Vertical Integration is Economics not Engineering

The integration of hardware and software is the holy grail for tech companies. It is most associated with Apple, but it also explains the recent stunning success of NVidia.

But what does vertical integration mean exactly and why is it so important?

A common way to think of vertical integration is to have hardware and software that works well together, each adapted to the other.

But if this were all, open source should work just as well. Android OEMs are free to adapt android to their phones, and so android phones should be just as vertically integrated as iPhones.

In fact, the key to vertical integration is that software is closed source and that the only way to use it is to buy certain hardware.

Economically, software and hardware excell at different things:

• Software locks you in. When you are used to certain software, using anything else is painful.

• Hardware is something you’re willing to spend money on.

The moment-to-moment experience of using a device is determined much more by the hardware then by the operating system. How does the keyboard feel when you type? Do the characters appear immidiately? Is syntax highlighting and intellisense immidiate? Is the device getting noisy or hot?

But hardware is a commodity. Even if you are satisfied with your laptop, you will not pay much of a premium to buy a laptop from the same OEM and the same CPU manufacturer again.

This limits the resources that hardware companies can invest in research.

If Intel or AMD make a better chip, they can only charge a premium until the other has caught up. They have to earn the money they invested back very fast.

If Apple makes a better chip, more people buy Apple devices and lock themselves (and even their friends and family) into the Apple ecosystem forever.