Why Vertical Integration Made Tesla More Powerful
By: Behzad Benam
Tags: Supply Chain, Vertical Integration, Automotive, Automakers, Tesla

In the real world, the vertical integration of a complete supply chain is complicated. Companies integrate products vertically that are very strategic components, such as the battery for an electric vehicle. For example, Apple integrates vertically to control iPhone components such as OLED or touch ID, but Apple still has suppliers. Netflix is ​​another example of vertical backward integration from a distributor to create TV shows. Many successful companies, such as Nike, Starbucks, Zara, Amazon, etc. use vertical integration.

In the past, automakers became design companies, focusing on supply chain management expertise. With this strategy, car manufacturers have transferred all combustion engine vehicle knowledge to suppliers for free. In the short term, they reduced production costs with strong outsourcing, but they lost the ability to advance technology in the long term. So they all focused on horizontal integration, and with this strategy, the main focus was supply chain management, and they were successful for a long time. This is probably due to combustion engines' maturity and the lack of need for major industry changes.

Tesla recognized the complex supply chain in the automotive industry and revolutionized the industry by using vertical integration. Tesla has integrated many production steps from battery production to electric motor production and self-driving algorithms and a powerful central control system vertically.

Legacy car manufacturers get their parts from many suppliers, and this was the main reason why vehicle architecture could not be fully defined and enforced by car manufacturers. Suppliers tend to offer an ECU (control system) for each new functionality to make more profit. We are now facing a very complex, historically developed vehicle architecture, which is not optimal.

The number of electric vehicle components is less than traditional vehicles with combustion engines, which could be another reason for Tesla to benefit from vertical backward integration to produce batteries and electric motors. Tesla soon realized that traditional vehicles' complex supply chain was not optimized for vehicle construction and decided to act differently.

As Alex Voigt pointed out, what Tesla has achieved:

”The largest accomplishment of Elon Musk is to have inspired the people who wanted to change the world and to have given them the opportunity to do it.”

There is still much work in the automotive industry to change the industry from a combustion engine to a battery or fuel cell electric drive, considering software as the most important part. Experts need to rethink and design vehicle architecture from scratch. This different mindset allows the OEM to look at the issue from a different perspective and find which components are strategically important and should be integrated vertically and which should not.

The focus here should be on the whole ecosystem from design to production and operation, such as supercharger, battery production, battery thermal management, etc.

Tesla initially had no other way other than integrating products vertically in-house to push innovation as high as possible. Elon Musk believed that the production of strategic products in-house is the key to success. For example, for many reasons, in the case of battery production, you can optimize the battery, electric motor, and all the elements around it by yourself. Besides, there will be no dependence on the supplier. At the end of the day, innovations make the difference between industries and products. Initially, the cost of vertical integration is higher, but once you set it up, you will make more money.

Vertical integration is a method that other vehicle manufacturers will follow to further control the most important part of the supply chain:

Definition of vehicle architecture by OEM not by several different suppliers

More control over the production process and product quality

To optimize delivery time and reduce dependence on suppliers.

Supplier validation is too complex for future innovations.

There will be many innovations in new technologies such as electric vehicles, which are not in line with the traditional already established supply chain in the automotive industry. Automakers have to make many new design decisions when producing such complex products and force them by vertical integration to make the products mature enough. Once the components and design of an electric car have matured, it is likely that some of the components, such as the production of combustion engines in the past, will be outsourced.

This is the idea of the ”first principle” thinking to break down complex problems and find innovative solutions based on basic facts and ignore current solutions.

How about the future,

Carmakers will focus more on backward vertical integration and gradually replace suppliers' role, at least for new technologies such as electric vehicles. In the future, most suppliers will be startups with new ideas. They are either supported by investors to expand widely or taken over by automakers in the early stages of a startup. This is how OEMs can optimize their backward vertical integration process and product in cost and innovation. According to Elon Musk, Tesla is a chain of startups.

Additionally, automakers need to integrate vertically forward to provide mobility solutions based on artificial intelligence (AI) technology that is now largely driven by Google and Uber. Mobility solutions are changing by automated driving technology and the car-sharing business model.

In the future, the world will be more complex. The pace of technology change will be faster due to many disruptive markets such as artificial intelligence, connectivity, electrification, and cloud-based computing. These rapid changes require small, flexible, low-cost organizations such as startups to work on new needs and deliver innovations. This is another reason why the supply chain market needs to adapt from large to small organizations for greater flexibility in the face of rapid change.