What is Fragmentation?
The term fragmentation refers to a supply chain divided into different parts. In simple terms, companies divide the production process between different suppliers and manufacturers when they fragment. Thus, companies use separate component suppliers and manufacturers to produce their goods and services.
These entities are often located in different countries, especially where labor is abundant and inexpensive. This allows companies to produce goods more profitably. Fragmentation has been made possible by improved technology and globalization.
Key points to remember
- Fragmentation involves the production of goods and services using separate component suppliers and manufacturers.
- Companies often produce their goods and services in parts of the world where labor is cheap and plentiful, making the process more cost effective.
- While globalization and improved technology are major causes of fragmentation, labor forces, economic conditions and regulations also contribute.
- Fragmentation can benefit developing countries but can lead to the exploitation of workers.
- Fragmentation of firms, markets and industries are three different types of fragmentation that occur within the economy.
Understanding Fragmentation
As stated above, fragmentation involves the use of different suppliers and manufacturers in the production process. Companies are fragmenting to reduce production costs, even if it means going abroad. Developing countries with cheap and abundant labor are commonplace, like those in Asia and Latin America.
Companies that operate in developed economies are looking for the necessary components as well as the potential suppliers available. They then use the cheapest places to source and assemble the parts for their finished products. For example, companies may source cheaper materials from one country and cheaper labor to produce their goods in another while the finished product ends up being sold in another country.
The process is often associated with globalization as companies seek to use the most profitable suppliers. Globalization and improved technology have paved the way for fragmentation as it becomes increasingly cheaper and easier to source, ship and track goods as they travel from one place to the other. Fragmentation is common in the electronics, transportation and apparel industries. Canada, Ireland, China and Mexico were the main suppliers of intermediate goods to the United States in 2019.
Free trade agreements can often provide countries with duty-free access to labor and materials. For example, the USMCA and its predecessor, NAFTA, put this in place between the United States, Canada and Mexico.
Special Considerations
As stated above, globalization and technological improvements are among the main reasons for fragmentation. But there are also other related reasons that lead to it:
- A shortage of unskilled labor in some developed countries, which may cause companies to look elsewhere to fill the gap.
- A slowdown in the economy and market dynamics can force companies to cut costs and look elsewhere to pick up the slack.
- Government intervention can lead to policy and regulatory changes, forcing companies to move production to areas where restrictions are looser or do not exist at all.
Imports of intermediate goods (components) increased by 48% between 2009 and 2016.
Advantages and disadvantages of fragmentation
Advantages
The most obvious advantage of fragmentation is its cost effectiveness. By sourcing from different suppliers and manufacturers, businesses are able to cut costs. This benefit can be passed on to the consumer, resulting in more affordable goods and services.
Developing countries benefit because of the increased demand for labor and materials. Local people are able to find employment and may be able to upgrade their skills when companies come looking for labor to source materials and produce their goods and services.
All of this helps businesses become more profitable, which benefits the economy. When corporate profits increase, companies invest more and they grow. This often leads to the following:
- Employment growth
- More money in consumers’ pockets
- Increase in production levels
- An increase in demand for products and services
Disadvantages
While finding cheaper labor and materials can be a boon for countries of origin, it can often come at a cost, especially in developing countries. In some cases, companies may end up exploiting the local workforce. For example, cheaper labor can mean low wages, long working hours and unsuitable working conditions for workers. additionally, employees may not be able to advance to acquire more skills.
The search for cheap labor and materials is often at the expense of the local market. Outsourcing the production and manufacturing process takes jobs away from domestic workers, which means increased unemployment in the company’s home country.
Product quality may also suffer due to the use of cheaper labor and materials. Going overseas to produce goods can also lead to this problem, as laws and regulations vary from country to country. For example, some countries may use items like lead paint in the production of their goods and services while others no longer use them.
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Cost reduction helps businesses and can be passed on to consumers.
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Employment increases in developing countries
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Rise in corporate profits, which benefits the economy
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Exploitation of local labor
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Outsourcing leads to unemployment in the company’s home country.
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Declining quality of goods and services
Types of Fragmentation
Business fragmentation
When a company fragments, certain aspects of its structure separate. This includes business direction, processes, procedures, infrastructure and business location. In many cases, business fragmentation can lead to inefficiencies and even losses.
Market fragmentation
This type of fragmentation can also be called market segmentation. This happens when market players are segregated or segmented into different groups based on their needs, especially consumers. This allows businesses to identify and target certain trends based on how individuals consume goods and services, thereby increasing efficiency and profits. Markets can be fragmented based on behavior, demographics or geography.
Industry fragmentation
Fragmentation occurs when there is no clear leader within an industry. This means that although many companies may operate in a specific sector, none of them has sufficient market share to influence prices, production, investments and their competition. Profitability is not an issue when industries are fragmented. Instead, it simply means new entrants to the market have few hurdles ahead of them.
Example of fragmentation
The airline industry is one that has experienced great fragmentation. Not only does metal need to be acquired, but larger items, such as electronic systems, also need to be assembled. Companies often source these materials in addition to the labor from countries where they are cheaper.
For example, an airplane may have the following elements:
- Its wings made in Germany with metals from Africa
- Its electronics created in Japan with chips made in China
- Glass in China
- Seats assembled in Mexico with textiles and Indian thread
Suppliers and manufacturers ship components to the United States where they are assembled and sold as a final product.
What is media fragmentation?
Media fragmentation involves the division of media, giving consumers more choice in the type of content they receive. For example, the industry is divided according to target audiences, such as conservative audience, left-leaning consumers, teenagers, fashion-loving people, and sports enthusiasts, among others.
The industry is further fragmented by how consumers receive their information, from television and radio to newspapers and digital sources.
An industry that is far too fragmented can often be problematic as outlets can struggle to reach their target audiences.
What is habitat fragmentation?
Habitat fragmentation occurs when large areas of habitable land are fragmented and segmented or destroyed. It is most often linked to land development by man and natural forces (land erosion, climate change, natural disasters). This can have an impact on the ecosystem, biodiversity and animal populations.
What is fragmentation in computers?
Fragmentation in computers is the storing of a single file in several different locations on a hard drive or other storage devices. Thus, these fragments or pieces are scattered in different areas. This often happens when people create, move, modify or delete files. This type of fragmentation can cause computers to slow down in speed and efficiency.
The essential
Fragmentation is a very important part of economics. Whether caused by globalization, regulatory changes or market forces, the goal is normally to reduce costs and increase profits. But like any other story, there are downsides to this process too. Businesses need to balance their bottom line with the issues of exploiting cheap labor and outsourcing while ensuring consumers continue to get quality goods and services they expect.