Vertical Integration Described: Types And Examples of Its Application
Vertical Integration: What Is It?
Vertical Integration Is A Tactic That Enables A Business To Streamline Operations By Directly Controlling Different Stages Of The Production Process Instead Of Depending On Outside Suppliers Or Contractors.
Instead Of Outsourcing These Operations, A Business Might Achieve Vertical Integration By Acquiring Or Forming Its Own Manufacturers, Distributors, And Retail Outlets. However, Due To The Sizeable Initial Capital Investment Needed, Vertical Integration May Be Considered Risky Potential Disadvantages.
Key Lessons
• In Order To Have More Control Over Its Supply Chain, A Corporation Must Directly Own Its Suppliers, Distributors, And Retail Outlets.
• The Benefits May Include Improved Manufacturing Or Distribution Processes, Lower Costs, And Increased Control.
• Vertical Integration Frequently Requires Significant Upfront Cash, Which May Limit A Company's Flexibility Over The Long Term.
• When A Vendor Tries To Purchase A Business Further Down The Supply Chain, This Is Known As Forward Integration (I.E. Acquire A Retailer).
• Backward Integration Happens When A Vendor Tries To Buy A Business That Came Before It In The Supply Chain (I.E. A Raw Material Provider).
How Does It Work?
When A Business Tries To Expand Across The Supply Chain Or Production Process, Vertical Integration Happens. A Corporation Engages In Vertical Integration To Become More Self-Reliant On Other Components Of The Process Rather Than Clinging To A Specific Point Along The Process. For Instance, A Manufacturing Company Might Want To Obtain Its Own Raw Materials Or Sell To Customers Directly. A Good Illustration Of Vertical Integration Is Netflix, Inc. Before Expanding Into Online Streaming Of Films And Films Licensed From Big Studios, The Company Began As A Dvd Rental Company.
Then, Netflix Executives Recognized That By Creating Some Of Their Own Original Content, Like The Popular Series Grace & Frankie And Stranger Things, They Might Increase Their Profit Margins. The Get Down, A 2016 Movie That Reportedly Cost The Corporation $120 Million, Is One Of The Disasters It Also Made. Today, Netflix Promotes Both Its Original Material And Programming That Has Been Licensed From Studios Via Its Distribution Model.
Netflix Implemented Vertical Integration To Become More Involved In The Creation Of Entertainment Earlier Rather Than Merely Depending On The Content Of Others.
Control Of The Supply Chain
The Supply Chain Or Sales Process Of A Typical Business Starts With The Acquisition Of Raw Materials From A Supplier And Concludes With The Selling Of The Finished Product To The Client.
A Corporation Must Control At Least Two Of The Processes Involved In The Development And Marketing Of A Good Or Service In Order To Engage In Vertical Integration. The Previously Outsourced Portion Of The Company's Production, Distribution, Or Retail Sales Operation Must Be Purchased Or Recreated.
To Cut Manufacturing Costs, Businesses Can Vertically Integrate By Buying Their Suppliers. By Establishing Websites And Real Storefronts, They Can Make Investments In The Retail Portion Of The Process. To Maintain Control Over The Distribution Process, They Can Spend Money On Warehouses And Vehicle Fleets.
The Establishment Of Buildings, The Hiring Of New Personnel, And Administration Are All Processes That Need A Large Financial Commitment. The Size And Complexity Of The Business's Activities Ultimately Grow As A Result Of Vertical Integration.
A Company's Increased Involvement In A Single Supply Chain Could Lead To A Market Monopoly. Vertical Monopolies Are Also Referred To As Monopolies That Develop As A Result Of Vertical Integration.
Vertical Integration: Types
A Corporation Can Accomplish Vertical Integration In A Variety Of Ways. Forward Integration And Backward Integration Are Two Of The Most Popular.
Backward Integration
A Business That Opts For Backward Integration Shifts Ownership Control Of Its Products To A Stage Earlier In The Production Or Supply Chain.
This Type Of Vertical Integration Has An Appropriate Name Because A Company Frequently Aspires To Acquire A Distributor Or Provider Of Raw Materials Near The Start Of A Supply Chain. The Businesses At The Beginning Of The Supply Chain Are Frequently Experts In One Particular Stage Of The Procedure (I.E. A Wood Distributor To A Furniture Manufacturer). The Furniture Company Would Strive To Bring The Wood Sourcing In-House In An Effort To Expedite Processes.
Amazon.Com, Inc. Began As An Online Book Seller Of Titles It Had Acquired From Reputable Publishers. While Continuing To Do So, It Has Expanded To Include Publishing. Eventually, The Business Expanded Into Thousands Of Branded Products. Then It Launched Its Own Private Label, Amazon Basics, To Offer A Large Number Of Them To Customers Directly.
Forward Integration
Forward Integration Allows A Business To Grow By Obtaining Control Over The Sale Of Its Final Goods And The Distribution Chain. A Clothes Manufacturer Has The Option Of Selling Its Finished Goods To A Middleman, Who Then Distributes Them In More Manageable Quantities To Particular Retailers. In The Event That The Clothes Producer Underwent Forward Vertical Integration, It Would Join A Retailer And Be Permitted To Launch Its Own Stores. If The Corporation Can Successfully Run Its Retail Section, It Would Strive To Increase Revenue Per Product.
Because It Is Frequently More Challenging For Businesses To Acquire Other Companies Further Up The Supply Chain, Forward Integration Is A Less Prevalent Type Of Vertical Integration. The Biggest Retailers At The End Of The Supply Chain, For Instance, Frequently Have The Most Cash Flow And Purchasing Power. They Frequently Have The Funds Available To Be The Purchaser Of These Retailers Rather Than Having Them Purchased (An Example Of Backward Integration).
Balance Integration
In A Vertical Integration Strategy, Known As Balanced Integration, A Corporation Seeks To Merge With Businesses That Are Both Before And Behind It In The Supply Chain. To Engage In Balanced Integration, A Corporation Must Both Obtain Raw Materials And Cooperate With Retailers To Provide The Finished Product, Acting As "The Intermediary" And Manufacturing The Product.
Think About How Coca-Cola Sources Its Raw Materials, Creates Its Beverage, And Then Distributes Bottled Beverages For Sale. In The Event That Coca-Cola Decides To Merge With Both The Suppliers Of Its Raw Materials And The Merchants Who Will Sell The Product, It Is Practicing Balanced Integration.
Balanced Integration Offers The Highest Potential Benefits Because A Corporation Is More Likely To Have More (If Not Complete) Control Over The Whole Supply Chain Process, Despite Being The Most Expensive And Hazardous Due To The Diverse Structure Of Corporate Activities.
Although Vertical Integration Can Lower Costs And Improve Supply Chains, The Associated Capital Expenses Can Be High.
Benefits And Drawbacks Of Vertical Integration:
Vertical Integration Can Lower Costs And Boost Productivity For A Business. Vertical Integration Can, However, Be Detrimental To The Business If Done Incorrectly.
Advantages
• Gaining More Control Over The Supply Chain And The Manufacturing Process Is The Main Objective Of Vertical Integration. Vertical Integration, When Done Correctly, May Result In Lower Costs, Economies Of Scale, And Less Reliance On Outside Parties.
• If The Entire Process Is Handled Internally, Vertical Integration Might Result In Lower Transportation Costs, Quicker Turnaround Times, Or Easier Logistics.
• Given That The Corporation Has Direct Control Over The Raw Materials Utilised Throughout The Manufacturing Line, This Could Also Lead To Higher-Quality Products.
• Companies Are Occasionally At The Whim Of Powerful Suppliers. Companies Can Avoid External Monopolies By Integrating Vertically.
• Additionally, A Business May Learn From A Retailer Whose Products Are Selling The Best; This Knowledge May Be Very Helpful In Deciding On Manufacturing And Product.
Disadvantages
• Vertical Integration Is A Long-Term Process That Requires Broad Support, It Cannot Happen Overnight.
• Purchasing The Appropriate Business, Integrating New And Existing Systems, And Ensuring Staff Is Trained Throughout The Full Production Process All Demand Significant Upfront Capital Expenditures.
• Companies Do Give Up Some Flexibility When They Vertically Integrate. This Occurs As A Result Of Their Financial Commitment To A Particular Method Or Item.
• A Corporation Won't Likely Have The Option To Refuse Purchasing From An Outside Vendor Because By That Point It Will Likely Have Committed Funds That Are Difficult To Get Back.
• A Business Can Also Miss Out On The Chance To Learn Something Special From Various Outside Vendors.
• Several Social Effects Of Vertical Integration Are Also Possible. Companies Risk Trying To Achieve Too Much And Losing Sight Of Their Primary Objective. Customers Might Not Also Be Comfortable With A Large Manufacturer's Culture Of Dealing Directly With Them.
Vertical Integration
Advantages
• May Result In Long-Term Cost Saving Due To Favorable Pricing And Minimal Supply Chain Disruptions
• Often Results In Economies Of Scale Which Increase Efficiency
• Reduces Or Eliminates The Need To Rely On External Parties/Suppliers
• Leads To Greater Control Over The Product, Inputs, And Process Which May Lead To Superior Products
Disadvantages
• Often Requires Large Upfront Capital Requirements To Implement
• May Reduce A Company's Ability To Be Flexible In The Long-Term
• May Cause A Company To Lose Focus On Their Primary Objective Or Customer
• May Result In Displeased Customer Base Who Would Prefer To Work With Smaller Retailer
Horizontal Versus Vertical Integration
• The Acquisition Of A Rival Company Or An Affiliated Company Is A Component Of Horizontal Integration. This Could Be Done By A Business To Get Rid Of A Competition, Develop Or Diversify Its Main Business, Enter New Markets, Or Boost Overall Sales.
• Vertical Integration Entails Acquiring A Crucial Supply Chain Element That The Business Had Previously Contracted For. It Might Lower Expenses For The Business And Offer It More Power Over Its Goods. In The End, It Might Boost The Business's Earnings.
• Horizontal Integration Is A More Focused Strategy That Makes A Company More Specialized Or Specialty Within A Particular Market, As Opposed To Vertical Integration, Which Spans A Corporation Along A Single Process.
• For Instance, A Business Can Choose To Specialize On Just One Aspect Of A Supply Chain, Such As Materials Procurement, Manufacturing, Or Retail, By Purchasing Complementary Businesses To Engage In Horizontal Integration.
• Many Studies Have Been Done To Determine When It Is Better To Merely Contract With Another Company Rather Than Acquiring Them. Published Contemporary Economic Theory On The Subject Is Decades Old.
Vertical Integration: Examples
A Case Study Of Vertical Integration Can Be Found In The Fossil Fuel Sector. Shell, Exxonmobil, And British Petroleum All Have Companies Focused On Oil Extraction And Refining As Well As Exploration Divisions That Look For New Oil Sources. The Finished Product Is Transported By Their Transportation Departments. The Petrol Stations That Transport Their Goods Are Run By Their Retail Sections.
A Vertically Integrated Entertainment Firm That Manages And Represents Artists, Produces Events, And Sells Event Tickets Was Founded In 2010 As A Result Of Live Nation And Ticketmaster's Merger. The United Company Operates And Owns Concert Venues And Sells Tickets For The Events That Take Place There.
This Is An Illustration Of Forward Integration From Ticketmaster's Perspective And Backward Integration From Live Nation's Perspective.
When Does A Purchase Qualify As Vertical Integration?
If An Acquisition Gives The Company Direct Control Over A Crucial Aspect Of Its Previously Outsourced Manufacturing Or Distribution Process, That Is An Example Of Vertical Integration.
Backward Integration Refers To The Purchase Of A Supplier By A Business. Forward Integration Describes The Process Through Which It Acquires A Distributor Or Store. In The Latter Scenario, The Business Frequently Acquires A Client, Whether It Be A Wholesaler Or A Retailer.
Is Vertical Integration Beneficial For A Business?
When Considering Vertical Integration, A Corporation Must Decide Which Is Preferable For The Long Term Of The Company. If A Business Produces Apparel With Buttons, The Buttons Can Be Manufactured Or Purchased. Making Them Eliminates The Markup The Button Maker Would Have Charged. It Might Allow The Business More Freedom To Alter Button Designs Or Colors. It Might Take Away The Frustrations Associated With Working With Suppliers.
Alternatively, The Business Would Need To Establish Or Purchase A Completely Independent Button Manufacturing Process, Purchase The Raw Materials Needed To Create And Attach Buttons, Recruit Personnel To Create The Buttons, And Appoint A Management Team To Oversee The Button Division.
What Sets Vertical Integration Apart From Horizontal Integration?
Vertical Integration Is The Technique Of Acquiring Several Supply Chain Components That A Firm Currently Does Not Handle. Contrarily, Horizontal Integration Refers To The Process Of Acquiring Comparable Businesses To Improve Upon What It Already Does. A Corporation Becomes More Diversified Through Vertical Integration, Whereas It May Become More Market-Specific With Horizontal Integration.
Why Does Vertical Integration Happen In Businesses?
Vertical Integration Is A Strategy Used By Businesses To Have More Control Over A Manufacturing Process' Supply Chain. The Manufacturer Can Control The Timing, Procedure, And Elements Of Additional Phases Of Development By Carrying Out Some Processes Internally. Long-Term Cost Reductions Could Also Come From Owning More Of The Process (As Opposed To Buying Outsourced Goods At Marked-Up Costs).
The Conclusion
Vertical Integration Is A Type Of Business Arrangement Where A Company Has Influence Over Various Supply Chain Stages. To Have More Control Over The Production Process, The Corporation Tries To Bring Processes In-House Rather Than Relying On Outside Vendors. Vertical Integration Aims To Streamline Processes For Long-Term Operations That Are More Efficient And Under Control, Even Though It Might Result In Higher Upfront Capital Expenditures.