Analysis Into the Vertical Integration Across the Value Chain of Sony

Topics: Economics

“The greater a firm? s ownership extends over successive stages of the value chain for its product, the greater the degree of vertical integration” (Grant, 2010, pp354). The consumer electronics industry value chain is depicted below: Thus a firm can be said to be vertically integrated if it owns and operates each of these stages of the value chain. The consumer electronics industry has many players who produce goods for purposes such as entertainment, communication and work.

There are many determinants of success, including technical innovation, price competitiveness and brand awareness.

The degree of integration in the value chain can influence success within the industry. Examples of firms who manage the value chain differently include Apple, who integrates their product design and retailing, but outsources the manufacturing & assembly of their products, whereas Dell keeps its product design and assembly in-house, whilst using market contracts for component manufacturing and retailing.

This report focuses on the consumer electronics division of Sony, a well-known brand in the industry, whose five different stages of the value chain (same as above chart) is analysed in more depth below.

1. Product Design The first stage of the value chain is Product Design, which Sony keeps in-house. The company emphasises on “building high-performance, easy-to-use and beautiful products with a distinctive Sony flair” (Sony, 20111).

Within the consumer electronics value chain, there are numerous benefits of the vertical integration of product design. Evidence suggests there is strong correlation between the launch of new products and market performance (Souder and Sherman, 2004). Consequently, new designs and products can capture and retain market shares and increase profitability (Tidd et al.

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, 2001). Thus by having ownership over the product design and innovation stage, Sony can maintain complete control in creating its own competitive advantages to have an edge in the market.

Due to the nature of product design, outsourcing would be unrealistic; Sony is likely to have Proprietary product technology unique to the firm e. g. their 3D technology. Consequently, there is incentive for the contracted company to behave opportunistically (Williamson, 1973), such as expropriating the technology and maybe even leaking it to rivals (Rao & Novelli, 2010; Business Week, 2009), and so contracts of vast complexity would need to be written and agreed to prevent such opportunism, which is expensive (Williamson, 1973).

Also, for the contractors to be incentivised to come up with the best technology or design, the contracts will have to be designed in such a way that the agency fees that the contractors will receive will be correlated to the market performance of the designed product, and this is extremely hard to measure or enforce in contract. Thus, the potential transaction costs (Coase, 1991), risks and complexity associated with Product Design far outweigh than the administrative and labour costs of vertical integration which makes outsourcing an unfavourable option.

However, there are risks associated with keeping the product design process in-house. Most significantly, there is the risk of not having the flexibility, skills and capability to come up with groundbreaking technology and therefore fall behind your competitors. For instance, Sony failed to anticipate the trend towards mp3 technology which led to loss of market share in the portable music devices market in the early 21st century (Uggla and Verick, 2008). Further, the administrative costs of product design in-house are high, with Sony’s investment in R activities amounting to JPY432 billion ($4. billion) in FY2010 (Datamonitor, 20111). On balance, vertical integration with respect to Product Design is the best strategy for Sony to adopt. Innovation within the technology industry is the key to success, and so Sony need to keep complete control over this process. 2. Manufacturing & Assembly Sony uses both in-house production and outsourcing for the manufacturing and assembly stage of their value chain (see Appendix A). In 2009, 50% of their total annual production was in their in-house factories in Japan, with 60% of this production destined for export to other regions (Datamonitor, 20111).

There are some benefits of maintaining vertical integration in manufacturing. First and foremost, vertical integration will help with control and coordination throughout Sony? s value chain. By owning production factories and operating its own logistics, it is readily able to respond to changes in consumer demand or market trends, with no reliance on external suppliers. That is, it has full control over its operations. Further, Sony has „trade secrets? which it wishes to protect from its rivals. In an industry which is shaped by technological advancement, keeping such trade ecrets is therefore of great importance. Not adopting an inhouse manufacturing strategy will always bear the risk of these secrets being expropriated by others. Also, if Sony were to outsource, it may require its manufacturers to make transaction-specific investments (Grant, 2010). There is a need for trust and a strong relationship, as well as rigid contractual agreements, thus making the transaction costs potentially high. Therefore it can be seen that manufacturing in house could avoid a lot of complexity.

However, keeping manufacturing vertically integrated poses several issues especially with a big part of their operations being based in Japan. Firstly, the average hourly wage rate in Japan is ? 5. 86 (Ministry of Health, Labour & Welfare, 2011), compared to countries like China which the rate is only ? 1. 28 (BBC, 2011). This has significant implications on operation overheads, and so the administrative costs associated with vertical integration. Secondly, the appreciating Yen has further raised overhead costs and has driven up the price of exports in recent years and therefore has made Sony? products less price competitive (Euromonitor, 2010). Finally, Japan is prone to natural disasters, with the Tsunami in March 2011 causing a significant disruption in component production, resulting in reduced device volume sales of its smartphones by 1. 5m in the three months to June 30 (Financial Times, 2011). Thus, “vertical integration represents a compounding of risk insofar, as problems at any one stage of production threaten production and profitability at all the other stages” (Grant, 2010 pp358).

A further disadvantage that Sony has through integrating manufacturing in their value chain is that it “tends to lead to higher overall costs because you need extra layers of management to coordinate all the activities” (Kennedy cited in Business Week, 2009). This money could be invested instead in product design which is the fundamental key to success for companies like Sony. Also, there are limited incentives for in house manufacturing to minimise costs or to respond promptly to internal requests or queries (Grant, 2010 pp357), which will affect efficiency in production.

The current manufacturing strategy might have to be reviewed as the risks seem to far outweigh the advantages. 3. Distribution Distribution is another aspect of Sony? s value chain, which involves taking the finished product from its manufacturing bases to retailing outlets worldwide. With regard to its current distribution policy, Sony can be seen as being vertically integrated, with logistics principally handled by Sony Supply Chain Solutions, Inc, a subsidiary founded and owned by the Sony Group. (SCSS) (Sony, 20112) There are a number of benefits of remaining vertically integrated in the operation of this part of the business.

Firstly, it enables Sony to have control over the process. They are able to avoid time delays which potentially could arise if they were to contract with an external company. Related to this is flexibility, whereby they can ensure they have a full lorry before sending out the shipment, which will allow for efficiency. For example, SCSS in Shanghai is utilising a combination of milk round routes and round trip trucks run to increase transportation efficiency, which is also contributing to reduced CO2 emissions (Sony, 20112).

As they produce such a large volume of products every year, it is better to avoid the transaction costs associated with contracting out to another logistics company as the minimum optimal scale is reached (Grant, 2010). As the frequency of transactions are high i. e. there will be a large number of shipments per week, the variable transaction costs will be high, and this could be avoided by keeping it vertically integrated. However, there are disadvantages associated with vertical integration in distribution.

Essentially, it is another part of the business to manage, and so can give rise to increased administrative costs through extra managerial levels, increased co-ordination across the business… etc. If they were to outsource, such costs could be avoided. An external contractor is likely to offer a significant discount as they ship large volumes of goods, thereby reducing the transaction costs. As for Sony, it is important to ensure the timely and accurate delivery of their products in order to maintain a good relationship with retailers.

Moreover, the scale of their distribution is large enough to make vertically integration a cost-effective option. In fact, they are profiting from their distribution subsidiary as they utilise their remaining capability to serve other companies. Thus vertical integration is the preferential strategy for Sony. 4. Marketing Sony? s marketing department prepares the marketing strategies in-house and then employs a number of advertising agencies to develop communication plans for each product genre.

For example, the 2011 global TV ad campaign for Bravia, by Grey London, aims to drive awareness of Sony? s 3D TV and the Qriocity streaming service for musics, TV and films (Owen and Brownsell, 2011). However, the company does not just rely on the advertising campaign to build up its brand value, it also resort to public relations by appointing leading PR agencies to create and implement PR strategies to promote the Sony products and the brand, and handle the social media, press office and experiential PR (Sony Electronics, 2011).

By employing the professional agencies and not creating/executing the campaigns themselves, Sony can utilise the marketing and PR expertise of the agencies that would be too expensive for Sony to develop themselves and too small part of the business for Sony to reach the optimal scale of efficiency (Grant, 2010, pp356). The transaction costs associated with outsourcing would be worthwhile. 5. Retailing Sony runs its retail operation with three types of vertical relationships: franchise agreements, direct-channel retail stores and partnership with other retailers.

Sony provides extensive support to the franchisee on the store concept and operational issues such as staff training and marketing (FranchisePlus, 2007). The benefit of adopting a franchising model for Sony is cost savings as the franchisees bears the investment and fixed costs for their franchises (Carney and Gedajlovi, 1991). Also, as the franchisees ultimately own the businesses, they will be naturally motivated to manage their business well (Rao & Novelli, 2010, pp238).

However, a disadvantage of franchising is that Sony does not have control over the quality of the operation of the retail stores, which could potentially lead to a negative impact on the brand image if the franchisee although motivated, „gets it wrong?. Indeed, Sonex Communications, a company who operates Sony franchises across UK, recently went into administration (Donnelly, 2011). Also, with a franchising strategy, Sony could obtain little feedback on how their products are perceived by their customers, and this would hinder their research and development and product design processes.

Lastly, there would be a loss of managerial expertise if most of Sony? s retail outlets are franchised and therefore managed by non-employees (Carney and Gedajlovi, 1991). Sony also directly owns and manages their online shop and some of its retail stores. Williamson (1979) pointed out the major benefit for companies to own its own retail outlets is that “adaptations can be made in a sequential way without the need to consult, complete, or revise inter-firm agreements”. For example, Sony has closed nefifth of its direct retail stores (TGDaily, 2011) and replaced them with its new flagship Sony Stores in March 2010 to improve customer experience. This level of flexibility could only be achieved if Sony owns their retail outlets. Also, through interacting with the customers in stores, Sony can receive customers? feedback on its product features and shopping experience directly, which would be useful to future product designs and developments. However, owning their retail stores can incur high administrative costs which include management costs, overheads and wages.

Additionally, Sony distributes its products through other retailers such as Currys, Argos, Wal-mart…etc. Sony could benefit from a wider distribution by selling their products through other retailers. The obvious setback of such a strategy is that with retailers also wanting to make a profit, Sony? s profit levels would be further decreased. However, the transaction costs associated with this are completely acceptable as Sony will be losing out a huge market if they give up on partnering with other retailers to sell their products. Appendix B shows that only 18% of people buy their computer straight from manufacturers.

Therefore, providing that Sony continue to use reputable firms such as Currys to do so, there is no need to make changes to this aspect of their retailing strategy. It is difficult to judge which the best strategy out of these three is. However, market research has shown that recent trends suggest that less people are going to other retailers to buy their computers (Mintel, 2011). Taking this into account, and also the setbacks of the franchising strategy, the future for Sony on their retailing operations probably lies into owning more of their own retail outlets. Suggestions Analysis of Sony? current value-chain indicates that changes can be made to their manufacturing and retailing. Manufacturing & Assembly Firstly, Sony should move most of their manufacturing away from Japan to other countries. Since it is expensive and extremely complex to set up their own factories in other countries, the best option for Sony will be to vertically de-integrate and outsource its manufacturing to companies in lower cost manufacturing countries such as China. By doing so they will avoid the high employee wages in Japan and thus have a positive impact on their cost structure and allow them to be more price competitive in the market.

Further, “dispersing production activities to various locations around the globe where each activity can be performed most efficiently can lower costs” (Rao & Novelli, 2010, pp281). If they were to base their production sites in a variety of geographic locations, they minimise the risk of production hold-ups through factors such as natural disasters, diversify the risks of currency fluctuations as well as being closer to their customers and so reducing transportation and distribution costs.

Further, there is an extensive global demand for their products, which lowers the minimum efficient scale of production, and so it would be economical to manufacture their goods in several locations. An ideal decision will be to reduce the manufacturing in Japan to the level just satisfying domestic demand (currently 60% of the production in Japan are exported), and to also keep the manufacturing of the innovative products in-house in Japan to minimise the risk of intellectual rights infringements.

Also, by de-integrating manufacturing from their value chain, they will be able to focus on their core competence of Product Design. Extensive outsourcing has been a key feature of fast-cycle product development throughout the electronics sector (Grant, 2010, pp358). Costs savings will arise through a reduction in the co-ordination and control of sub units within the business, and so fewer management levels, as well as the fixed costs of manufacture.

Sony will be able to invest money saved into Product Design whilst simultaneously being price competitive against other companies such as Apple. In fact, it is consensus that the blame for Sony? s poor performance in recent years is largely down to them not being able to keep up with their competitors in terms of product design and innovation. However, there are risks and disadvantages with adopting this strategy. By outsourcing the manufacturing process, Sony will be outsourcing the „know-how? of its products; its proprietary product technology which is unique to Sony.

There is risk that the supplier will expropriate the technology for their own use or that they will sell it on to Sony? s competitors (Rao & Novelli, 2010, pp294), which would lead to a loss of competitive advantage in the product design stage of the value chain. However, Sony can apply for Intellectual Property Rights (IPR) to minimise this risk. By being legally protected, Sony can ensure their property is protected, with the existence of an IPR acting as a deterrent to the outsourcing company of opportunistic behaviour.

However, there will be legal costs incurred throughout this process, which is a form of transaction cost. Further, there could be the problem of asset specificity which makes it unfavourable to outsource. If Sony develops some groundbreaking technology whereby in the manufacturing process an investment in specialised equipment is required, the supplier that they outsource the manufacturing to may have to invest in specialised assets to produce their goods, which increases transaction-specific spending.

Mutual dependency between the supplier and Sony is created, where each party might fear that the other will abuse the relationship by seeking more favourable terms. It may be difficult to find a supplier who is willing to invest in the technology to manufacture products which are specific to Sony, as they may feel they are becoming reliant on Sony as a source of income, which could act as an inhibitor of trust between the two parties. Further, the supplier will know that Sony is dependent on them and so there is an incentive to charge a higher price and act opportunistically.

Thus Sony will need to ensure that they have contractual agreements in place to inhibit opportunistic behaviour, which increases transaction costs. However, where closer supplier-customer ties are needed – particularly when one or both parties need to make transaction-specific investments – then a longer term contract can help avoid opportunism and provide the security needed to make the necessary investment (Grant, 2010, pp363). Thus Sony should establish long term contracts with the outsourced companies.

However, the setting up of long term contracts will be a form of transaction cost incurred. A final problem of outsourcing is hold ups. This could be eliminated by contracts that fully specify prices, quality, quantities, and other terms of supply under all possible circumstances (Grant, 2010, pp356), but yet this also contributes to transaction costs. It can be seen that transaction costs are always worrying yet inevitable for companies looking to de-integrate. However, to look at it from a positive perspective, the transaction costs of outsourcing in this industry is relatively ow. This is because that most products in this industry is standardised (Financial Times 2005), and many other players in the electronics market outsource their manufacturing, such as Apple, suggests that there are many potential companies who have the capabilities to manufacture Sony? s products. Setting aside the potential possibility of the asset specificity problem, the existence of many buyers and sellers in the market, with a number of alternatives, reduces the transaction costs and switching costs (Grant 2010).

Retailing In the short term, Sony should continue with the structure that it adopts i. e. a mixture of franchises, ownmanaged retail stores and other retailers. However, once their brand recognition and reputation improves after a few years, they should reduce the number of franchises, and instead increase the number of retail outlets they own (especially in developing countries). The reason that immediate change in the retail ownership is not needed is because brand reputation and recognition is extremely important in determining if retail outlets will succeed.

Brands like Apple with outstanding brand recognition could afford to own and open their own retail outlets, while as for example for less well-known brands like Alba, it will be really risky to operate their own retail stores. Therefore, it is recommended that Sony spend a few years on improving its product design and innovation and therefore improving its brand recognition before owning more retail outlets. As stated previously, the existence of a feedback loop is the main incentive for Sony to own their retail stores as opposed to franchises.

To compete at the very top level, Sony ought to be cutting the edge in product design and innovation, and the feedback loop could really be of great help. Also, Sony needs to be opening more retail outlets in the developing countries to strengthen their established presence in the market, as Sony has a better brand recognition in those countries. For instance, in 2010, Sony? s sales in India grew faster than the market (Sony, 20113). Also, by having control over the continual investment in opening retail outlets, it will contribute towards increasing Sony? market share and ensure that the direction the brand is going is defined according to their plans rather than the franchisees?. They will be able to monitor the quality of the stores and react quicker to changes in consumer tastes, something which they have less control over if they were to continue store expansion through franchise agreements. Further, Grant (2010) said “not only do manufacturing and retailing require very different organisational capabilities; they also require different strategic planning systems, different approaches to control and human resource management, and different top management styles and skills. Therefore, if Sony were to de-integrate the manufacturing process in the value chain, they can focus on Product design and Retailing, adopting a suitable organisational structure like Apple, who display a robust financial position – the company’s total revenue increased to $65,225 million in FY2010 from $19,315 million in 2006, representing a compounded annual growth rate (CAGR) of 36% (Datamonitor, 20112). Their growth in the market is attributable to a strong brand image of technical innovation, which Sony is capable of too.

The risks of reducing and eventually phasing out the franchise agreements are that there will be increased administrative costs of integration. There will be a need for more managers to control the process. However, the greater the operation i. e. the number of retail stores they manage themselves, the lower the minimum efficiency scale. Thus as they expand the number of stores they operate themselves, they will become more efficient, and so reduce the fixed costs of vertical integration. Also, it is worth mentioning that the main focus for Sony? future development is product design and innovation, so as long as owning more retail stores could help in this aspect, the transaction costs could be negligible. Conclusion Suggestions made to the current value chain of Sony are to serve for one sole purpose, which is to increase the profitability and market share of Sony. This is going to be achieved with a focus on improving product design and innovation, something which Sony has been falling behind their competitors in recent years. Therefore, by outsourcing more manufacturing and owning more retail shops, Sony? investment capital, managerial expertise and strategy focus could be reshuffled and used on product design and innovation, which hopefully will see Sony catch up with its competitors and reach the heights they previously were in the late 20th century. References BBC, 2011. China minimum wage up by 21. 7% despite economic cooling [online]. Available from: http://www. bbc. co. uk/news/business-15456509. [Accessed: 29 November 2011]. Business Week 2009. Can Outsourcing Save Sony? [online]. Available from: http://www. businessweek. om/globalbiz/content/jan2009/gb20090130_697510. htm. [Accessed 28 November 2011] Carney and Gedajlovi, 1991. Vertical Integration in Franchise Systems: Agency Theory and Resource. Strategic Management Journal, Vol. 12, No. 8 (Nov. , 1991), pp. 607-629 Datamonitor 20111. Sony Corporation [online]. Available from: http://360. datamonitor. com. ezp1. bath. ac. uk/Product? pid=881B16EF-3BEC-4BDD-B10A-26FAB18DEC3B [Accessed 26 November 2011]. Datamonitor 20112. Apple Inc [online]. Available from: http://360. datamonitor. com. zp1. bath. ac. uk/Product? pid=5B0A0C20-9BB6-4284-A575AC0F2261F45C&view=SWOTAnalysis. [Accessed 30 November 2011] Donnelly, C. , 2011. Sony Centre owner calls in administrators [online]. Available from: http://www. channelweb. co. uk/crn-uk/news/2112104/sony-centre-owner-calls-administrators. [Accessed 30 November 2011] Euromonitor International 2010. Sony Corporation [online]. Available from: http://www. portal. euromonitor. com. ezp2. bath. ac. uk/Portal/Pages/Analysis/AnalysisPage. aspx. [Accessed 26 November 2011].

Financial Times 2005. Severe pressure on prices, missed opportunities, the need to buy big components and the threat of new format wars are making life difficult for a consumer products group that has lost some of its proprietary grip, writes Michiyo Nakamoto Financial Times:London Financial Times 2011. Sony Ericsson blames loss on Japanese earthquake; Mobile & Telecoms. Financial Times: London. FranchisePlus, 2007. [online]. Success Story-The Dividend From Dedication, Jan – Feb Issue, 2007 (Vol 3. Issue 6. ) Available from: http://www. ranchise-plus. com/success230107. asp[Accessed 29 November 2011]. Grant, R. , 2010. Contemporary Strategy Analysis: Text and Cases. 7th ed. Wiley Htlounge, 2010. Sony fighting against Apple by opening its own retail stores [Online]. Available from http://www. htlounge. net/art/11050/sony-fighting-against-apple-by-opening-its-own-retail-stores. html. [Accessed 28 November 2011] Hobbs, J. , 1996. A Transaction Cost Approach to Supply Chain Management. Supply Chain Management: An International Journal, Vol. 1 Issue: 2, pp. 5 – 27. IPR, 2011. What is Intellectual Property? [online]. Available from: http://www. ipr. co. uk/intellectual_property_guide/what_is_intellectual_property. html. [Accessed: 29 November 2011] Kay, J. , 1993. Foundations of Corporate Success: How business strategies add value. Oxford: Oxford University Press. Ministry of Health, Labour & Welfare, 2011. Minimum wage [online]. Available from:http://statsjapan. com/t/kiji/11521. [Accessed: 29 November 2011]. Mintel, 2011. Desktop, Laptop and Tablet Computers – UK – August

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Analysis Into the Vertical Integration Across the Value Chain of Sony
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