From Horizontal to Vertical to Functional: A New Strategy for Growth in the 21st Century

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06/01/2015 Leave a comment

The conventional wisdom holds that corporations are wholly unique, each pursuing a differentiated vision and mission. Yet when it came to their overarching business strategy and formula for growth in the 20th century, nearly all of the members of the Fortune 500 followed a similar plan and model to become the diversified behemoths they are today. More importantly, this growth formula has largely run its course and is perhaps even counter-productive, necessitating a new growth formula for the 21st century. Fortunately, it is becoming clear what this new growth strategy looks like.

Nearly every member of the Fortune 500 began with a single innovative product or service that eventually found a receptive audience. A great example is Coca-Cola, invented in 1886 by a pharmacist in Atlanta, GA. Coca-Cola was the first beverage brand to employ the industrial age formula of mass manufacturing + mass distribution + mass communications to manufacture at scale, distribute beyond a local market and build awareness and demand with consumers.

But the exponential growth of Coca-Cola came through the application of this formula to a succession of new brands, growing horizontally to eventually dominate the beverage category. Some brands were invented (Diet Coke), while others were acquired (Minute Maid). This growth model – of adding brands to dominate a category – is called “horizontal integration.” And this was the primary growth strategy of every single maker of consumer products in the 20th century: from Coca-Cola to P&G to General Electric to General Motors to Microsoft. Our key example of Coca-Cola, which started as a single product sold from a single pharmacy in Atlanta, GA and serving less than 10 drinks per day, grew to become a global company with a portfolio of over 3,500 products sold in over 200 countries, serving an astounding 1.7 billion drinks per day! Source: Coca-Cola.

A second business strategy also emerged in the 20th century. This strategy focused on improving the efficiency of operations, cutting out middlemen to boost profitability. Called “vertical integration,” companies investigated each piece of the supply chain to find and remove inefficiencies. Some industries, like petroleum, are nearly 100 percent vertically integrated. However, even companies like Coca-Cola became more vertically integrated in recent years by acquiring the network of independent bottlers that handled distribution in local markets.

The history of business in the 20th century was the unfolding saga of horizontal and vertical integration. Today, nearly all of R/GA’s clients are reporting the same news: the strategy of growth through horizontal and vertical integration is no longer delivering the same kinds of results that it did in the past. In essence, these strategies are played out, with little incremental growth opportunity in mature markets like the United States or Western Europe.

Perhaps the biggest crimp on growth is the strategy itself. The process of horizontal integration has led to a marketplace in which products and brands have proliferated well beyond the point where any single brand has leverage with consumers. There is an overabundance of options in every major category. While Coca-Cola grew from one brand to over 3,500 products, its key competitor, Pepsico, grew from a single brand to over 200, not to mention other competitors including Dr. Pepper Snapple Group, Nestle and Danone. In this mature marketplace with a myriad of options available to consumers, the strategy of a new product, flavor or line extension coupled with extensive mass media can no longer deliver predictable growth. In essence, the primary growth strategy has led to commoditization.

A new growth strategy has emerged. And the successful application of this strategy has fueled growth in ways unprecedented in business history. In fact, the successful practitioners of this strategy became the most valuable companies in the world – in much the same way that the successful practitioners of horizontal integration, like Coca-Cola and P&G, became the most valuable companies in the 20th century.

This new generation of successful marketers is building entire “ecosystems of value” that blur together products and services in ways that deliver greater value to consumers. Each new piece creates an additional node in the ecosystem, further driving up value. What constitutes an ecosystem of value? There are increasing consumer benefits that accrue from buying into more nodes, while each node is also a potential entry point for new customers. We call this new marketing approach “Functional Integration.” The pieces are functionally connected in a way to reward deeper participation in the brand.

The textbook case study of Functional Integration is Apple. When Steve Jobs returned as CEO in 1997, the company was on the brink irrelevance. Its sole product, the Macintosh, had fallen to an all-time low in PC market share. Undeterred, Jobs unleashed a strategy of new products combined with unifying services that made Apple, at the time of this writing, the most valuable company in the world, with a market cap in excess of $650 billion. Source: Yahoo Finance

In 2001, Apple released OS X. Each new Macintosh came with a free copy of a software program called iTunes, enabling users to manage a digital music library. Less than a year after the introduction of iTunes, Apple introduced the third node in its ecosystem: the iPod. The interconnection between products and services was beginning to become more apparent. Mac+iTunes+iPod is a functionally integrated ecosystem of value. If you owned a Mac and used iTunes to manage your digital music library, then the purchase of an iPod made all the sense in the world. As a customer, you derived additional value by purchasing this next piece from Apple. The ecosystem continued to grow with the launch of the iTunes Music Store, the iPhone, the App Store, the iPad, and, most recently, iCloud. The success of this ecosystem is unprecedented in business history, with millions of consumers owning or using every single piece.

Apple is not the only brand practicing Functional Integration. Companies like Google and Amazon have created similar ecosystems. Lest we think that Functional Integration is just a strategy for technology companies, it’s actually happening just about everywhere. In the era of networked media, Functional Integration is the best way to de-commoditize brands and create new reasons for consumers to buy more.

Other companies from outside the technology field are pursuing a similar strategy. Nike is the world’s largest manufacturer of athletic apparel with a horizontally integrated portfolio of products for just about every major athletic activity. Starting with the launch of Nike+ in 2006, Nike became a company offering a combination of products AND digital services, including a new algorithm of athletic activity called NikeFuel.

Car companies are racing to invent the “connected car.” Dozens of companies, from Nest to Philips to SmartThings, are working to invent the “connected home.” And “connected health” is now the goal of hundreds of startups. From the Internet of Things to “Connected Everything,” the future of business is the integration of products with digital services. And the goals of Functional Integration are the most powerful force transforming the consumer electronics industry right now.

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