Apple taught the tech world that going vertical — where a company owns many of the critical technology ingredients that it uses in its products — can result in big payoffs. Products like the iPhone and iPad are made with Apple software, chips, and hardware.

Because Apple succeeded so well with that vertical business model, other companies are following suit. Add to the fact that big tech companies are sitting on a lot of cash and you’ll find that the result is a merger and acquisition boom, said Frank Quattrone (pictured, left), head of merger advice firm Qatalyst Partners.

This is the phenomenon we wrote about on the triumph of vertical models over the horizontal model. In horizontal businesses, each company carves out a certain role. With the PC, Microsoft made the operating system. Intel made the chips. And IBM shipped the computer.

Now, Apple designs chips that it uses in mobile phones that run its own operating system. Microsoft makes its Xbox 360 hardware and supervises the design of its chips. Intel has broadened beyond chips with its purchase of software firms Wind River Systems and McAfee. And Oracle is designing hardware and chips thanks to its purchase of Sun Microsystems. Acquisitions across industries within the tech sector are now far more likely than ever before.

“In every category, you used to have one or two buyers,” he said. “Now that companies are buying across industries, there are many more potential buyers.”

That means the potential for merger mania is gathering steam. Quattrone talked about this trend in a conversation with venture capitalist Bill Gurley (pictured, right) of Benchmark Capital at the Web 2.0 Summit in San Francisco today.

Quattrone is known for his past jobs at Morgan Stanley, Deutsche Bank, and Credit Suisse First Boston where he played a big role as a financier of Silicon Valley. He helped Cisco, Netscape and Amazon.com go public. But then he got caught in a scandal that took him out of the investment-banking business. He was prosecuted for interfering with a federal investigation into how shares were allocated for IPOs. That led to a long legal struggle. The case was eventually dropped. Quattrone’s name was cleared, but his reputation was tarnished.

Quattrone said that, after his ordeal , that he did serious soul-searching. He thought about doing a private equity fund, shifting the green technology, or philanthropy. But he decided he had the most fun giving advice to tech companies considering merger and acquisition deals. That’s whats gives him a window into today’s M&A environment.

HP has had to face tough realities this week. Fortunately, there is a way for it to survive: Embrace the inevitable trend favoring “vertical” companies.

In the first part of the 2000s, IBM and HP went in two vastly different directions: HP acquired Compaq to bolster a horizontally-integrated PC business, while IBM sold its PC division to Lenovo and focused on creating a vertical stack of enterprise products.

In the early 2010s, HP’s decision to attempt to dominate PCs has come back to haunt it. Even though HP is the number one PC seller, the low-margin business doesn’t pay, so the company is exiting both the desktop and mobile consumer computer business.

Now HP needs to act fast to remain competitive in the enterprise.

Rule of three

Earlier I described how the consumer computing business is consolidating based on the “rule of three” economic theory and that three big players would dominate the industry: Apple, Google and Microsoft. To play in this market requires a full vertical stack, offering customers everything they need from hardware to applications. Competitive companies will need the ability to extract efficiencies between and from each layer: mobile operating systems, mobile devices, desktop operating systems, personal computers, web browsers, productivity applications, content distribution and cloud services.

Given the vertical integration required to play in the consumer computing business, it is no surprise that HP decided to exit. In order to compete, HP would need to build out cloud services, a desktop operating system, and more. Microsoft, with its domination of the desktop PC and productivity applications businesses, has already spent years and billions of dollars filling its gaps, and will continue to spend billions until it wins the number three spot. HP, and in particular its raucous shareholders, have neither the financial gumption nor a base of technology for an attempt to be the number three in the consumer market.

So it is a wise move for HP to exit the consumer computing business and focus on its enterprise business. However, HP is jumping out of the frying pan and into the fire, as IBM, Oracle and Microsoft have been aggressively building integrated enterprise stacks over the past decade. The rule of three is applying itself to the enterprise space as well, and HP is getting left behind.

Owning the stack

The importance of owning every piece of the stack is increasingly critical. When Oracle decided to end support for the Itanium processor, HP had no database of its own to fall back on and resorted to suing Oracle to support its platform. Both IBM and Oracle are optimizing their databases and middleware to run super efficiently on their respective operating systems, processors and storage. IBM started the verticalized enterprise trend in the early 2000s by widening the memory bus to its PowerPC machines in order to extract more performance out of its DB2 database, forcing Oracle to acquire Sun in order to match database performance.

IBM and Oracle verticalizing enterprise software and hardware is much like the consumer verticalization. Apple’s ability to create efficiencies by building its own iPhones and iPads is a big part of what forced Google to acquire Motorola Mobility. HP board member Marc Andreesen may be right that software is king in his new cloud investments like Facebook and Zynga, but in the hardscrabble world of enterprise and consumer computing, IBM and Apple have verticalized software and hardware and clobbered HP in both the enterprise and consumer markets.

So how will HP build a complete enterprise stack? HP’s acquisition of Autonomy is a great start and fills the gap in enterprise search to compete with IBM’s OmniSearch, Oracle’s Secure Enterprise Search and Microsoft’s FAST. However, HP still has huge gaps compared to its competitors, including collaboration software, business applications, analytics, middleware, and database.

HP’s gaps are perfectly filled by SAP. And SAP’s gaps in services, enterprise search, operating system, processor, storage and management are all filled by HP. A merger of SAP (valued at $60 billion) and HP (valued at $49 billion) would create a $109 billion behemoth capable of competing with IBM ($188 billion), Oracle ($125 billion) and Microsoft ($201 billion). Large mergers like this can be a disaster, but HP’s CEO Léo Apatheker used to be the CEO of SAP and worked there for twenty years, so there is one person who actually knows both organizations.

HP needs to move fast. HP should dump its printer business along with its other low margin hardware businesses, merge with SAP to get a full stack, and then go on a shopping spree to shore up the weaker parts of the combined HP-SAP stack such as EAServer, StreamWork and HP-UX.

We are about to see a scrum amongst all of the larger enterprise players to acquire companies at every layer, such as TIBCO, Teradata, Jive, Salesforce, Red Hat, and likely even my own company, analytics vendor Webtrends. Microsoft may even take another try at Intuit now that it is no longer a monopolist.

Otherwise both HP and SAP risk losing the third place in the rule of three to Microsoft. It should be noted that despite its detractors, Microsoft has actually had amazing execution over the past decade and is the only contender to hold its own in both the consumer and enterprise computing stacks.

HP and SAP need to stave off Microsoft as the small- and medium-sized business enterprise player, or they will both wind up being carved up and bought by IBM and Oracle.

Top photo by Lee Torens/Shutterstock.

Peter Yared is the VP/GM of Social at Webtrends. He has founded four e-commerce and marketing infrastructure companies that were acquired by Sun, VMware, TigerLogic and Webtrends. You can follow him at @peteryared.

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Apple understands it. Amazon understands it.

But nearly every other gadget manufacturer is missing the point: It’s not about the specs any more. It’s about the ability of devices to deliver a seamless, integrated, easy-to-use experience that combines plenty of desirable content and useful services, with a minimum of hassle.

Call it “vertical integration” or whatever you want, it’s the strategy employed by successful companies like Apple, Amazon, Nike and Microsoft to make some of their products nearly unbeatable in the market.

Apple’s iPad is not the world’s most successful tablet because of its hardware engineering (though that helps). It’s successful because it’s locked into the iTunes marketplace, giving it a vast, built-in library of music, movies, TV shows, audiobooks and apps. That connection is often restrictive, but it also offers many people more than enough content to choose from, and it’s easy to use.

It’s also why an Apple television could become a serious competitive threat. By turning television channels into apps, it could bypass the cable box (and the cable company), letting viewers interact with Internet-based, streaming content (browsing through shows, for instance) via an app that runs on their iPhone, iPad or computer and delivers the shows to their television.

Similarly, the Kindle Fire will be a serious competitive threat to other e-readers and tablets (if not the iPad), as I’ve written before, because it’s matched with a huge library of e-books and music, plus Amazon’s small but growing library of movies and Android apps.

Nike+ is by far the most successful health and fitness monitoring tool on the market, despite the fact that other devices have more capabilities or offer platforms that are more open and more flexible. Why? Nike+ combines the massive reach of Nike’s shoe business with a simple, easy-to-use online service that lets you track your walks and runs and share data with your friends. It helps that it ties into Apple’s hardware as well.

Microsoft has done a similar trick with its XBox 360, following the model laid down by Sony and Nintendo and making its console successful by tightly integrating it with an online network, a huge array of game titles and accessories (most notably Kinect) that are unparalleled in the market.

You don’t have to be a giant company to pull off this kind of integration, though. Square is a remarkably successful payment-processing company in part because of the easy tie-in between its card-reading hardware (a tiny dongle that’s so cheap the company gives them away by the basketful, for free), its app, and Square’s online services. That integrated system gives Square the ability to build new products, like its point-of-sale device or a consumer wallet product, which build upon the installed base of its existing customers.

It’s the tie-in between hardware, software and services that gave Square its first leg up. It would have been far less successful if the company had concentrated on selling card-reading hardware, or apps, without first figuring out how to link everything together in an easy-to-use way.

Why is vertical integration suddenly so important? For the same reasons that it’s suddenly so easy to start a social network or an app company: There’s lots of wireless infrastructure out there , processing power is abundant and cheap, and cloud services make it easy to deploy server resources flexibly.

In other words, if it’s easy to make a cloud-based social network that customers access through an iOS app, it’s also that much more feasible to integrate cloud services into a specialized piece of hardware.

And for now, at least, consumers seem more taken with specialized gadgets that are simple and easy to use than they are with complex devices that can do anything but are hard to figure out.

So when you’re handicapping new hardware products, ask yourself what I ask: How well does it integrate with software and online services?

For example, Barnes & Noble’s Nook Tablet is a promising-looking device, only $50 more than the Kindle Fire and even more powerful under the hood than the iPad 2. Too bad Barnes & Noble doesn’t have the same kind of media library that its competitors do. Books, yes, but the company comes up short in other content and in apps (and you won’t even be able to install standard apps on the Nook Tablet).

The Jawbone Up is another interesting example. It tracks your every movement throughout the day, using the same simple accelerometer technology that’s built into every other fitness-tracking device. It comes with an iOS app, and it may well be very well-built, easy to use and good-looking. But its success or failure will depend on the extent to which it’s able to integrate with a larger array of Internet-based services, so you can add apps to it, track new kinds of data, or integrate that data into other health and fitness tracking apps.

So this holiday season, and when I go to the Consumer Electronics Show in January to check out the gadgets that are coming up in 2012, I’ll be looking for devices that do more than just wow me with the specs. You should too.

NOTE: Subscribe to my newsletter and you can read these columns a whole day before they appear on our website.

Photo: Not an effective form of vertical integration for gadgets. Photo by Dave Campbell/Flickr.

Related articles

• Hands-on with the Nook Tablet, and a chat with B&N’s Nook CTO (video) (venturebeat.com)
• B&N revamps $99 Nook Simple Touch with better E-Ink screen, drops Nook Color to $199 (venturebeat.com)
• From smartphones to televisions, how Apple will avoid the fate of RCA (venturebeat.com)

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Poor Microsoft. After sitting on top of the world for more than a decade, it has seen its business chipped away on all sides: Web-based email, cloud-based software, tablets, phones, databases, and even developer tools.

But those who are quick to talk about the end of Microsoft are jumping the gun.

Microsoft posted a record $18 billion in revenues for its most recent quarter, and it would have shown healthy profits as well if it hadn’t written off $6.2 billion due to its useless acquisition of aQuantive a few years ago. Think about that: It took a $6 billion mistake to make this company post its first loss in two decades as a publicly-traded company.

Also, Microsoft has $63 billion in cash and short-term investments. It still holds a dominant position in many markets, including the not-insignificant duo of PC operating systems and office software.

It’s true that Microsoft doesn’t have the cool factor of competitors like Google and Apple. It’s got a phenomenal R&D organization, but the most successful thing to emerge from that organization recently seems to be the Surface — the old, table-sized Surface — which hasn’t exactly taken the world by storm. And its stock price has gone essentially nowhere in 10 years, which means anyone who joined the company in the past decade hoping to become a millionaire is still waiting for their big payday. That has to make it difficult to recruit top-notch talent, especially in a market where computer science graduates can command six-figure salaries and rich stock option grants right out of college.

However, there are clear signs that Microsoft understands the gravity of its strategic situation and is moving to turn its ship around.

ZDNet columnist Ed Bott sifted the tea leaves in Microsoft’s most recent quarterly 10-K filing and found signs that the company is moving towards a more aggressive, vertically-integrated structure. Surface — the new, iPad-sized Surface — may be more than just a shot across the bows of Microsoft’s manufacturing partners; it may be the first step in the company’s plan to build and sell a complete stack of hardware, software, and services.

“The strategic importance of a vibrant ecosystem increases as we launch the Windows 8 operating system, Surface devices, and associated cloud-based services,” the 10-K states. It goes on to refer to additional software and cloud-based services, as well as “other hardware devices we design and market.” Its OEM partners are not mentioned anywhere in this section, Bott notes.

In other words, Microsoft is taking hardware seriously at last. Where it used to stand out for a few niche products (mice) and one outright hit (Xbox 360), the company is now eyeing hardware plays across an unspecified range of markets. The Surface is just the beginning.

This, of course, is not just because Microsoft wants to become a hardware company and start enjoying the lucrative returns and fat margins of a modern electronics company. (Hint: I’m being sarcastic.) Rather, the company sees that there’s power in a vertically-integrated stack of hardware, software, and services, as Apple has amply demonstrated. When you control the entire market, you are in a much more powerful position than when you are merely a supplier. That’s why Microsoft’s starting to tie everything together with a common, Metro-styled design, with ample integrations between its software and cloud services, with a host of Bing-powered data services for humans and for application developers. Rebranding Hotmail as Outlook.com is just the latest step in a long march in this direction.

The tech industry is at a point that favors vertical integration right now, which is why Microsoft is not the only company embracing this strategy. Google is adding hardware maker Motorola to its portfolio, augmenting its operating system, cloud services, and marketplace. Amazon is building a wider and wider range of its own hardware too, soon to include a phone.

Now, Microsoft has some serious challenges ahead of it. The Surface is a pretty good tablet, but it hasn’t won the hearts of Apple lovers the way, say, Google’s Nexus 7 has done. Windows Phone is a promising operating system but is still coming from far behind iOS and Android.

The transition to Windows 8 will be shocking and disturbing to many Windows users, and there’s a risk that Microsoft will lose people to alternatives like OS X or, who knows, maybe even Google Chrome OS. There’s no doubt that the Windows 8 rollout will be critical to the future of Microsoft, as VentureBeat’s Matt Marshall recently wrote.

The company is aware of these issues and has listed a litany of risks Microsoft faces in the coming year. It’s not going into this blind. But these are big issues.

And then there’s still that talent challenge. When I talked with VoodooPC founder Rahul Sood recently about his new job running Microsoft’s Bing Fund, he raved about what a great place to work it was. But I’m not sure Microsoft is getting that message across to the next generation of programmers and engineers.

It’ll need to fix that perception problem if it’s going to succeed in what may turn out to be one of the most ambitious pivots in tech history.

Deal Decor, an ecommerce site that allows consumers to buy quality furniture online at a reduced price, has announced $1.2 million in seed financing.

Deal Decor sources its inventory directly from factories. Each week, three new pieces of furniture are featured on the site. If enough people decide to purchase an item, the company buys the furniture wholesale from the manufacturer and delivers it to consumers. By eliminating the middlemen and using group buying to cut down on costs, Deal Decor can offer furniture for far less than mainstream retailers.

This model also cuts out the unpleasantness of spending a Saturday at Ikea, although Deal Decor does not yet offer Swedish meatballs as part of the shopping experience. Something for the team to consider.

Most of Deal Decor’s partner factories also produce furniture for stores like Crate & Barrel, Pottery Barn, Home Depot, and Williams-Sonoma. While this does not mean the items for sale have these brand names associated with them, the company alleges that its offerings have the same level of quality as the large retailers’.

Similar to hot ticket company Warby Parker, Deal Decor will have a few showrooms in each market so customers who still want the sensory experience of shopping can actually see the pieces.

Deals stay open for 10 days, or until enough people have opted into a deal to fill a shipping container. When the deal closes, Deal Decor places an order with the factory and then has it shipped to the buyers, for up to 70% less.

Deal Decor is currently running its first deal for California residents. The company is based in San Francisco.

Investors include Rick Thompson, Ed Cluss, Mark Stevens of Sequoia Capital, Brad Koenig formerly of Goldman Sachs, MJ Elmore from Institutional Venture Partners, Jim Mclean of Crosslink Capital, and others.

Andreessen Horowitz is beautifying its portfolio. Today, the prestigious venture capital firm led a $10.3 million round of financing in Julep Beauty Incorporated.

Julep is a fast-growing cosmetics brand that sells nail polishes, bath and skin products, and makeup. It does all its business online. In addition to regular sales, Julep also offers a subscription service along the lines of Birchbox, where “Mavens” receive a box filled with a curated selection of Julep goodies.

In the past year and a half, Julep has launched 52 new beauty products and 186 nail colors. The startup attributes this remarkably fast rate of production to a lean e-commerce business model, which does not involve physical stores and relies on social media channels for marketing. Julep factors fan feedback into its product decisions and envisions beauty as a “two-way conversation” between the brand and the women engaging with it. The low overhead costs mean more resources can be devoted to iterating quickly and rolling out new products every month.

Julep is part of a larger trend of vertically-integrated e-commerce companies like Nasty Gal, Warby Parker, Indochino, Beachmint, Shoedazzle, and Everlane (to name a few) that cut out the supply chain and get their products directly to consumers at significantly lower prices.

Julep was founded by former Starbucks executive Jane Park. Jeff Jordan, a partner at Andressen Horowitz, said in a statement that Park and her team “have leveraged the Internet to build Julep into a compelling brand at a pace previously unheard of in beauty.”

In 2012, Julep launched nationwide on QVC and Sephora. This second round of financing will fuel development into new categories of cosmetics. Maveron Venture Partners, which led Julep’s first round, also contributed to this financing.

“As direct TV proved to be a launching pad for enduring beauty brands decades ago, we believe new social media channels will be the catalyst for launching the next great multi-channel beauty companies,” said Maveron board member Jason Stoffer in a statement. “Julep is a pioneer in using Facebook, Pinterest, and the social web to deeply engage its community of beauty lovers around color and fashion-forward beauty products.”

Lady Gaga manager Troy Carter, Precedent Investments, Will and Jada Pinkett Smith, Jay-Z’s Roc Nation, Western Technology Investments, and Version One Ventures also participated in this funding round. Julep is based in Seattle, Wash.

Photo Credit: Screenshot

Getting a man to shop can be a difficult task. Indochino has raised $13 million to make it easier.

Indochino is an online menswear store that makes shopping for stylish clothing as painless as possible. Men pick from a selection of suits, shirts, outerwear and accessories to choose their style, customize their choices with details like monograms and linings, and go through a quick step-by-step guide to create their measurement profile. The clothes are then made and delivered within 35 days of ordering.

“Most men need all the help they can get when shopping for their own wardrobe,” said Tom Stemberg, Managing General Partner of Highland Consumer Fund, in a statement. “By providing higher quality custom menswear at a lower cost, Indochino has revolutionized the direct-to-consumer business and become a global presence in custom menswear.”

Highland led this round and Stemberg will join the company’s board. Madrona Venture Group and Acton Capital Partners also participated in this round. Vertically-integrated e-commerce startups are taking off, as well as fashion startups geared towards men who appreciate the convenience of online shopping. Last April, online mens clothing retailer Bonobos raised $16.4 million and other startups like Frank & Oak and Trunk Club have garnered attention for making good style easy and accessible to the average Joe. By cutting out the middlemen, companies like these can offer higher quality goods at a lower cost and prove a greater layer of personalization.

This financing will be used to investment in marketing and product development. Indochina is also opening up a pop up ‘Traveling Tailor’ store in Boston, where men can be measured and styled in person. Indochino is headquartered in Vancouver, BC. It was founded in 2007 and has raised $17.25 million to date.

Photo Credit: Indochino

Venture capitalists are better known for sporting Oxford button-downs than for wearing T-shirts, but today, they are going casual.

Pickwick & Weller is an e-commerce startup that designs, manufactures, and sells “the perfect T-shirt.” Today, the company launched its Spring 2013 line and revealed a high-profile list of investors, including Forerunner Ventures, Felicis Ventures, SV Angel, Baseline Ventures, and Mousse Partners.

Ashton Kutcher is one of the founders of Pickwick & Weller, along with serial entrepreneurs Ryan Donahue — a founding member of the PayPal design and user research — and Matt Rowe [above]. The trio has spent many years in the tech and fashion communities, and they wanted to create a brand that appealed to people looking for casual clothing for the workplace.

“The workplace has changed,” Donahue said in an email. “It’s become more creative and more casual, and the T-shirt is the work uniform of choice for entrepreneurs, hackers, makers, and artists.”

Pickwick & Weller works with a range of high quality materials such as supima, modal cotton, cashmere, silk and linen. Donahue said with T-shirts, the fit is just as important as the fabric, and since the company has adopted an entirely online business model, it can offer high-end products at a lower price point.

Vertically integrated, online-only clothing companies are taking center stage of the fashion world. Not only are consumers shopping online more frequently, but entrepreneurs, fashion designers, and brands are eschewing traditional retail channels for those that provide greater flexibility. Pair that with the fact that in the tech world “the T-shirt is king,” and the interest towards Made-in-America products, and you have a startup sitting at the center of multiple cultural, fashion, and Internet trends.

Pickwick & Weller’s design headquarters is in Los Angeles, with the business headquarters in San Francisco. There are currently nine employees. In addition to the insutuiotnal investors listed above, Ashton Kutcher, Warby Parker founder Dave Gilboa, and Max and Nellie Levchin also participated in this round.

Photo credit: Pickwick & Weller