Henry Ford’s name is forever linked to the Model T, the automobile that revolutionized manufacturing and transformed America. But it was the subsequent model, the Model A, that changed the way corporate America and our economy were structured.
Ford’s restless mind turned to better control over the production of the Model A and the Rouge River Plant began to take shape, first in his imagination and very quickly into reality.
“The Rouge” as it became known, was a complex of buildings in Dearborn, Michigan, where raw materials were converted into parts for assembly into automobiles. Within the Ford organization, the process was known as “from ore to automobile” and economists called the underlying concept “vertical integration.”
The Rouge River works had its own power plant, which generated all of its electricity needs and occasionally provided power for the local community as well. Rouge operations included a steel mill, whose raw materials came from Ford-owned iron ore mines in Michigan, coal mines in Pennsylvania and a safety glass factory. It was an integrated operation that controlled every stage of automobile production.
The idea for the integrated Rouge River works was Henry Ford’s and, significantly, the idea of how it would operate was the product of his entrepreneurial vision. He was fortunate, also, to have a son, Edsel, who understood the concept and ensured that it worked right. Not all vertical integration efforts were so well-conceived or fortunate.
The Rouge plant was mostly an internal development, although it did involve acquisitions of iron ore and coal mines. Vertical integration in today’s economy more often involve mergers and acquisitions. They are frequently the result of not some over-arching plan but dissatisfaction with suppliers either over quality or meeting delivery schedules, or both. Sometimes as well it results from a desire to insulate the parent company from the kind of wild price swings that can characterize commodity markets. In general, then, vertical integration moves through mergers or acquisition are efforts to control costs rather than prices.
Horizontal integration involves consolidations through mergers or acquisitions at the same level of production or sales. Examples include such things as a retail business acquiring a competitor’s stores, two wholesale distributors merging, or one airline purchasing another. The motivation or goal may often be profit margin improvement by eliminating duplicated operations. Still, this type of consolidation reduces the number of competitors in a market and, intended or not, has a direct effect on market prices.
In a recent development in business integration, CVS, the giant drugstore chain, recently announced plans to purchase the Aetna insurance company for $69 billion. Unfortunately for economists, analysts, and regulators, though, the consolidation of the two companies doesn’t fit comfortably into either a vertical or horizontal merger category.
The reason why it doesn’t fit the templates is that its purpose is neither cost and quality control nor profit margin improvement. Instead, the motivation behind CVS’s acquisition of Aetna is to launch both companies into a completely new business model, a one-stop shopping experience where customers can pick up their prescription drugs, get medical attention at a clinic, and process their billing and reimbursement claim through the on-site medical insurance service.
In theory, there is large opportunity for cost savings. Gone would be the mound of repetitive forms and assorted paperwork that still threatens to suffocate both suppliers and consumers of medical services. Gone also would be the wasted time in transportation, and wait times. It is not clear where doctors will fit into the picture, though, and that might prove to be a significant issue.
Still, one-stop shopping is a retail concept that has been tried before and found to be more difficult than it looks on a spread sheet. Sears’ one-stop shopping strategy in the 1970s, for example, turned in disappointing results. Obviously, though, that experience was not enough to dampen enthusiasm for the concept since the retailer is now pursuing the same strategy once again.
Analysts of the CVS-Aetna merger see it as changing health care as we know it. They may be right, but it is not clear what its effect on competition and its impact on costs to consumers will be. Because the acquisition does not fit into the usual categories of vertical or horizontal consolidation, it will be a challenge to federal antitrust regulators. They will be examining a new business model and trying to sort out the likely cost savings and calculate who is likely to claim them.
Besides launching a new business model, the CVS-Aetna merger may introduce another novel concept: an antitrust case that will capture the attention of the public. We haven’t seen one of those, really, since 1911 when the courts broke up Rockefeller’s Standard Oil Company.
James McCusker is a Bothell economist, educator and consultant.
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