In the internet economy, old-fashioned supply chains are disintegrating at a lightning pace. The web is accelerating the disintegration in every industry by eliminating the cost advantages that used to come with keeping everything together under one roof. Indeed, we are rapidly getting to the point where vertically integrated companies will be at a distinct disadvantage when trying to compete with companies that utilize virtual supply chains. Companies held hostage by in-house suppliers will be slower and less able to respond to changing products and markets. To understand why this is happening, we need to look at the glues that have held supply chains together for so long.
Transaction costs with suppliers are just about the stickiest.
The costs of establishing a relationship with a third party, such as qualifying quality, negotiating costs, developing agreements around intellectual property rights and planning for joint investments, can be overwhelming. In fact, simply finding suitable vendors can be a showstopper. For example, in the early days of outsourcing for industries like toys or apparel, managers spent weeks traveling in Asia looking for suppliers. Once the companies get suppliers on board, there are the routine transaction costs to deal with, such as employing buyers to make the purchases and logistics managers to oversee the flow of materials between the suppliers and the factory. For vertically integrated firms, these transaction costs still exist but are often hidden in overhead structures, giving the impression that it is cheaper to produce rather than to buy.