Fragmentation

What Is Fragmentation?

The term fragmentation refers to a supply chain that is broken up into different parts. Put simply, 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 in a more cost-effective manner. Fragmentation was made possible by improved technology and globalization.

Key Takeaways

  • Fragmentation involves the production of goods and services using separate suppliers and component 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 the main causes of fragmentation, labor forces, economic conditions, and regulations also contribute.
  • Fragmentation can benefit developing nations but can lead to the exploitation of laborers.
  • Business, market, and industry fragmentation are three different types of fragmentation that occur within the economy.

Understanding Fragmentation

As noted above, 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 as well as the potential suppliers available. They then use the cheapest places 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.

The process is often associated with globalization as companies seek to use suppliers who are the most cost-effective. 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. Canada, Ireland, China, and Mexico were the largest suppliers of intermediate goods to the U.S. in 2019.

Free trade agreements may often provide countries with duty-free access to labor and materials. For instance, the USMCA and its predecessor, NAFTA, set this up between the U.S., Canada, and Mexico.

Special Considerations

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

  • A shortage of unskilled laborers in some developed nations, which 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.

Imports of intermediate goods (components) increased by 48% between 2009 and 2016.

Advantages and Disadvantages of Fragmentation

Advantages

The most obvious benefit of fragmentation is its cost-effectiveness. By going to different suppliers and manufacturers, companies are able to 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 are able to gain employment and may be able to boost their skills as companies come in search of labor to source materials for and 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.

Pros
  • Cost reduction helps companies and may be passed on to consumers.

  • Employment boosts in developing nations

  • Rise in corporate profits, which benefits the economy

Cons
  • Exploitation of local workforce

  • Outsourcing leads unemployment in the company's home country.

  • Drop in quality of goods and services

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 their 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 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.

What Is Media Fragmentation?

Media fragmentation involves the division of media outlets, giving consumers more choice in the type of content they receive. For instance, the industry is broken up based on target audiences, such as conservative viewership, left-leaning consumers, adolescents, people who enjoy fashion, 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 may find it difficult to reach their target audiences.

What Is Habitat Fragmentation?

Habitat fragmentation takes place when large areas of habitable land are broken up and segmented or destroyed. It is most often related to land development by humans and natural forces (land erosion, climate change, natural disasters). This can impact the ecosystem, biodiversity, and animal populations.

What Is Fragmentation in Computers?

Fragmentation in computers involves storing a single file in several different locations on a hard drive or other storage devices. As such, these fragments or pieces are scattered in different areas. This often occurs when individuals create, move, make changes, or delete files. This type of fragmentation can lead to lower computer speeds and a drop in efficiency.

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.

Article Sources
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  1. World Integrated Trade Solution. "United States Intermediate Goods Imports by Country in US$ Thousand 2019."

  2. United States International Trade Commission. "Intermediate Goods Imports in Key U.S. Manufacturing Sectors."