Vendor to Partner to Competitor to Assassin

Following up on yesterday’s post on supply chain management, today we’ll discuss what happens when a company cedes too much power and control to a vendor.
Years ago Compaq (remember them?) was a leader in the PC industry. Now, they no longer exist. Why? In large part because they outsourced key parts of their business to a vendor that became a partner that became a competitor.
As Clayton Christensen put it in an interview; “there’s a tendency in the supply chain for the vendor in the emerging market to integrate forward until they hollow out their customer, and in many ways what they do is they commoditize their customers.
Christensen likes to cite Compaq. Like many electronics firms, Compaq outsourced parts of their product to off-shore companies. In this case, Compaq outsourced the simple circuit boards in their computers to Flextronics, a Singapore-based company. After a few years, Flextronics “came back to Compaq and said as long as we’re doing the circuit boards, let us do the whole mother board, because it’s not really your core competency, and we can do it for 20 percent less. Compaq says, you could do it for 20 percent less. If we outsource that to you we could get all of these circuit manufacturing assets off our balance sheet. They make the transfer, and Compaq’s revenues are unaffected, but its cost actually improved by 20 percent. At Flextronics, their revenue and profitability improved smartly. Wall Street likes what Compaq and Flextronics did.
Then Flextronics says, as long as we’re doing the mother board, why don’t you just let us assemble the whole computer, because that’s not really your core competency, and we can do it for 20 percent less.
Compaq looks at that and says, we could get rid of all our manufacturing assets. They make that transfer. Compaq’s revenues are unchanged but its profitability improves, and Wall Street really likes this. At Flextronics, revenue and profitability improve as well. Wall Street likes this too. This goes on as Flextronics takes over the manufacture of the whole computer followed by the supply chain.
From Flextronics’ point of view, it’s getting into value-added services now. So not only does its revenue improve, but its gross margins improve. Finally, Flextronics says, as long as we’re managing the whole supply chain for you, why even bother designing the dumb computer? That’s not really your core competency, and we’re dealing with all the component vendors anyway. Compaq says, yeah, our core competency really is our brand. We can fire all of our engineers if you do that for us.
So little by little the supplier in the Third World starts to eat their way up inside of the customer, and every step forward they take progressively trivializes the remaining value that Compaq adds, until in the end they’re providing almost no value and the company vaporizes.” [emphasis added] (quote from WorldTrade Magazine, The Supply Chain as ‘Disruptive Technology, December 12, 2006)
Compaq is to Big Insurance Co as Flextronics is to Big Managed Care Co., except it sounds like the folks at Flextronics moved a little slower, and were a bit less heavy-handed. Because what is happening in the market now is large payers (and small and medium ones too) are effectively outsourcing medical management to network/bill review/case management vendors. BigInsCo will argue that no, the adjusters are still in control – sure, just like the engineers were at Compaq. Meanwhile, BigMgdCareCo is busy figuring out how to maximize its revenue from BigInsCo.
And as we’ve seen, BigMgdCareCo succeeds when there are lots of medical bills with high medical charges.
So maybe my original thesis statement was wrong. Perhaps what’s really going to happen is not that managed care firms are going to ‘hollow out’ insurers, but instead they are going to bleed them dry.
And because the insurers no longer control the medical, there’s not a damn thing they can do about it.