2011), which is not the case with the luxury sector. While the luxury sector has to maintain its unique position and engage in corporate social responsibility to enhance its brand image, consumer electronics industry is governed by other factors. Response to growing competition, compliance to regulatory norms, meeting consumer demands and shrinking product development cycles have forced the consumer electronics companies to address these concerns through mature supply chain management models. Thus there is a trend to outsource none-core operations while maintaining vertical integration of core competencies. Core competencies in design and innovation are being retained in-house by firms such as Apple, HP and Dell even as they embrace contract manufacturing for non-core functions. This strategy of outsourcing non-core operations along with vertical integration has been attributed to rapid technology growth which requires complex manufacturing capabilities. Low cost manufacturing in third world countries has also prompted such changes. The global fashion industry is characterized with intense competition, market demand uncertainty and short product life cycles (Kim, 2013). It thus becomes a strategic imperative for luxury fashion companies to design an effective supply chain strategy to be able to respond quickly to the changing consumer demands and preferences. A high-performing fashion company would have to choose a focus strategy in order to protect its proprietary knowledge and the brand, in which case they would prefer in-house sourcing and centrally controlled retail operations. However, if the firm chooses to target an industry-wide market, it would have to opt for outsourcing and a decentralized channel strategy. Thus, while Zara, the Spanish retailer follows vertical integration as it owns nearly the entire supply chain, right through design and production to distribution and logistics including worldwide stores, its competitors such as Benetton and The Gap prefer to outsource production (Guan & Rehme, 2012). Therefore, in the case of fashion industry the competitive priorities and the target market has to be considered in designing the supply chain strategy (Kim, 2013). If it has proprietary knowledge to protect (such as Zara) it would opt for a tightly controlled supply chain. Therefore, the firm’s knowledge becomes the most critical resource in shaping its supply chain strategy. This is also the case with luxury goods which drives them to have control over their suppliers. In the automobile sector also, differences have been found across regions and firms. Ford Motor Company’s River Rouge Complex near Detroit was the ultimate in vertical integration which could build a car from start to finish in just a couple of days (Vonderembse & Dobrzykowski, 2009). The complex included a steel mill, a float glass plant, designing, fabrication, production, machining and final assembly. Their function included purchase of raw materials to the final product. Even consumer goods companies implemented vertical integration because it was believed to reduce risks and increase profits. Most large auto companies are shifting production in emerging economies such as China. As China has become a major player in global auto manufacturing, it has attracted world’s major auto makers. However, the foreign firms experience challenges in managing supplies as they have to deal with local Chinese suppliers (Liao & Hong, 2007). They can invest in the local partners but foreign firms cannot have more than 50% stake in the supplier firm. The supply chain in the automotive sector starts from raw materials and design and up to distribution. Because of intense competition in the automotive sector, the firms have been forced to focus on their core competencies and outsource or even offshore work that can be done cheaper elsewhere. Even the Japanese auto makers that thrived on the arms-length nature of horizontal and vertical business relationships are experimenting with suppliers across the world for better quality at better prices (Duke, 2007). However, Toyota has been succeeding in its vertical supply chain strategy through the formation of “keiretsu” which is the formation of a business group linked in a supply relationship (Kumoi & Matsubayashi, 2014). However, manufacturing firms have moved away from vertical integration and towards supply chains involving many organizations. This shift occurred as supply chains became longer and complex and consumers demanded differentiated products (Vonderembse & Dobrzykowski, 2009). This demands shorter production runs, which increases setup costs while scheduling becomes complex and inventory expands. As it became difficult to manage complex supply chains where decisions could be delayed due to hierarchical structure, the manufacturing sector found it profitable to outsource certain components. Besides, the cost of managing and controlling vertical organizations increased. The situation in Brazil’s automotive industry is quite different as the automotive companies have built special parks or industrial condominiums. Major automotive companies such as Ford, Volkswagen, General Motors, Renault, Toyota and DaimlerChrysler have built such condominiums wherein the direct suppliers known as systemists, are physically installed within the walls of the automaker’s plants (Pires & Neto, 2008). These systemists are located next to the assembly line and supply complex systems but they do not participate in the vehicle’s final assembly line. The most significant element is that the systemists are not expected to devote all their resources to this automaker but have the flexibility to supply to other automakers as well. This is in contrast to the luxury sector where the artisans and suppliers have been restricted from supplying to anyone else (Brooke, 2014). Such an arrangement of building industrial condominiums facilitates product and production management while enabling the automakers to exercise control over quality and timely supplies (Pires & Neto, 2008). Along with reduction of product development costs, it also reduces time-to-market through curtailed communication channels. Because of improved integration production and inventory costs are also reduced. Shared infrastructure results in overall cost reduction for both parties. Most importantly, the automotive suppliers assume responsibility even as automakers impose high demand. Chrysler’s Toledo Supplier, with its integrated partners, KTPO, Magna, and OMMC, is the most productive plant in North America (Vonderembse & Dobrzykowski, 2009). As the suppliers invest capital, the financial and operating risks are shared. The automotive firms can provide demand information to all the tiers in the supply chain, thereby curtailing communication costs. Most importantly, this strategy helps them respond quickly to changes in the market place. This report concludes that the luxury sector focuses on vertical integration to a large extent to maintain its unique position, to avoid uncertainties in supply, to avoid risks and to have control over quality, where cost reduction is not the main motivation. However, not all luxury companies own every stage of the process from raw materials to retail sales. It would depend on the luxury segment and the position of the company within the segment. In the high volume sector, particularly the consumer electronics and the automotive sector, there has been a shift away from vertical integration towards building supplier parks. This shift has been driven by industry factors such as competition, changing consumer demands, as well the need to drive down costs at various levels. Despite these pressures, the automotive and the consumer electronics sectors maintain vertical integration in core competencies while outsourcing non-core functions. These high volume sectors are regulated sectors and are bound to comply with regulatory norms, while also discharging environmental responsibility. The strategy of complete vertical integration will not work in the high volume sector because of the rapid changes in technology which make the production cycles shorter. These high volume sectors maintain design and innovation in-house while they outsource production of non-core components. This suggests that in all cases, be it in the luxury apparel sector or high volume sectors, wherever proprietary knowledge has to be maintained, firms would opt for tighter supply chain control. References Brooke, S. (August 14, 2014). Luxury sector goes vertical. Supply Management. Available from http://www.supplymanagement.com/analysis/features/2014/luxury-sector-goes-vertithe cal Brun, A. & Moretto, A. (2014). Organisation and supply chain for quality control in luxury companies. Journal of Fashion Marketing and Management, 18 (2), 206 - 230 Caniato, F. et al. (2011). Supply chain management in the luxury industry: A first classification of companies and their strategies. Int. J. Production Economics, 133, 622–633 Dhekne, R. & Chittal, SS. (2011). Supply Chain Strategy For The Consumer Electronics Industry. WIPRO- Applying Thought. 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Journal of Enterprise Information Management, 20 (5), 511-526 Pires, SRI, & Neto, MS. (2008). New configurations in supply chains: the case of a condominium in Brazil’s automotive industry. Supply Chain Management: An International Journal, 13 (4), 328 - 334 Vonderembse, M. & Dobrzykowski, D. (2009). Understanding the Automotive Supply Chain: The Case for Chrysler’s Toledo Supplier Park and its Integrated Partners KTPO, Magna, and OMMC. Available from http://www.wistrans.org/cfire/documents/AutoSupplyChainCase10_30_09%20FINAL.pdf Read More