Ostensibly, large number of businesses throughout the globe still operates under the tag of vertical business model. One reason is that it is quite easy to establish a business on vertical base. The second compelling reason is that vertical business model passes two cardinal tests: it conveys its business concept clearly and its profits add up to positive integer. Read more…..
Ms Joan Magretta, management consultant penned up an article in Harvard Business Review titled “Why Business Models Matter?” (HBR May 2002). Therein she described a business model as one telling a good story. In addition she presented two tests a business model should breast-up. Narrative Test requires the story must make sense. Numbers Test commands Profit & loss must add up. When I looked deeply into this matter, I found that in most cases vertical business model passes muster in both tests. Let me explain what vertical business model is and how it functions:
Vertical Business Model
When a business manufactures and sells or otherwise deal with such activity in an upward integrated manner it comes under the portal of vertical business model. Though of common type, vertical business model deals in specific area. Its focus is specific and it sells mainly a line of product that shows high degree of specialization. Jewellery manufacture, diamond processing, manufacture of parts or components to computers, autos, electrical and electronic goods are few of these specialized ventures. Vertical business model seeks market domination in the chosen sphere or a monopoly position in a particular market segment. As a result operational activities tend to be sophisticated using technology in appropriate manner. In addition to in-house staff vertical business model seeks and obtains services of external consultants and advisers.
Both supply chain and value chain are strictly planned and maintained. In the case of supply chain machinery and materials are acquired from dedicated sources. You know that value chain deals with making and selling of products or services. Here again business reinforces the value chain by stringent quality control and sticking to delivery schedules along with dynamic sales programmes that target segmented market using varying channels anchored on a win-win customer relationship. In sum, vertical business model facilitates efficient co-ordination of key income drivers such as sales and key expense drivers such as cost of sales.
As the name goes, vertical business model depends more or less on vertical integration as part of the business philosophy. Acquiring resources such as warehouses, stores manufacturing facility is key to this business type. Hence, we notice that tremendous amount of assets are built –up within a business, financed by internal revenue, long term loans or buyer credit. The last is much more common in the case of automakers. Even though enlarging size and scope to meet up with increased demand could present, in the short term, a challenge to a vertical business, in the long term it translates such event into a rewarding business opportunity. Computer parts vendors, for example, go through this phase, mainly encouraged by what we call “scalability pluses”. Scalability refers to the ability of the business to handle growth in the market demand for its products. Scalability pluses arise when a business invests in increasing its scalability and finds that the additional capacity could be sold to different buyers. Amazon.com had invested huge money on its IT infrastructure. Later in 2006 it offered cloud computing services creating altogether new customers in the form of web companies. This event is cited and noted by Professor Alexander Osterwalder in his book on “Generating Business Models”.
A vertical business model fits easily into creator and distributor type companies. A creator is a business that manufactures product and sells it with a margin. On the other hand, a distributor business buys from a manufacturer and re-sells to ultimate buyers after adding its mark-up. Since both these types border on product or service specialization we note that many businesses today can operate a vertical business model with much ease. More than that, with lot more profit.
Muthu Ashraff
Business Adviser
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