Disruption, disintegration and the
dissipation of differentiability
Clayton M. Christensen, Matt Verlinden and George Westerman
This paper proposes a deductively derived model to help managers who preside
over decisions to integrate or outsource to assess ex ante whether, when and why it
might be strategically and competitively important to develop internal capabilities
to perform certain activities in-house, and when it would be sensible and safe to
outsource elements of value-added. Among the paper’s conclusions are that the
competitive advantage from vertical integration is strongest in tiers of the market
where customers are under-served by the functionality or performance available
from products in the market. Vertical integration tends to be a disadvantage when
customers are over-served by the functionality available from products in the
market. Vertically integrated firms will therefore often dominate in the most
demanding tiers of markets that have grown to substantial size, while a horizon-
tally stratified, or disintegrated, industry structure will often be the dominant
business model in the tiers of the market that are less demanding of functionality.
1. Introduction
Whether to become or remain vertically integrated is a question of vast strategic
importance inmany industries. In recent years, firms such as Alcoa, Lucent and General
Motors, for whom vertical control over most steps in their value chains had historic-
ally constituted an important basis of competitive advantage, have sold upstream
businesses that produced components or intermediate materials, in order to focus on
the portions of their value chains that they consider to be core to their business. Others,
like IBM, continue to own but are de-coupling upstream from downstream operations,
tasking the former to sell components openly in the market, and the latter to procure
components from external suppliers when necessary to maintain competitiveness. In
contrast, Microsoft is aggressively integrating downstream from its initial operating
system products into a variety of applications software markets; Intel has integrated
into chipsets and motherboards using its microprocessors; and telecommunications
and entertainment companies have integrated together in bewildering ways.
Some business experts have praised these actions, while other reputable observers
have reacted with skepticism. For example, IBM’s management have been criticized
for having outsourced the microprocessor and operating system of their personal
computer from Intel and Microsoft, choosing to participate primarily in the design and
Industrial and Corporate Change, Volume 11, Number 5, pp. 955–993
© ICC Association 2002

assembly stages of value-added in their product. While history has proven the decision
to have been unfortunate for IBM, at the time the decision was made it was judged by
many as the right thing to do.
1
It has indeed been difficult to predict, a priori, which of
these moves toward or away from vertical integration would be judged in retrospect as
having beenmanagerially astute, and which would be viewed as strategically flawed. Too
often for decisions as important as these, their wisdom can only be judged with the
benefit of history.
This paper proposes a deductively derived model to help managers who preside over
decisions to integrate or outsource to assess ex ante whether, when and why it might be
strategically and competitively important to develop internal capabilities to perform
certain activities in-house, and when it will be sensible and safe to outsource elements
of value-added. Our conclusions are that:
1. The competitive advantage from vertical integration is strongest in tiers of the
market where customers are under-served by the functionality or performance avail-
able from products in the market. Vertical integration tends to be a disadvantage
when customers are over-served by the functionality available from products in the
market.
2. As a result of (1), vertically integrated firms will often dominate in the most
demanding tiers of markets that have grown to substantial size, while a horizontally
stratified, or disintegrated, industry structure will often be the dominant business
model in the tiers of the market that are less demanding of functionality.
3. The tendencies listed in (1) and (2) occur in end-use markets for complete product
systems, such as automobiles and computers. But they also can occur in the markets
for subsystems and components, which themselves comprise multiple constituent
parts and materials.
4. Most often, vertically integrated firms tend to dominate many markets at the outset.
Because of the patterns observed in our earlier studies, however—in which the pace
of technological progress proceeds at a faster rate than customers in any given tier
of the market can utilize that progress—the dominant business model in any given
tier of the market will tend to shift over time from vertically integrated firms to a
horizontally stratified population of specialized firms.
5. The generalization in (4) can be reversed, however, when performance gaps emerge
in markets due to discontinuous shifts in the functionality demanded by customers.
When this occurs, the pendulum of competitive advantage is likely to swing back
toward vertically integrated firms, as companies seek to compete with each other on
the basis of superior product functionality again.
6. When the dominant business model in a tier of the market shifts from vertical
integration to horizontal stratification, the ability to achieve above-average profit-
ability tends to transfer from the firms that design and assemble end-use products
that historically had not been good enough, to those that build those subsystems
1
See, for example, the discussion of IBM’s outsourcing decisions in Fortune, 14 April 1997.
956 C.M. Christensen,M. Verlinden and G.Westerman