Apple and the Vertical Integration Dance

NEW YORK (TheStreet) -- What distinguishes today's "device economy" from yesterday's "PC economy" is the tight control brands have over their ecosystems.

Back in the day, long before Y2K, this question seemed settled. Apple ( AAPL) failed as the sole-source supplier for the Macintosh because it could not scale production to meet demand. Microsoft ( MSFT) won the market, despite being five years behind with its Windows software, because it gave its partners freedom.

That wasn't the Microsoft brand on your PC, and Microsoft didn't veto applications running on Windows. In fact, when Microsoft made its first tentative effort to control software markets, through its Internet Explorer browser, the U.S. Justice Department swatted it down, tying it up with lawyers who kept Microsoft from doing much of anything interesting for years and years.

China made Steve Jobs' revenge possible. Chinese OEMs could produce plenty of iPods, iPhones and iPads to meet demand, leaving Apple free not only to design as it wished, but to control what it designed.

Now Apple calls the tune and everyone -- even Microsoft -- must dance to it. Microsoft's creation of what Slashgear calls the Xbox Music Service is derided because it follows this trend. My name is on the box, so I control the market the box creates -- that's Apple talk.

The bigger story is what happens before the sale. Apple has created a race toward complete vertical integration. Apple controls the chips, it controls the assembly process, its stores do the selling and that "giant sucking sound" you hear is profit going into its Cupertino, Calif., headquarters.

Intel ( INTC) has been hit hard by this trend. Device makers prefer the control they get from tweaking ARM Holdings ( ARMH) designs to being dependent on Intel chips.

Amazon.com ( AMZN) is taking this a step further with its reported move to acquire Texas Instruments' ( TXN) mobile chip division, as reported by The Next Web.

It's a good deal for TI, which can grow faster in markets like embedded chips for cars and power delivered over Ethernet networking systems, than with bulk orders of mobile chips to Amazon. Since it's not selling its foundries, it will still be making money on what Amazon produces. Amazon simply gets control of the design and the design process.

All this is aimed at squeezing ever-thinner margins out of markets measured in the hundreds of millions of units every quarter, according to Gartner Group estimates. You need competitive features, you need to update the whole product line at least once a year, and you have to hit those price points -- $200 on the low end, $500 on the high end -- or forget it.

To do that Apple's rivals have learned they need to control everything from the design of the chips to their assembly, and from their sale to the after-market the sale creates. In this Amazon, Google ( GOOG) and Microsoft all face the same hardware problem, while Samsung and Chinese companies from Lenovo to Alibaba all face the same software problem.

Sure, Apple has its own problems. Its assembly partners face labor concerns, which can spill over into problems for the brand, illustrated by a recent "Saturday Night Live" sketch. But in order to remain competitive, all these other companies have to risk the same problems.

Dancing to Apple's tune means more than killing your after-market ecosystem, dominating the software, content and hardware sales resulting from your sale of a device. It also means controlling how that device is made, and what goes into it.

Now that the pattern is established, the question becomes whether this will remain under American control. For 2013, watch what Samsung, Lenovo, Alibaba and Sony ( SNE) decide to do for an answer.

This game has just begun, and it's going global.

At the time of publication, the author had positions in AAPL, MSFT, GOOG, TXN and INTC.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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