Business owners are always looking for new ways to grow their businesses. Vertical integration is one way to do this. Vertical integration means that a company is in charge of more than one level of the supply chain.
This can mean that it owns or buys its source suppliers (called “backward vertical integration”), its downstream wholesalers (called “forward vertical integration”), or both (called “complete vertical integration”).
Pros Vertical integration
Vertical integration has many benefits that can help your business be more profitable and competitive in the market:
Make economies of size work
When a company lowers its set cost per unit, this is known as “economies of scale.” One way to do this is to buy goods in big quantities and spread the cost over a larger number of items. Another way to take advantage of economies of scale is to cut costs. This can be done by getting rid of expensive markups from middlemen, combining management and staff, and making operations run more smoothly.
For instance, Walmart runs its own delivery centers, which gives them more control over how their products get to customers. Their success has been helped by using cutting-edge technology and coming up with better ways to load and send goods. The company keeps trying out new technologies, like virtual reality, hyperlocal delivery centers, and drones, to be more efficient and save money.
Walmart’s success is also due in part to the fact that it keeps prices low for customers by cutting costs.
Make new ways to make money
With online shops like Amazon and the Chinese e-commerce giant Alibaba, makers can now sell directly to customers anywhere and at any time, opening up a whole new source of income. Why rent and staff places if people can buy your goods from the comfort of their own homes?
By adding new delivery centers in new areas or buying a new brand, vertical integration can help your business grow in new places. Most of the time, regional growth works best when a company grows within its own supply-and-distribution section.
For example, when Proctor and Gamble bought Iams pet food, it gave the company access to more markets around the world. And after opening shops in the fashion cities of the world, Louis Vuitton, which makes fine leather goods, became a popular place for women all over the world to shop.
Maintain quality control
If you make cakes and make your own cake mixes, you don’t have to worry about a source cutting back on the eggs or using something else. If you make salad oil and own your own olive trees, you don’t have to worry about mislabeling, which was found to be the case in over two-thirds of extra virgin olive oil sold in shops. When a company has more power over the production process, it can keep quality standards higher.
Set yourself apart from your competition
A vertical merger could help a company stand out from its rivals. For instance, a business that makes goods could set itself up as a store and offer its customers something that its competitors can’t. For example, when Apple opened its first store in 2001, it was able to serve people in a way that Microsoft couldn’t.
Keeping secret processes or recipes secret
Some secret recipes are so valuable that they are kept as real trade secrets, and it would be impossible to hire someone else to make them, like Coca-Cola.
Cons Vertical Integration
Vertical integration can have many benefits, but it also has risks, like:
Distribution routes that are already in place could be hurt
Let’s say you make handbags and have been selling them to gift shops that are run by themselves. You might sell directly to users on your website as a way to do vertical integration. When you make plans to sell things online, you need to think about how you might lose sales through the ways you already sell things. Will gift shops take away sales you already have?
Not a good result
Vertical mergers can be expensive, and growing the supply chain doesn’t always lead to more money. Setting up and running a manufacturing or distribution center may cost a lot of money, and your business may find it hard to compete with others that outsource to countries with cheap labor. The vertical merger also gives less room for change, so it is hard to stop.
Getting old because of new inventions
When new technologies come out quickly, a company could be hurt by its use of vertical integration. The company then has to put money back into the new technologies to stay competitive, which can be expensive and may require workers to be retrained.
Less of them means a higher price
If you go into manufacturing, you might not be able to keep costs as low as independent sellers who sell to many different customers. For example, when an automaker makes its own tires, it probably only makes enough to meet its own needs. A separate tire company, on the other hand, can sell to many automakers and get a better economy of scale as a result.
Unexpected problems at work
When a union company and a non-union company work together, labor problems can happen. For example, if a non-union company vertically joins with a union supplier, the parent company might shut down the supplier and outsource the service to save money. In fact, this is what has been happening in the flight business, where the number of repair jobs sent to lower-cost shops abroad has gone up.
Loss of focus on the business that started it all
Some companies are so good at what they do because they specialize that they almost don’t need to compete with anyone else. Your business might be great at selling its goods, but it might not be able to handle the production process well. A vertical merger could make it harder for the company to succeed and could even change the culture for good.
Even though there are many benefits to vertical integration, it is important to think about all of the risks before going forward. You might find that other methods, like buying a business at your own level in the supply chain, offer better chances with less risk.