Vertical Integration

Before a product reaches the customer, it passes through many stages. For bread, these are roughly grain cultivation, milling, baking, and sale in a shop. Normally, each stage is handled by a different company, and the firms buy from one another. Vertical integration means: a single company takes on several of these stages itself. The bakery then also runs the mill and its own shop. The counter-concept is specialization in a single stage, where everything else is bought in.

Why tech giants want the whole chain

Whoever owns several stages is less dependent on suppliers. This is especially important in the AI industry. The fast specialized chips for AI computations are scarce and expensive, and a single manufacturer dominates the market. Whoever can design their own chips doesn’t have to wait and doesn’t have to accept any price.

A second advantage is margin. Each stage normally earns something from the next. Whoever operates the stages themselves keeps this profit in-house. This explains why companies like Google, Amazon, or Apple pour billions into their own chip development, even though they could buy finished chips.

But there is a downside. Each additional stage costs capital and expertise, and it ties the company down firmly. If better technology comes from outside, a vertically integrated company finds it hard to simply abandon its own factory. Specialists are often faster and cheaper than the conglomerate that does everything itself.

The stages of AI value creation

In the AI industry, roughly four stages can be distinguished. At the bottom are the chips, i.e., the computing units. Above these lie the data centers, where thousands of these chips work together. Above that come the models themselves, i.e., the trained programs that generate text or images. At the very top are the applications that users actually work with, such as a chatbot or a search function.

A company becomes integrated by acquiring stages or by building them itself. Acquisition is faster: one takes over a company that already develops chips. Building it yourself takes years but provides more control. Both fall under the same term.

It is important to distinguish this from horizontal integration. Horizontal means that a company acquires competitors at the same stage, for example a bakery acquiring the bakery on the next street. Vertical means expansion upward or downward in the chain. Antitrust authorities look at both forms, but assess them differently.

Vertical integration in news and products

The best-known case is Apple. The company designs the chips for its devices itself, builds hardware and operating system, and sells apps through its own store. That is precisely why the iPhone chip and iOS fit together so precisely. That is also precisely why Apple repeatedly clashes with authorities who see its own App Store as an abuse of power.

In AI news, the term often hides behind other phrasings. When a headline says that a corporation is unveiling its own AI chip, it’s about vertical integration. The same applies to news about proprietary data centers or stakes in chip factories. The statement that a provider controls the entire stack also means exactly that.

For investors, the degree of integration is an important metric. It indicates how stable a company’s profits are and where it remains vulnerable. A model provider without its own chips depends on its supplier’s prices. A common misconception, incidentally, is to equate vertical integration with monopoly. It only describes the reach across the chain, not the market share at a single stage.