Digital Robber Barons and Digital Vertical Integration

I love talking about business models because in the end, it’s usually the best business model, not the best technology, that wins the day. And digital transformation has the potential to reinvent business models by leveraging superior customer, product and operational insights to disrupt industry value chains and disintermediate customer relationships (see Figure 1).

Figure 1: Leveraging Data and Analytics to Reinvent Business Models

As the title of the book “Moneyball” states (“Moneyball: The Art of Winning an Unfair Game”), some of these reinvented business models will be based on “winning an unfair game”.  We have historical lessons about how Robber Barons[1] of the late 1800’s created and won “an unfair game” that gave them monopoly power over suppliers, customers and competitors.  To create this unfair game, Robber Barons leveraged a concept called “vertical integration” to dominate industry value chains and construct indissoluble customer and supplier dependencies.

Let’s review the lessons of these Robber Barons to understand how digital transformation might enable modern companies to win the digital unfair game.  

Vertical Integration History Lessons

Back in the late 1800’s, Robber Barons exploited vertical integration – which is the combination within one company of two or more stages of production or value creation normally operated by separate companies – as the way to reinvent business models. Vertical integration is a strategy whereby a company owns or controls its suppliers and/or distributors in order to optimize its value chain and de-risk its business models. Vertical integration benefits companies by allowing them to optimize key internal processes, shift costs and risks to dependent value chain players and improve operational efficiencies.

These Robber Barons leveraged vertical integration to create “economic moats” that locked out and blocked potential competitors. The term “economic moat”, popularized by Warren Buffett, refers to a business' ability to maintain competitive advantages in order to protect its long-term profits and market share from competing firms while charging monopoly-like prices to its customers and onerous terms to its suppliers. Just like a medieval castle, the moat serves to protect the riches of those inside the castle from outsiders[2].

Andrew Carnegie is an example of a Robber Baron who used vertical integration to create economic moats for Carnegie Steel. Carnegie Steel (later U.S. Steel) became the dominant steel supplier in the U.S. through the vertical integration of the steel value chain process.  Carnegie owned not only the steel mills that produced the different grades and types of steel, but Carnegie also owned the iron ore mines that was the main ingredient in steel production, coke/coal mines that powered the blast furnaces from which steel was produced, and the railroads and shipping that transported the iron ore and coke to the steel mills and the finished steel products to its customers[3] (see Figure 2).

Figure 2: Carnegie Vertical Integration.  Source: Unknown (but it’s pretty cool)

Today we are witnessing digital-first companies leveraging “digital vertical integration” to disrupt business models, reinvent customer relationships, and power their digital transformation initiatives.  A new breed of Digital Robber Baron has emerged who is mastering digital vertical integration to create a business model that generates data that is the source of value (the iron ore and coal/coke equivalents), the advanced analytics that codifies and scales those sources of value (the resulting steel equivalent) and the store fronts, customer experience and logistical excellence that delivers the final product or service to the customers.

Digital Vertical Integration

There may be no better example of a modern company exploiting vertical integration to disrupt traditional business models and reinvent customer relationships than Amazon (see Figure 3).

Figure 3: “Visualized: A Breakdown of Amazon’s Revenue Model” from the Visual Capitalist https://www.visualcapitalist.com/amazon-revenue-model-2020/

The Amazon Digital Vertical Integration virtuous digital transformation cycle involves:

• Step 1) Providing a wide-array of store fronts and services including online stores, subscription services (Amazon Prime, Prime Video, Prime Music), physical stores (Whole Foods, Amazon Books) and even an online marketplace that provides the iron ore and coal/coke equivalent for the modern Robber Baron,
• Step 2) Providing the data and analytics platform (Amazon Web Services) that converts the store front and services data and converts that into customer and product insights (mathematical propensities as to what products what customers are likely to buy when and at what prices).  And what the heck, how about getting your customers (and competitors in some cases) to fund the continuing expansion of the AWS data and analytics capabilities (e.g., RedShift, SageMaker) which is the equivalent to the Carnegie Steel Mills, but with ridiculously better margins (see Figure 4),
• Step 3) Use the customer and product insights and propensities gleaned from the data using the AWS analytics platform to drive logistical, marketing and merchandising optimization and monetization efforts in the store fronts, services and market places.
• Step 4) Even create your own logistics and delivery services that helps ensure a timely and successful customer experience (and collects even more logistics data in the process for later mining and monetization).

Figure 4: Source: AWS Artificial Intelligence and Machine Learning Architecture

Absolutely brilliant…unless you are an Amazon competitor.

Summary

The digital robber barons 1) harvest customer, product and operational data through customer-facing business models and 2) sell (as a service) the data management and AI / ML platform that mines and codifies the customer, product and operational insights and propensities buried in that data.  These insights and propensities are subsequently monetized via a hyper-personalized customer experience as well as pricing, merchandising, inventory and logistics optimization that creates even more customer, product and operational data that can be subsequently mined and monetized.  It’s a virtuous cycle that leverages digital vertical integration to combine multiple high-value steps of the production process within the same organization.  

In the future, Amazon’s digital vertical integration prowess could enable them to seamlessly move into new industries including financial services, healthcare services, or educational services. Amazon has already created the data and analytics infrastructure and capabilities necessary to uncover the customer, product and operational insights necessary to excel in those new industries.

As I like to say, “the economies of learning are certainly more powerful than the economies of scale” and it looks like the modern Digital Robber Baron can exploit both economies of learning (with respect to continuously-learning and adapting customer, product and operational insights) as well as economies of scale (with a data and analytics platform that can almost scale infinitely). See Figure 5.

Figure 5: Economies of Learning More Powerful Than Economies of Scale

Old school robber barons…meet the modern digital robber barons!

[1] A Robber Baron is a person who has become rich through ruthless and unscrupulous business practices (originally with reference to prominent US businessmen in the late 19th century). https://en.wikipedia.org/wiki/Robber_baron_(industrialist)

[2] What Is an Economic Moat? https://www.investopedia.com/ask/answers/05/economicmoat.asp?utm_source=twitter&utm_medium=social&utm_campaign=shareurlbuttons

[3] “Carnegie Steel: Building a Modern America” https://digital.hbs.edu/platform-rctom/submission/carnegie-steel-building-a-modern-america/