A Different Approach: Vertical Integration in Satellite Manufacturing

What is Vertical Integration?

Vertical integration refers to a firm bringing additional elements of the industry value chain under common ownership[3]. Simply put, it involves bringing previously out-sourced operations in-house. Firms can vertically integrate both upstream (away from the end user, ex. into raw materials production) and downstream (closer to the end user, ex. into providing data analytics), depending on their relative location in the supply chain[4]; Figure 1. details this process in-depth.

Figure 1. Upstream vs. Downstream Vertical Integration

In industries such as Oil & Gas, a fully vertically integrated approach is not only common, but a necessity of doing business. In other areas, such as the automobile sector, firms may prefer quasi-integration approaches or its equivalents (such as long-term contracts). In general, vertical integration strategies are adopted as a means of increasing efficiency, controlling costs, and reducing 3^rd party risk. The commonly cited benefits of vertical integration are detailed in Figure 2, though it is important to note that in order for the strategy to be effective, these incentives must outweigh the high setup cost and additional risks associated with integrated operations.

Figure 2. Benefits of Vertical Integration

The Rise of Vertical Integration in the Satellite Sector

Nearly 15 years after the advent of SpaceX and Blue Origin, the space industry is almost unrecognizable. The Constellation program is long gone, LEO has replaced GEO as an investor’s playground, and large, performance-driven platforms are being replaced by swarms of small satellites. Where before there existed a culture of mark-ups, downward pricing pressure and a shift towards commercial revenue streams has spurred increased interest in maintaining cost effective and efficient operations.

Driven in no small part by vertical integration activity in the launch sector, the satellite sector is now beginning to show a greater propensity to manufacture, integrate, operate, and even manage end user sales entirely in-house. Particularly in the small satellite segment, major players such as Planet, Spire, and GomSpace have already at least partially adopted this strategy, and SpaceWorks research suggests many more firms are still to follow.

Figure 3. Modern Satellite Manufacturing Value Chain

The allure of vertical integrated operations, a la SpaceX, is hard for satellite manufactures to resist. An increased focus on large, disaggregated satellite constellations (vs. single, highly capable spacecraft), contributes to the need for economies of scale to close capital-intensive business cases. Inconsistent component suppliers additionally provide headaches that vertical integration promises to resolve. For many in the small satellite segment, it may even be an imperative in order to develop the emerging markets they hope to serve.

Still, vertical integration is a costly, and near irreversible corporate strategy, with significant associated risks. While the benefits can be great, firms that fail to effectively implement put themselves at an extreme disadvantage, one that could be costly in an industry where first-to-market firms seem to trump fast-followers more often than not – a fact not likely to be lost on CXO teams. So what is it that makes vertical integration suddenly so compelling in an industry that once seemed to barely know such a strategy existed?

In attempt to better understand the corporate motivations behind the rise in vertical integration across the satellite manufacturing sector, SpaceWorks undertook a multi-part study investigating how internal and external control, risk, and changing industry trends are changing the way satellite manufactures operate. Originally presented at the NASA Cost & Schedule Symposium, this continually evolving series is intended to help satellite industry executives fully understand the framework surrounding decisions to vertically integrate.

Part I: A Necessary Evil

With the rise of the small satellite sector has come an industry-wide shift towards disaggregated, constellation architectures. This shift has caused significant ramifications across the greater satellite manufacturing sector – perhaps the most publicly visible was Maxar’s shocking announcements that they would be winding down their GEO division to focus entirely on small satellite production[5].

As traditional giants like Maxar go back to basics and remind themselves of the lessons from the lean revolution, more agile start-ups, such as Planet and Spire are leaning on the software revolution to power their efforts[6]. Regardless of the inspiration, one thing is clear: the name of the game is efficient manufacturing. For the operators pursuing large constellations, economies of scale are not a luxury, but an absolute necessity.

The vast majority of these companies are not deep-pocketed government agencies or telecos, but enterprising start-ups with limited runway. These organizations are thinking in weeks or months, not years or decades… a far cry from the traditional development times associated with the satellite industry. Not only do they face shorter timeframes, but, SpaceWorks research suggests, they are on average looking to launch as many as 50 satellites per year. Closing a business case requiring hundreds of satellites to be produced and launched every few years is a tall order without running an incredibly lean operation.

Still, building satellites is not as simple as assembling circuit boards. There is a reason why vertical integration failed to gain traction in the satellite manufacturing sector of the late 20^th century… tribal expertise, proprietary testing procedures, and established processes all helped to protect traditional manufacturing firms from vertically integrated new entrants. With the influx of small satellite constellations, however, traditional manufacturing may have met its match. While smaller constellations almost certainly make sense to be produced using traditional approaches and established firms, SpaceWorks research suggests that the vertical integration breakeven point may not be as high as one would expect.

In Figures 4 & 5, SpaceWorks explores the costs of hypothetical 3U and 300 kg communications satellite constellations under different manufacturing approaches. In both cases, costs were estimated parametrically, based on a master-equipment-list provided by the engineering team at SpaceWorks. The average per unit cost (APUC) reflects the total development and production costs of the constellation, amortized across the number of operational satellites.

APUC is initially quite high for the vertically integrated approach, reflecting the upfront costs associated with building of new facilities, processes, etc. Overtime, as the manufacturer begins to achieve significant economies of scale, APUC drop significantly, and at a much quicker rate than traditional manufacturing. SpaceWorks’ research suggests that because firms are able to absorb nearly all of the surplus from learning effects (no sharing with suppliers), and can more easily accelerate their development timelines, they are able to dramatically reduce costs.

Figure 4. 3U Communications CubeSat Constellation Average Per Unit Cost

For the 3U satellite constellation, these results suggest that at approximately 88 satellites the vertically integration manufacturing approach breaks even with a traditional manufacturing approach. Given the average 3U constellation is close to 150 satellites, this has an important implication for operator-manufacturers: if you are not looking at vertically integrated approaches, you may be leaving money on the table.

Figure 5. 300kg Communications Small Satellite Constellation Average Per Unit Cost

This number may be far lower in larger satellite constellations. A similar analysis of a hypothetical 300 kg communications satellite constellation yielded a breakeven point at just 39 satellites. A number of factors contribute to the lower breakeven in this segment, including more gradual learning effects, and higher development costs for both traditional and vertically integrated approaches. Given that these types of satellites are an order of magnitude higher in per-unit cost, it is understandable why capital constraints have prevented this segment from overly embracing a vertically integrated strategy, but these results suggest it may actually be worthwhile. The implication for operators of larger satellite constellations is that despite their high upfront expenditures, vertically integrated approaches can rapidly make up for higher initial setup costs.

Of course, per unit cost is only one part of a much more complicated equation that must consider the time value of money, enterprise risk, and realistic capital constraints. It appears, at least initially however, that achieving economies of scale could be a significant motivator for choosing a vertically integrated manufacturing approach. Particularly for companies pursuing large satellite constellations (100+), the rewards can be great, despite significant challenges associated with such an approach.

This initial exploration into economies of scale in small satellite manufacturing provides a valuable baseline for considering the impact of other market forces. Stay tuned throughout the rest of 2019 to read the remaining parts of “A Different Approach”, and be sure to catch our forthcoming paper, “An Analytic Explanation for Vertical Integration Behavior in the Marketplace” at the International Cost Estimators & Analysts Workshop in May!

Caleb Williams

Caleb Williams is the Lead Economic Analyst at SpaceWorks Enterprises, where he oversees delivery of business strategy and economic analysis engagements for private-sector clients. His primary focuses include market demand modeling, parametric cost assessment, business case development, and strategic analysis. He received degrees in Economic Consulting and Marketing from the Kelley School of Business at Indiana University.

Stephanie DelPozzo

Stephanie DelPozzo is an Economic Analyst at SpaceWorks Enterprises, where she specializes in the market research for the future LEO economy and emerging small satellite industry. She received degrees in Political Science and Economics from Florida State University.