Back to the Future: Vertical Integration is the Winning Strategy

For two decades, horizontal business models in the high tech industry reigned supreme, as companies like Intel, Microsoft, EMC, HP, Cisco, and Oracle came to dominate within their horizontal layer at the expense of DEC, Wang, Apollo, Data General, and others that clung to vertical business models despite fundamental shifts in the industry.

Fast forward to today, coming off a near-death experience in the financial markets, where we live in an environment of increasing consolidation, reduced competition, and greater uncertainty. An environment ideal for vertical reintegration by select companies who can utilize the changing dynamics to potentially build winning vertically integrated strategies to own the end-to-end stack. Here are a few examples of vertical reintegration in action:

• Oracle buying Sun to deliver hardware & software combinations to become the backbone of most enterprises worldwide
  
• Cisco getting into the server market with UCS - and with a $33B war chest, they can buy their way into storage and IT services if they choose
  
• EMC getting into server virtualization (aka VMware), systems provisioning and management in the data center
  
• Dell buying Perot Systems to get into the higher margin, more strategic enterprise IT services space
  

If you're skeptical these examples equate to a 'back to the future' shift towards vertical business models, consider the following dynamics:

• Co-opetition is out; Bare-knuckle competition is in. Larry Ellison has declared war on IBM to become the dominant player in the software and systems business from application to disk. Cisco served notice to HP and IBM concerning the server business, and is willing to sacrifice their networking OEM business for world domination in the converged infrastructure business.
• Vertical is relatively cheap. Despite a much improved stock market, company valuations are still relatively cheap. Combine cheap valuations with open source, fabless semiconductor businesses, commodity hardware, and SaaS, and it's not as expensive to buy your way up the stack as it used to be.
  
• Businesses buy solutions, not products. Products don't solve business problems, solutions do. A lot of companies make good point products, but the companies that can package them up so customers don't have to allocate their own IT resources to put them together, will have a seat at the table, be strategically positioned, and win the sale.
• Eroding margins. This is the nature of a maturing industry. But if you own the end-to-end stack, are the backbone of most enterprise infrastructures, and are sticky and strategic to IT operations, you're in a better position to control margins.

Whether this vertical reintegration trend is good or bad for the industry and customers is a topic for another blog. It's way too early to judge, anyway. But it's a good bet there will be more M&A, further shifting battle lines, and several bumps in the road that will prevent a quick return to the future in this unfolding plot.