Pros, Cons, and Examples of Vertical Integration

Pros, Cons, and Examples of Vertical Integration

Vertical integration is a reorganization tactic.

Businesses are constantly seeking ways to save expenses while maintaining the quality of the goods and services they offer. By incorporating various parts of its production process and supply chain into its business, a firm can gain a competitive advantage. Vertical integration is the term used to describe this type of structure.

There are typically six steps of a supply chain that are recognized, depending on the source of the information. Materials, suppliers, manufacturing, and distribution are the phases of vertical integration.

When two businesses at various phases of production are combined, there are three basic forms of integration, each having a number of shared benefits and drawbacks.

Types of Vertical Integration

Vertical integration comes in a variety of forms. All forms entail a merger with another business at least once during one of the four pertinent supply chain stages. The distinction relies on where the company is in the supply chain’s hierarchy.

It is referred to as being integrated forward when a corporation at the top of the supply chain manages steps further down the chain. Examples are iron mining firms that also own “downstream” businesses like steel mills.

When companies at the end of the supply chain take on tasks that are “upstream” from their goods or services, this is known as backward integration. As an illustration of a business with backward integration, consider Netflix, a video streaming firm that produces and distributes content.

A company that merges with other companies to try to control both upstream and downstream activity is said to have a balanced integration.

Examples

Target is an illustration of a vertically integrated business because it has its own store brands and manufacturing facilities. It produces, distributes, and sells its own goods, doing away with the need for third parties like manufacturers, shipping services, or other logistical requirements.

Manufacturers can also vertically integrate. Many clothing and footwear brands have a flagship location where they sell a broader variety of their goods than are offered by other outlets. In many cases, you can get discounted items from the previous season in outlet stores.

Advantages

There are five notable advantages of vertical integration that give a business a competitive edge over rivals that are not integrated.

  • A corporation with vertical integration can prevent supply disruption. It is better able to manage and address any supply issues by managing its own supply chain.
  • A business gains from avoiding suppliers in dominant markets. Terms, prices, and the availability of goods and supplies are subject to these providers’ control. A corporation can cut expenses and avoid production slowdowns brought on by negotiations or other factors outside of the company when it can get around suppliers like these.
  • Better scale economies are provided through vertical integration for businesses. When large businesses can reduce costs while increasing productivity, they do so by taking advantage of their size. For instance, a business could reduce the cost per unit by making bulk purchases or by reassigning staff from underperforming projects. By reducing procedures and integrating management, vertically integrated businesses reduce overhead.

The idea of producing more in order to reduce prices is known as “Economies of scale.” By increasing supply, reduces fixed and variable costs per unit and raises the allure of a product to consumers.

  • Businesses remain up to date on their rivals. Retailers are aware of the hot commodities. A corporation might produce “knock-offs” of the most well-known brand-name goods if it had a retail outlet, manufacturing facility, and supply chain. A knock-off is a product that is identical to the original but has the branding, packaging, and marketing materials of the original company. This is only possible for strong retailers. Suing for copyright infringement would put brand-name manufacturers in danger of losing significant distribution through a sizable store, which they cannot afford.
  • There are techniques for lower pricing. A vertically integrated business can pass on the cost benefits to the customer. Examples include the majority of national grocery store brands, Walmart, and Best Buy.

Disadvantages

  • The cost is vertical integration’s main drawback. For businesses to build or purchase factories, a significant amount of capital is required. Then, in order to preserve productivity and profit margins, they must keep the plants functioning.
  • By obliging them to follow trends in the segments it integrated, vertical integration diminishes a company’s flexibility. Imagine that a business bought a retailer for its goods and opened an outlet location that sold the previous stock as well. The rival retailers started utilizing a new technology, which increased their sales. To remain competitive in that market, the new parent business would now need to acquire that technology.

Technology that is developing quickly might have a significant impact on integration. Diverse technologies used at various supply-chain stages might also make integration challenging and more expensive.

  • Losing focus is another issue. For instance, managing a lucrative factory demands a different set of talents than managing a successful retail store. Finding a management group that excels at both is challenging. Management may lose sight of their core skills in favor of the recently acquired assets as a result of integration.
  • Culture shock is a problem. Additionally, it’s unlikely that any business will have a culture that supports both factories and retail outlets. A prosperous shop draws sales and marketing professionals. This kind of culture isn’t conducive to the needs of manufacturers, and the resulting tension can result in miscommunication, hostility, and decreased production.

Vertical Integration of a Supply Chain

Instead of letting other businesses manage one aspect of product sourcing, production, distribution, or marketing, many large organizations choose to take full control of these processes.

Vertical integration is a step many firms simply cannot afford to take, despite the fact that it is favorable to some large businesses that have strategically positioned themselves in their market and industry. Any business thinking about taking this action should be careful to fully comprehend its capacity to scale while bearing the costs of acquisitions.

Frequently Asked Questions (FAQs)

What distinguishes vertical integration from horizontal integration?

In horizontal integration, a business increases its client base and product offerings, typically by buying a rival or a brand that complements its own. Instead of expanding operational controls, as vertical integration does, it is intended to boost profitability through economies of scale.

Vertical integration was invented by who?

Since the Industrial Revolution, vertical integration has been a concept. One of the first to use it extensively was Andrew Carnegie. His business, Carnegie Steel, was in charge of the railroads that transported materials, the steel mills themselves, the iron mines that were used to extract the steel-making components, and the coal mines that gave the energy to produce the steel.

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