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Vertical integration on the rise

VERTICAL INTEGRATION is becoming an issue in the commercial vehicle market, particularly the truck market, and is being driven by OEMs' desire to reduce costs.

That's the opinion of George Taylor, general manager of the truck engine division/power systems marketing division for Caterpillar Inc. Taylor made a Heavy Duty Dialogue presentation, “Global Truck: How Far Will the Industry Take Vertical Integration and Harmonization?”

Taylor said that vertical integration means that OEM truck manufacturers will determine which components are available on the truck, and in most cases, all or many are manufactured by the truckmakers themselves.

“What's in it for business?” Taylor said. “OEMs obviously see increased profitability opportunities and the potential for better productivity. The questions from a business standpoint are, ‘Will it be done? Does it make sense for everyone to go down this path? Do OEMs have the core competencies to do this? Do they have enough unit volume to be successful with vertical integration?’

“Caterpillar spent over a million dollars inventing ACERT technology, and we spread that R&D investment across a $12-billion engine business. Can all OEMs really do this effectively? Do they have the core competency, even the bigger ones, to be successful? At Caterpillar, we are highly vertically integrated. With some of our products, however, we frequently leverage joint-venture partnerships to deliver breakthrough technological solutions for our customers. Is there, or should there be, a place in the market for a company that carves out customer choice as a differentiating and sustaining competitive advantage? Because some OEMs choose vertical integration, does that mean all truck manufacturers should do this?

“This should or could cause some companies to lose their identity. The most profitable OEMs over the last 20 years are the ones that are the least vertically integrated. Are there other options? The auto industry has been successful with tier one suppliers who essentially provide an entire system, as opposed to OEMs who provide everything themselves. Why can't this work for trucks?”

Demise predicted

Is complete vertical integration inevitable? Taylor said the purveyors of vertical integration have been predicting the demise of independent component suppliers for some time.

“Nevertheless, we realize that relationships for independent component manufacturers such as Caterpillar with our key OEM customers will have to change,” he said. “In the future, they will. But does that mean vertical integration? Are there some other choices that will be more financially beneficial to OEMs, and especially to customers?

“Our strategy at Caterpillar has been, and still is, to develop a process of virtual integration. We plan to differentiate ourselves with superior technology provided to a number of different OEMs. What's in it for the customers? The question is whether the North American truck fleet customer will accept the famous Henry Ford choice: any color as long as it's black.

“While some believe we will see lower costs from OEMs due to vertical integration, many of them don't want to change technology or lose the dealer support that Caterpillar and other independent component suppliers provide. They also don't want to have to retrain their technicians to another technology or be totally dependent on OEMs to provide them the best-in-class for all critical components in the truck. We believe the market will choose several approaches to solving this. Caterpillar is dedicated to being a solutions provider that drives customer advantage with superior value. In fact, we were frequently asked by customers to consider providing additional components as part of a total solution. In many cases, this goes beyond the engine. It may mean we need to work closely with other component manufacturers to find ways to add value, which could mean a total vehicle design or, in some cases, unique dealer support for pre- or post-product installation.”

He said there are two other issues: harmonization and globalization.

He defined harmonization as the process of merging all the truck standards and regulations for emissions, safety, and even vehicle configuration into one standard on a worldwide basis.

He said it's being driven by the desire for a global engine, which OEMs and engine manufacturers are striving for. It also means having one set of standards for emissions and safety on a worldwide basis.

“It looks like the worldwide standards for various types of equipment will converge into a single standard somewhere in the 2012-2014 time frame,” he said. “Whether it's a component manufacturer or an OEM, the ability to manufacture one product that can be used in all, or virtually all, markets would be helpful. This will not only reduce the complexity and expense of providing multiple products for each market but should also result in reducing or at least containing the ultimate price of trucks or other commercial vehicles for the end-user customer. It'd be good for component manufacturers and OEMs as well as for customers if there was one worldwide standard.

“What would it look like for customers? End users would have more environmentally friendly products but in some countries, sticker shock could be so substantial because the cost of trucks and other commercial vehicles in today's lesser regulated markets would have to be substantially higher. The environmental pressure on a worldwide basis as well as the need to contain costs is heading us in the direction of global harmonization.”

He said emerging markets such as India, China, and eastern Europe are increasing the demand for trucks.

“What's in it for business?” he said. “Revenue and profit gains while participating in these markets either as an importer or as a joint-venture partner with a producer in a local market. But there is another opportunity for OEMs and component manufacturers, which is to reduce component costs by manufacturing key parts in these emerging markets and then exporting them to other countries where they have assembly plants. Some of this is already happening in the auto market and beginning to pick up momentum in the truck market as well.

“So what's the benefit to the customer? Certainly better products and more choices. It also may provide the ability to mitigate the ever-increasing cost of providing this new technology. A big benefit for the host country means not only jobs, but economic growth as well. If properly handled, this could be a win-win for business as well as end-user customers.”

He defined globalization as a situation where some major components such as engines, and to the extent possible, the truck as a whole, would essentially be the same anywhere in the world.

“At Caterpillar, we strongly believe that globalization is being driven by customer needs,” he said. “Customers today expect the same quality and availability of your products any place in the world they choose to do business. They also expect new technology solutions. Not just the product itself but on an integrated basis before, during, and after the sale. Customers also require support availability on a consistent basis anywhere in the world today.

“What's the impact of this in business? It means better productivity. Being able to manufacture a consistent product on a worldwide basis can generate increased market share and especially customer satisfaction if it's properly delivered. It also means the potential for profitable and healthy dealer networks around the world.

“There's no magic pill for success. It takes a vision, it takes a plan, it takes a strategy, and then, as Larry the Cable Guy would say, ‘You've just got to get it done.’”

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