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Vertical strategies and outsourcing

 

An effective vertical strategy involves the continuous process of re-designing task
responsibilities (in collaboration with suppliers and customers) to create greater value-
added internally in ways that leverage a firm’s unique capabilities. At a particular time
in its organizational evolution, the number of vertically-related processing
stages within a firm’s organizational span could encompass a large number of internal
transactions — from ultra-raw materials to the ultimate consumer. For example, Ford Motor
once (1) mined the ore to make the (2) steel used to (3) fabricate the bodies of
the automobiles it (4) assembled and (5) sold through wholly-owned distribution channels
that culminated in (6) new car showrooms and (7) after-sale service salons.
Shell Oil once (1) explored for and (2) produced crude oil that was (3)
transported in (4) owned oil tankers, (5) polymerized in-house from (6) monomers (after
the initial (7) cracking stage was performed within its own refinery), and (8) synthesized
into various hydrocarbon compounds — such as plastics or resins — for ultimate sale as
its (9) branded trash bags or paints.
In a well-designed vertical integration strategy — regardless of how many steps the firm
performed in-house, and regardless of the form of business enterprise used to execute
each step — the objective would be to capture high profits from each task comprising its
value chain. Vertically related steps with lower profitability potential
(or decreasing contributions to the firm’s core competencies) would be outsourced.
A continual triage process would question which core knowledge the
firm should build upon. Activities that have become less critical to competitive success
would be outsourced to specialists as competition evolved; as an industry’s success
requirements evolve, so too does the mix of value adding activities emphasized by the
firm.
Ethical Pharmaceuticals. Some pharmaceutical companies have recently been
outsourcing research activities in the path to creating new molecules. For a company like
Merck, research was its most important activity and the most critical asset it controlled
was technological prowess — as evidenced by patents over its substances. As the
pharmaceutical industry changed dramatically during the last 50 years, however,
technology became less critical to success than being prescribed within managed
healthcare centers — being pushed through a hospital’s (or other healthcare delivery
outlet’s) portal for delivery to patients.
In a world with constant pressures for improved financial performance, companies must
use their first mover advantages to exploit whatever advantages they possess quickly —
for example, to become the standard medication recommended in hospital formularies for
a specific indication. Physicians prescribe the first-mover substance primarily until the
next innovator substance comes along and makes the previous standard obsolete. Having
a seventeen-year-old patent means nothing in a hypercompetitive environment like the
pharmaceutical industry where innovations are launched frequently.
There is too little breathing space between innovations to go it alone. The only breathing
space between cannibalizing innovations is the time it takes the new substance to attain
formulary approval in the healthcare delivery system. Perhaps that is why Merck used
precious research dollars to acquire Medco.
Contract research organizations (CROs) and contract manufacturing organizations
(CMOs). Merck may still largely do its own research and development in-house, but
many pharmaceutical companies contract with partner organizations for value-chain tasks
— fundamental research, applied research, testing prior to Federal Drug Administration
(FDA) approval, or manufacturing of one (or all) of the active ingredients — to
accelerate the innovation process, especially in the face of the human genomics project.
Such pharmaceutical companies use their distribution systems to market the ultimate
substance — regardless of where the substance was created. Having their brand name on
innovative substances preserves their image as a leading pharmaceutical company, when
in actuality, their research prowess was enhanced by access to their virtual network of
outsourcing partners. Such arrangements allow pharmaceutical firms to use other firms’
skills, substances, and patents under licensing arrangements whereby all partners
ultimately benefit from the pharmaceutical firm’s success in the marketplace.
In the pharmaceutical industry examples, each outsourcing partner contributes a plank or
two for the pharmaceutical firm’s platform and the resulting virtual network thrives (or
fails) depending upon how well a drug platform floats and how many prescribing
physicians climb onboard it. Similarly, within contract manufacturing organizations, like
Cambrex, productive capacity is prepared for manufacturing pharmaceutical active
ingredients well in advance of FDA approval of new drugs. Pharmaceutical firms that
outsource active ingredients sha

 

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