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Disrupting Your Supply Chain

The high-tech world has gone through several business model revolutions.  In fact, the jump from one computing paradigm to the next has been the model of disruptive innovation.  Many of these jumps have also been accompanied by changes in supply chain management and have reoriented traditional supplier relations.

In the days when the mainframe was at the top of the IT food chain, IBM controlled every phase of industry development–both hardware and software. However, when the market moved to PCs (which IBM created) they miscalculated and concluded that the real money lay in the hardware (and they never thought PCs would take off the way they did).  As a result, IBM “outsourced” the production of the PC operating system to a 19 year old college dropout who built Windows. IBM’s biggest mistake, however, was that it failed to retain the rights to Microsoft Windows and the operating system soon became more important than the hardware.

It turned out that the OS, rather than the rapidly commoditizing hardware market, was where the money was.  (Also, Intel, which had been a subcontractor of IBM as well, rose to prominence in the microprocessor space.  Intel’s laser focus on CPUs would see it ascend to similar heights of profitability as Microsoft.)  Instead of allocating capital to develop its own end-user hardware (it was a much lower margin business), Microsoft and Intel focused on their valuable inputs to the end-user products (computers and servers) and let OEMs build the hardware and sell to customers.  The name of the game was specialization: focus on your unique input and let everyone else compete over the scraps.  Compare Microsoft’s and Intel’s profit margins over the last 10 years (29% and 21%, respectively) to the profit margins of the OEMs Dell and HP (4.4% and 5.2%, respectively).

Apple–once an IT afterthought with a small, but loyal fan base–challenged that convention, took full control over the development process of its products and worked on making tightly integrated, seamless devices.  This strategy, though questioned in the beginning, eventually paid huge dividends (literally).  Apple was able to create the next wave of cool IT products by tightly controlling innovation in a way that a loosely linked group of suppliers could not. (i.e. OEMs, largely due to their razor-thin margins, focused on cutting costs, not paradigm shifting innovation).  Now Apple is the most valuable company in the world and at one recent point, it even had more cash on hand than the U.S. Government.  Not bad.  It’s no wonder that others are now trying to imitate Apple’s success.

Both Google and Microsoft have taken steps in this direction.  First, Google tried this with the highly rated Nexus One and flopped brutally (however, some argue that device was successful as a “demo unit” to better illustrate what an Android phone could be).  Now, Microsoft is emulating Apple’s tightly integrated approach and cutting out their typical hardware customers in producing their new tablet, the Microsoft Surface

A recent NY Times article describes how Microsoft executives came to the startling revelation that they had to try a new approach to compete in the tablet space.

Microsoft learned through industry sources that Apple had bought large quantities of high-quality aluminum from a mine in Australia to create the distinctive cases for the iPad, according to a former Microsoft employee involved in the discussions, who did not wish to be named talking about internal matters.

The executives were stunned by how deeply Apple was willing to reach into the global supply chain to secure innovative materials for the iPad and, once it did, to corner the market on those supplies. Microsoft’s executives worried that Windows PC makers were not making the same kinds of bets, the former employee said.

The incident was one of many over the last several years that gradually pushed Microsoft to create its own tablet computer, unveiled last week. The move was the most striking evidence yet of the friction between Microsoft and its partners on the hardware side of the PC business. It is the first time in Microsoft’s almost four-decade history that the company will sell its own computer hardware, competing directly with the PC makers that are the biggest customers for the Windows operating system.

As mentioned before, Microsoft found it hard to compete with Apple because the incentives of its customers (the OEMs that sell Windows branded products to end-users) were not aligned with the incentives of Microsoft.

In the end, the [Microsoft] H.P. tablet was thick, the Intel processor it used made the device hot, and the software and screen hardware did not work well together, causing delays whenever a user tried to perform a touch action on its screen. “It would be like driving a car, and the car not turning when you turn the wheel,” the former H.P. executive said.

That kind of problem was unacceptable, especially after Steven P. Jobs, then Apple’s chief executive, unveiled the first iPad, to glowing reviews, just three weeks after the H.P. device was shown.

Microsoft worked with other hardware partners to devise products that would be competitive with the iPad, but it ran into disagreements over designs and prices. “Faith had been lost” at Microsoft in its hardware partners, including by Steven Sinofsky, the powerful president of Microsoft’s Windows division, according to the former Microsoft executive.

Needless to say, some OEMs are upset that Microsoft is cutting them out of their traditional role in the Microsoft ecosystem–but that is the nature of innovation.

That some of Microsoft’s partners were not told beforehand about the Surface has led to a “sense of betrayal” in the industry, according to one source.

“This has always been a point of contention between OEMs and Microsoft — Microsoft getting into the hardware space,” a second source said.

Microsoft is not alone in adopting a more tightly integrated approach to innovation.  Although the first entirely Google smartphone crashed and burned, the device’s failure has not dissuaded its creators from trying again. Google, like Microsoft, is searching for ways to out-innovate its opponents on the production level.  Google is set to release the Nexus Q, a companion to their Android devices which facilitates cloud-based media on home entertainment devices.  Google decided to build the Nexus Q close to home in Silicon Valley (And, unlike Apple, Google is bringing much of the actual manufacturing closer to home as well).  According to one Google executive, this decision was all about innovation:

“We wanted to innovate fast. This is the first end-to-end hardware product that Google has ever put out,” said John Lagerling, Google’s senior director of Android global partnerships…. We wanted to see if we could do fast (design iterations) rather than having our engineers fly across the world.”

Given the complexity of the technology and the cut throat nature of high-tech competition, it is hardly surprising that both Google and Microsoft are more closely emulating Apple’s model (and putting their own tweaks on it) and attempting to bring innovation closer to home–at least for some product lines. (Both Google and Microsoft need to try something different as they are already significantly outspending Apple on R&D.  Clearly Apple’s method of production has some benefits.)

Shaking up your supply chain and vertical integration is not an inherently bad thing, even though some will cry foul.  Disruption produces winners and losers.  Society, as a whole, benefits, even though those that can’t survive the paradigm shift lose.  (Some, however, like IBM reinvent themselves. Its failure to adjust to the client-server computer paradigm nearly bankrupted the once most profitable company in the world–until it reemerged as predominantly a revolutionary supplier of software and services.)

Whether it is Microsoft’s partners complaining of being cut out of their traditional role or Android partners worried about Google buying Motorola, these companies are taking aggressive steps to compete with Apple, a company that has revolutionized the way business experts look at supply chains.

Even though there is no guarantee the Apple’s strategy can be mimicked, shaking things up is unquestionably good.  In disrupting their supply chains, production partners, and the industry status quo, Microsoft and Google are pushing the rest of the ecosystem to innovate rapidly in order to stay relevant.

It is extremely important for innovation and consumers that producers feel free to experiment, and even fail, with every aspect of even tried and true development processes.  As one industry commenter put it:

One interesting thing to note after watching Microsoft’s announcement last week and Google’s announcement this week is how desperately these two companies are trying to emulate Apple in the way that products are both built and announced. Microsoft took pains to design a “beautiful” product, and even spent much of the announcement talking about the material used to design the Microsoft Surface and how thought was put into every single line. Google obviously went the same route with the Nexus Q, which is a sphere that has a neon-like ring that glows different colors based on the music played.

I’m not sure any of the [non-Apple products] will be as successful at generating enthusiasm for consumer products, computer technology or gadgets as the late Steve Jobs. But I do think it’s best for those of us who buy these products that so many companies are trying.

I could not agree more.


Some, if not all of society’s most useful innovations are the byproduct of competition. In fact, although it may sound counterintuitive, innovation often flourishes when an incumbent is threatened by a new entrant because the threat of losing users to the competition drives product improvement. The Internet and the products and companies it has enabled are no exception; companies need to constantly stay on their toes, as the next startup is ready to knock them down with a better product.