Fragmentation: Definition, Examples, Pros and Cons in Business

What Is Fragmentation?

The term fragmentation refers to a supply chain that is broken up into different parts. Companies spread the production process across different suppliers and manufacturers when they fragment. As such, companies use separate suppliers and component manufacturers to produce their goods and services.

These entities are often in different countries, especially where labor is plentiful and inexpensive. This allows companies to produce goods more cost-effectively. Fragmentation was made possible by improved technology and globalization.

Understanding Fragmentation

Fragmentation involves using different suppliers and manufacturers in the production process. Companies fragment to reduce production costs—even if this means going abroad. Developing nations with cheap and plentiful labor are common locations, such as those in Asia and Latin America.

Firms that operate in developed economies research the components needed and find available suppliers. They then use the cheapest sites to source and assemble the parts for their finished items. For instance, companies may source cheaper materials in one country and inexpensive labor to produce their goods in another while the finished product ends up being sold in yet another country.

Globalization and improved technology paved the way for fragmentation, as it becomes increasingly cheaper and easier to source, ship, and track goods as they travel from place to place. Fragmentation is common in the electronics, transportation, and apparel industries.

In 2022, supply chains were affected by the COVID-19 pandemic as consumers saw shortages of products on shelves and price increases for those products. Global suppliers and sources of items such as computer chips, coffee, and lithium for electric vehicle batteries were impacted by the challenges of lockdowns and shipment issues.

Special Considerations

As noted above, globalization and improvements in technology are among the main reasons why fragmentation occurs. But other related reasons lead to it:

• A shortage of unskilled laborers in some developed nations can push companies to look elsewhere to fill the gap.
• A slowing economy and market dynamics may require companies to cut costs and look elsewhere to pick up the slack.
• Government intervention may lead to changes in policy and regulation, forcing companies to move production to areas where restrictions are looser or don't exist at all.

Advantages and Disadvantages of Fragmentation

Advantages

The most obvious benefit of fragmentation is its cost-effectiveness. By going to different suppliers and manufacturers, companies can cut their costs. This benefit can be passed on to the consumer, resulting in more affordable goods and services.

Developing nations benefit because of the increase in demand for labor and materials. Local populations gain employment and may be able to boost their skills as companies search for source materials to produce their goods and services.

All of this helps companies become more profitable, which benefits the economy. When corporate profits rise, companies invest more and they grow. This often leads to the following:

• Job growth
• More money in consumers' pockets
• Rising production levels
• An increase in the demand for products and services
  

Disadvantages

While the search for cheaper labor and materials may be a boon for source countries, it can often come at a cost, especially in developing nations. In some cases, companies may end up exploiting the local workforce. For instance, cheaper labor may mean low wages, long work hours, and unsuitable working conditions for workers. in addition, employees may not be able to advance to get more skills.

The search for cheap labor and materials often comes at the expense of the local market. Outsourcing the production and manufacturing process takes jobs away from domestic workers, which means an increase in unemployment in the company's home nation.

Product quality may also suffer because of the use of cheaper labor and materials. Going abroad to produce goods can also lead to this problem since laws and regulations vary in different countries. For example, some countries may use items like lead paint in the production of their goods and services while others no longer use them.

Types of Fragmentation

Business Fragmentation

When a business becomes fragmented, certain aspects of its structure become separated. This includes corporate leadership, processes, procedures, infrastructure, and business location. In many cases, business fragmentation may lead to inefficiencies and even losses.

Market Fragmentation

This kind of fragmentation may also be referred to as market segmentation. It occurs when market participants are separated or segmented into different groups based on their needs—notably consumers. This allows companies to identify and target certain trends based on how individuals consume goods and services, thereby increasing efficiencies and profits. Markets can be fragmented based on behavior, demographics, or geography.

Industry Fragmentation

Fragmentation happens when there is no clear leader within an industry. This means while many companies may operate in a specific industry, none of them have enough market share to influence prices, production, investment, and competition. Profitability isn't a problem when industries are fragmented. Instead, it just means that new entrants into the market have few barriers ahead of them.

Example of Fragmentation

The airline industry is one that experienced a great deal of fragmentation. Not only does the metal have to be acquired but larger items, such as electronic systems, must also be assembled. Companies often source these materials in addition to labor in countries where they are cheaper.

For instance, an airplane may have the following:

• Its wings manufactured in Germany with metals from Africa
• Its electronics were created in Japan with chips made in China
• Glass in China
• Seats assembled in Mexico with textiles and thread from India

Suppliers and manufacturers ship the components to the United States where they are put together and sold as the final product.

The Bottom Line

Fragmentation is a very important part of the economy. Whether it's caused by globalization, regulatory changes, or market forces, the goal is normally to lower costs and boost profits. But just like any other story, there are also downsides to this process. Corporations have to balance their bottom lines with problems related to the possibility of exploiting inexpensive labor and outsourcing while ensuring consumers continue to get the quality of goods and services they come to expect.