LG and Vertical Integration (Ch 10)

Backward Vertical Integration          

LG owns several companies that make components that are used in LG products. In this example, we see LG producing a new smartphone using a battery developed by LG Chem (a chemical company that LG bought out). Other components like the screen were developed by their subsidiary, LG Display.

Interestingly, the processor for the new smartphone is being supplied by Qualcomm. So why has LG chosen to vertically integrate displays and batteries but not processors?

We need to look at several of the "rules" of vertical integration to understand this.

Proposition 3 says that when another firm has valuable, rare and costly-to-imitate resources but that are too costly to acquire, don't vertically integrate. On the other hand, Proposition 4 says that you should vertically integrate when the firm has business functions that are valuable and has resources and capabilities that are costly to imitate. 

It could be that integrating microprocessor manufacture is very costly. It may not add much value either as microprocessors are practically a commodity and LG only needs to achieve parity with competitors when it comes to processing power in their phones.

On the other hand, the most important ways to differentiate smartphones are around the things that users care the most about: Size and weight, display and battery life. Using three subsidiaries, LG Chem, LG Display and LG Innotek, LG has integrated the capabilities that will give their phones the most competitive advantage. To some extent, this is a implementation of Proposition 4.