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How Does Vertical Integration Work? Pros, Cons and Examples
Disruptions in distributed supply chains have made news in recent years because they have prevented customers from getting the products they want, when they want them, hurting companies’ finances and damaging their reputations. One way companies can exert more control over their supply chains is through vertical integration, whereby they take ownership of more steps in the manufacture and sale of their products and services.
In theory, vertical integration helps a company secure more aspects of the supply, production and distribution functions and, ultimately, the sale of its goods and services, improving efficiencies and reducing costs along the way. While some companies achieve significant competitive advantage through vertical integration, the approach requires sizable capital investments and, in some cases, can limit the flexibility that comes from partnering with a federation of suppliers. Companies must consider the business case for vertical integration — the costs, benefits and challenges — very carefully.
What Is Vertical Integration?
Most companies rely on a number of suppliers and partners to produce and distribute their products, from raw material suppliers and manufacturing partners to distributors and retailers. Vertical integration refers to any effort by a company to take ownership of two or more steps in this supply chain, thereby “integrating” them into its own business. Rather than focusing solely on a single aspect of the process — say, ecommerce sales or finished manufacturing — the company opts to extend its reach and market power either forward or backward along the supply chain. Sometimes, a company will integrate in both directions. Some do this by building their own capabilities from the ground up, and others do it via merger and acquisition.
However it’s done, the idea is to gain more control over supply chain processes by bringing more of them in-house. Vertical integration requires sizable up-front financial outlays. But, in the right circumstances, the strategy can serve to streamline a company’s journey from raw materials to the delivery of a product into a customer’s hands, reducing costs and raising customer value — which can yield competitive and financial advantages over the long term.
A manufacturing company, for example, may decide to backward-integrate by sourcing its own raw materials — giving it greater visibility for managing its inventory of those materials — or forward-integrate by selling directly to end customers, eliminating distributors and/or retailers. Many companies have embraced vertical integration, from oil and gas leaders to high-tech firms. In some cases, vertical integration has been elemental to corporate survival and success. In others, vertical integration has proven costly and even led to corporate failure.
- Vertical integration involves a company taking ownership of two or more steps in its supply chain.
- It’s often categorized directionally: Companies can integrate upstream processes (backward integration), downstream stages (forward integration) or both (balanced integration).
- As vertical integration expands a company’s market footprint, it usually requires hefty up-front investment and can be operationally challenging.
- When done well, benefits include lower costs, greater control, improved visibility and more.
- Weighing the pros, cons, costs and return on investment for a vertical integration initiative requires access to high-quality supply chain data and analytics.
Vertical Integration Explained
To illustrate how vertical integration might proceed, consider the steps in a supply chain. Typically, the process begins with the purchase of raw materials, then proceeds through various stages of production, from which a finished product emerges, is distributed and, ultimately, sold to the end customer. A nonvertically integrated company might implement just one piece in that chain of processes. If the company wants to vertically integrate, it must expand its operations to include steps before and/or after the step it already performs. The company may choose to acquire one or more of its suppliers in hopes of reducing manufacturing costs or gaining more control over production. Or it might invest in the retail end of the process, opening physical stores or introducing ecommerce capabilities to get closer to the customer and increase profit margins. It might invest in warehouses and vehicle fleets to take more control over distribution and logistics.
When a company decides to vertically integrate, it always faces a build-or-buy decision. The company may choose to build some part of the production, distribution or retail sales process from scratch, re-creating one or more aspects of the supply chain that it had previously outsourced. Alternatively, they may buy their way into vertical integration, acquiring or merging with suppliers, manufacturers, distributors or retailers.
Whether they build or buy, vertical integration is a big investment. Companies must devote significant up-front capital, whether they are establishing their own capabilities or attaining them through mergers and acquisitions. They have to build or purchase physical facilities, hire additional employees and management and invest in new business processes and technologies — all of which increases the size and complexity of the overall organization.
Types of Vertical Integration
There are several types of vertical integration. A company may expand further “upstream” in the supply chain (backward integration), further “downstream” (forward integration) or move in both directions (balanced integration). Any approach in which a company eliminates steps in the journey from raw materials through production to the customer can be called disintermediation, but that term is usually reserved for when companies try to take over a step between themselves and the final customer.
Backward integration happens when a company moves a process in-house so as to take control of earlier, or upstream, steps in the supply chain process. Fast-food restaurant McDonald’s is a good example of backward integration, having taken ownership of certain processes all the way back to the agricultural production that supplies ingredients for its eateries.
By contrast, forward integration is when a company takes ownership of processes further along, or downstream, in the supply chain, perhaps by taking control of distribution or sales of finished goods and services. Nike, for example, took a forward integration approach in establishing its own retail stores. The Walt Disney Company’s launch of the Disney+ streaming service, which allows it to deliver its entertainment library directly to consumers, is another example.
When a company vertically integrates processes both upstream and downstream, it’s pursuing balanced integration. Naturally, this can occur only when a company sits somewhere in the middle of a supply chain (rather than at one end or the other). Balanced integration can be trickier to pull off but can also offer greater benefits when executed well. Apple, for example, extended itself both forward in the supply chain with the opening of its retail stores and backward, when it designed its own semiconductors.
Disintermediation refers to the process of removing intermediaries — aka “middlemen” — from a company’s supply chain, usually to get closer to the customer but always to reduce costs and increase efficiencies. Computer manufacturer Dell and electric-auto maker Tesla are examples. Both opted to exclusively sell their products direct to consumers rather than rely on distributors, dealerships and retailers. Tesla also offers an example of balanced integration, as it operates its own plants and designs its own batteries and charging stations, in addition to its direct sales approach.
Benefits and Drawbacks of Vertical Integration
When companies can make a clear case for the value of vertical integration — for example, to address supply or demand risks — and have the capabilities to pursue it, vertical integration can help a company reduce costs, improve efficiency and have more control over its supply chain. When executed poorly or without a clear rationale, vertical integration can be a costly mistake. Vertical integration often involves trade-offs, requiring companies to carefully evaluate the advantages and disadvantages relative to their specific circumstances.
Benefits. Among the most notable potential benefits of vertical integration are: greater economies of scale, as an organization’s fixed-cost base is spread across a larger range of operations; the migration of some fixed, external costs (e.g., logistics) to variable costs, over which the organization has greater control; fewer supply chain disruptions, or at least more visibility , which gives the company an earlier warning when a possible disruption is coming; lower lead time ; and faster time to market, because with more control over the supply chain, the company can prioritize new-product activities when it is advantageous to do so. Thinking further, cases of forward integration could lead to improved customer or market insight; and that, together with greater control over supply chain inputs and processes, can lead to higher quality products and services. Taking ownership of more steps in a supply chain may even help a company deal with inflation . Together, all these benefits add up to an organization that is better able to synchronize supply and demand and capture more of the available profit margin in a given market.
Drawbacks. But a successful vertical integration means a company must manage multiple challenges, any one or combination of which could derail those benefits and leave the organization worse off. Vertical integration is not a quick fix — it’s a long-term strategy that requires significant up-front capital expenditures and yet may take a relatively long time before its returns are realized. So, it requires a long-term commitment at all levels of the organization, especially the C-suite. By definition, vertical integration increases organizational complexity — it means a company must add to its existing operations, and, if it is to realize the potential benefits, it must thoughtfully integrate those operations with existing processes and systems. In some ways, it can decrease an organization’s flexibility relative to partnering because of the sunk investment in infrastructure. It can decrease an organization’s focus on its original core competencies. And, in extreme cases, a company that is very successful at vertical integration can catch the eyes of antitrust regulators.
Degrees of Vertical Integration
Companies that pursue vertical integration should understand the risks and rewards of the strategy. They should also consider the degree to which vertical integration makes sense for the organization. Companies do not necessarily have to go “all in” with a vertical integration approach to achieve some significant benefits. There are varying degrees of integration to explore, from full integration to none at all.
Full vertical integration
For any given organization, full vertical integration can mean one of two things. Most often, it refers to an organization that seeks to acquire or build all the assets, resources, capabilities and skills necessary to take over one entire step in its supply chain, either upstream or downstream. But it can also refer to an organization that takes full control over all the steps in its supply chain, from the raw materials to the customer’s doorstep.
Quasi vertical integration
There is a wide variety of strategies that stop short of total integration that companies can employ to secure some of the benefits of vertical integration via a more contained — and, therefore, less risky — investment. Often, this means acquiring a minority interest in one or more upstream or downstream companies. It could also involve joint ventures, strategic alliances, asset acquisitions, technology licenses and franchising opportunities, all of which entail lower up-front costs and can offer greater flexibility than fully integrating a supply chain process .
Companies can exert more control upstream or downstream by signing long-term contracts with a partner, potentially increasingly predictability and/or decreasing costs.
In contrast to long-term contracts, which offer some consistency and predictability, trading in the so-called spot market occurs when companies purchase supplies as needed for the next step in the production process. Sitting at the opposite end of the spectrum from full vertical integration, these are one-off transactions for satisfying immediate needs.
Vertical Integration Examples
Carnegie Steel was one of the first and most significant examples of balanced, full vertical integration. By the 1890s, the industrial giant had acquired all sources of supply, as well as logistics and shipping. The company wielded significant market power, owning and operating iron ore and coal mines, steel mills and coal processing plants, and even the ships and railroads that moved everything throughout the supply chain.
Historically, the telecommunications industry has been tightly integrated, initially to ensure end-to-end control of the complex infrastructure required to deliver telephone services. Throughout the 20th century, most telephone companies made their own telephones, telephone cables and other supplies; they also sold and delivered their services directly to customers.
The oil and gas industry has been marked by extreme vertical integration (and, sometimes, disintegration). Exxon Mobil, for example, has integrated each stage of the industry value chain within its business units. Its upstream division owns and manages global production assets and processes. Its downstream division includes refineries and retail outlets. And its chemical division produces synthetic petrochemical products. Similarly, BP has an upstream segment responsible for oil and gas exploration, development and production, as well as a downstream segment that includes a logistics and retail network to ship and sell its fuels, lubricants and petrochemicals.
The merger of Live Nation and Ticketmaster in 2010 offers another case study in balanced vertical integration. For Ticketmaster, which sells tickets to events, the transaction represented forward integration, while for Live Nation (which produces events), it was a backward integration strategy.
SpaceX offers a more recent example of vertical integration. In contrast to competitor United Space Alliance (a joint venture between aerospace companies Boeing and Lockheed Martin), SpaceX manufactures most components in-house, which lowers its costs to the tune of $370 million per launch.
Is It Time to Integrate? Your NetSuite Data Can Tell You
Companies with good supply chain visibility will be in the best position to assess opportunities for vertical integration within their own value chains. NetSuite’s Supply Chain Management capabilities make it easier for companies to track spending and monitor supplier performance over time, with an eye toward the potential benefits of integration. And, for those organizations that do make the leap to greater vertical integration, robust supply chain management software is critical to optimizing integrated operations and unlocking the full value of the investment. NetSuite software can empower vertically integrated companies to reduce the costs associated with planning and executing supply chain processes, improve inventory management , increase cash flow, and identify and mitigate risk with predictive analytics and scenario planning.
Vertical integration can be difficult to capitalize on — it’s costly, complex and not easily undone. However, when well executed, it can confer a number of advantages, including greater control, reduced costs, increased profitability, better product or service quality, increased customer and market insights and more. Those companies with good visibility into their existing supply chain in either direction, along with access to integrated data analytics, will be best equipped to explore the opportunities of vertical integration.
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Vertical Integration FAQs
When is an acquisition considered vertical integration?
Not all corporate acquisitions result in vertical integration. However, when a company acquires a trading partner (either a supplier or a customer), it is an example of vertical integration because it results in the company owning and operating more steps in its supply chain.
What’s the difference between vertical and horizontal integration?
With horizontal integration, a company is expanding its reach in its existing area of core competency (say, a manufacturer acquiring another manufacturer or an accounting firm acquiring another accounting firm). With vertical integration, a company is reaching beyond its existing area of focus to take on additional roles in the product or service value chain, whether that’s a technology company that takes over the sourcing and production of its components or a luxury-goods maker that expands into retail sales.
What is vertical and horizontal integration?
Horizontal integration takes place when a company acquires a competitor or related business, expanding its footprint in its core competency. A grocery chain may buy a rival chain to, say, eliminate competition, expand into new geographic markets or increase its overall sales. Vertical integration involves the acquisition of a key component of a company’s supply chain, either upstream or downstream from its own core competency. Companies pursue vertical integration for a number of reasons, including increased control, reduced costs or improved margins. When a company takes over an upstream step, such as a manufacturing business taking over sourcing of raw materials, it is called backward integration. When a company brings a downstream step in-house, such as a manufacturer that opts to open retail or ecommerce direct sales channels, it is called forward integration. A company could also pursue a balanced integration approach, expanding its reach in both directions.
Is vertical integration profitable?
In short, it depends. A number of variables can determine the profitability of a vertical integration strategy. Examples of successful and failed vertical integration abound. In addition, there are different approaches and degrees of vertical integration possible. A vertical integration strategy can deliver advantages, including greater economies of scale, lower variable production costs, decreased logistics costs and quality concerns and — yes — increased profitability. However, full vertical integration takes time, requires significant capital investment and can result in increased complexity and decreased flexibility. Companies must consider the advantages and costs of a specific vertical integration approach carefully. Some companies are able to secure significant competitive advantage via vertical integration, while others may determine that the costs of integration outweigh its benefits.
What is an example of vertical integration?
Carnegie Steel was one of the first examples of full vertical integration. By the 1890s, Carnegie owned mines for iron ore and coal, steel mills and coal processing plants, as well as the ships and railroads that moved raw materials and finished products throughout the supply chain. Similarly, some of the world’s largest oil and gas companies control both downstream and upstream operations, from exploration and extraction to refining and logistics to retail and business sales. Technology giants Amazon and Apple have pursued balanced integration opportunities over the years. (Balanced integration is when a company acquires steps in the supply chain both preceding and following its own link in the chain.) Electric-auto maker Tesla embraced balanced integration from the start, running and operating its own plants and opting to sell its products directly to consumers.
What is a vertical integration structure?
A vertical integration structure involves a company taking over multiple stages of its production or sales processes rather than relying on external suppliers and trade partners.
What is vertical integration in economics?
In economics, vertical integration is the term used to describe a business strategy in which a company takes ownership of two or more key stages of its supply chain. A vertically integrated automaker, for example, might produce automobile components and vehicles and also sell directly to customers.
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- Vertical Integration
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Vertical Integration Explained: How It Works, With Types and Examples
Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.
What Is Vertical Integration?
Vertical integration is a strategy that allows a company to streamline its operations by taking direct ownership of various stages of its production process rather than relying on external contractors or suppliers. Companies can achieve vertical integration by acquiring or establishing their own suppliers, manufacturers, distributors, or retail locations rather than outsourcing them. Vertical integration can be risky due to the significant initial capital investment required.
- Vertical integration requires a company's direct ownership of suppliers, distributors, or retail locations to obtain greater control of its supply chain.
- The advantages can include greater efficiencies, reduced costs, and more control along the manufacturing or distribution process.
- Vertical integration often require heavy upfront capital that may reduce a company's long-term flexibility.
- Forward integration occurs when a vendor attempts to acquire a company further along the supply chain (i.e. acquire a retailer).
- Backward integration occurs when a vendor attempts to acquire a company prior to it along the supply chain (i.e. a raw material provider).
Investopedia / Mira Norian
How Vertical Integration Works
Vertical integration occurs when a company attempts to broaden its footprint across the supply chain or manufacturing process. Instead of sticking to a single point along the process, a company engages in vertical integration to become more self-reliant on other aspects of the process. For example, a manufacturer may want to directly source its own raw materials or sell directly to consumers.
The supply chain or sales process typically begins with the purchase of raw materials from a supplier and ends with the sale of the final product to the customer. Vertical integration requires a company to take control of two or more of the steps involved in the creation and sale of a product or service. The company must buy or recreate a part of the production , distribution, or retail sales process that was previously outsourced.
Companies can vertically integrate by purchasing their suppliers to reduce manufacturing costs. They can invest in the retail end of the process by opening websites and physical stores. They can invest in warehouses and fleets of vans to control the distribution process.
All of these steps involve a substantial investment of money to set up facilities and hire additional talent and management. Vertical integration also ends up increasing the size and complexity of the company's operations.
As a company engages in more activities along a single supply chain, it may result in a market monopoly. A monopoly that occurs due to vertical integration is also called a vertical monopoly.
Types of Vertical Integration
There are a number of ways that a company can achieve vertical integration. Two of the most common are backward and forward integration.
A company that chooses backward integration moves the ownership control of its products to a point earlier in the supply chain or the production process.
This form of vertical integration is aptly named as a company often strives to acquire a raw material distributor or provider towards the beginning of a supply chain. The companies towards the start of the supply chain are often specialized in their distinct step in the process (i.e. a wood distributor to a furniture manufacturer). In an attempt to streamline processes, the furniture manufacturer would try to bring the wood sourcing in-house.
Amazon ( AMZN ) started as an online retailer of books that it purchased from established publishers. Although it continues to do so, it also became a publisher. The company eventually branched out into thousands of branded products. Then, it introduced its own private label, Amazon Basics, to sell many of them directly to consumers.
A company that decides on forward integration expands by gaining control of the distribution process and sale of its finished products.
A clothing manufacturer can sell its finished products to a middleman , who then sells them in smaller batches to individual retailers. If the clothing manufacturer were to experience forward vertical integration, the manufacturer would join a retailer and be able to open its own stores. The company would aim to bring in more money per product, assuming it can operate its retail arm efficiently.
Forward integration is a less common form of vertical integration because it is often more difficult for companies to acquire others that are further along the supply chain. For example, the largest retailers at the end of the supply chain often have the greatest cash flow and purchasing power . Instead of these retailers being acquired, they often have the capital on hand to be the acquirer , which is an example of backward integration.
A balanced integration is an approach to vertical integration where a company aims to merge with companies both before it and after it along the supply chain. A company must be the middleman and manufacture a product to engage in balanced integration. That's because it must both source raw materials as well as work with retailers to deliver the final product.
Consider the supply chain process for Coca-Cola ( KO ) where raw materials are sourced, the beverage is concocted, and bottled drinks are distributed for sale. Should Coca-Cola choose to merge with both its raw material providers as well as retailers who will sell the product, the company is then engaging in balanced integration.
Though most costly and risky due to the diversified nature of business operations, balanced integration also poses the greatest upside as a company is more likely to have greater (if not full) control over the entire supply chain process.
Although vertical integration can reduce costs and create a more efficient supply chain, the capital expenditures involved can be significant.
Advantages and Disadvantages of Vertical Integration
Vertical integration can help a company reduce costs and improve efficiency. However, when executed poorly, vertical integration may have negative consequences on the company.
The primary goal of vertical integration is to gain greater control over the supply chain and manufacturing process. When performed well, vertical integration may lead to lower costs, economies of scale , and a lower reliance on external parties.
Vertical integration may lead to lower transportation costs, smaller turnaround times, or simpler logistics if the entire process is managed in-house. This may also result in higher quality products as the company has direct control over the raw materials used through the manufacturing line.
Companies may sometimes find themselves at the whim of suppliers who have market power. Through vertical integration, companies can circumnavigate external monopolies . In addition, a company may gain insights from a retailer on what goods are selling best; this information may be very useful in making manufacturing and product decisions.
Companies can't vertically integrate overnight. In fact, it is a long-term process that requires widespread buy-in. This also includes heavy upfront capital expenditure requirements to acquire the proper company, integrate new and existing systems, and ensure that staff is trained across the entire manufacturing process.
By vertically integrating, companies do sacrifice some degree of flexibility. This is because they commit capital to a specific process or product. Instead of being able to decline purchasing from an external vendor , a company will likely have committed money that can not be easily recovered. In addition, a company may lose the opportunity to gain unique knowledge through different external vendors.
Vertical integration may also have several social impacts. Companies may end up trying to do too much and lose focus on their ultimate goal. In addition, customers may not support the culture of a large manufacturer also interfacing directly with customers.
Long-term cost saving due to favorable pricing and minimal supply chain disruptions
Economies of scale, which increase efficiency
Reduces or eliminates the need to rely on external parties/suppliers
Greater control over the product, inputs, and process, which may lead to superior products
Requires large upfront capital requirements to implement
Reduce a company's long-term flexibility
Loss of focus on a company's primary objective or customer
Displeased customer base that would prefer to work with smaller retailer
Vertical Integration vs. Horizontal Integration
Vertical integration involves the acquisition of a key component of the supply chain that the company has previously contracted for. It may reduce the company's costs and give it greater control of its products. Ultimately, it can increase the company's profits.
Horizontal integration , on the other hand, involves the acquisition of a competitor or related business. A company may do this to accomplish any or all of the following:
- Eliminate a rival and cut out its competition
- Improve or diversify its core business
- Expand into new markets
- Increase its overall sales
While a vertical integration strategy stretches a company along a single process, horizontal integration is a more pointed approach that causes a company to become more specific or niche within a certain market. For example, instead of engaging in all aspects of a supply chain ranging from materials sourcing, manufacturing, or retail, a company can choose to master only one of those facets by acquiring similar companies to engage in horizontal integration.
Much analysis has gone into reviewing when it is more optimal to simply contract with another company as oppose to acquire them. Published modern economic theory on the matter dates back decades.
Examples of Vertical Integration
Netflix ( NFLX ) is a prime example of vertical integration. The company started as a DVD rental business before moving into online streaming of films and movies licensed from major studios. Executives then realized they could improve their margins by producing some of their own original content like the hit shows "Grace & Frankie" and "Stranger Things." It also produced some bombs, like 2016's The "Get Down," which reportedly cost the company $120 million.
The company now uses its distribution model to promote its original content alongside programming licensed by studios. Instead of simply relying on the content of others, Netflix performed vertical integration to become more engaged in the entertainment development process earlier.
Fossil Fuel Industry
The fossil fuel industry is a case study in vertical integration. British Petroleum ( BP ), ExxonMobil ( XOM ), and Shell ( SHEL ) all have exploration divisions that seek new sources of oil and subsidiaries that are devoted to extracting and refining it. Their transportation divisions transport the finished product. Their retail divisions operate the gas stations that deliver their product.
Live Nation & Ticketmaster
The merger of Live Nation and Ticketmaster in 2010 created a vertically integrated entertainment company that manages and represents artists, produces shows, and sells event tickets. The combined entity manages and owns concert venues, while also selling tickets to the events at those venues.
When Is an Acquisition Considered Vertical Integration?
An acquisition is an example of vertical integration if it results in the company's direct control over a key piece of its production or distribution process that had previously been outsourced.
A company's acquisition of a supplier is known as backward integration. Its acquisition of a distributor or retailer is called forward integration. In the latter case, the company is often buying a customer, whether it was a wholesaler or a retailer.
Is Vertical Integration Good for a Company?
Whether vertical integration makes sense for a company depends on what's good for it in the long run. If a company makes clothing with buttons, it can buy the buttons or make them. Making them eliminates the markup charged by the button-maker. It may give the company greater flexibility to change styles or colors while eliminating the frustrations that come with dealing with a supplier.
Then again, the company would have to set up or buy a whole separate manufacturing process for buttons, buy the raw materials that go into making and attaching buttons, and hire people to make the buttons along with a management team to manage the button division.
What Is the Difference Between Vertical Integration and Horizontal Integration?
Vertical integration is the practice of acquiring different pieces along a supply chain that a company does not currently manage. Horizontal integration is the practice of acquiring similar companies to further master what it already does. Vertical integration makes a company broader while horizontal integration may help it penetrate a specific market further.
Why Do Companies Use Vertical Integration?
Companies use vertical integration to have more control over the supply chain of a manufacturing process. By taking certain steps in-house, the manufacturer can control the timing, process, and aspects of additional stages of development. Owning more of the process may also result in long-term cost savings (as opposed to buying outsourced goods at marked-up costs).
Vertical integration is the business arrangement in which a company controls different stages along the supply chain. Instead of relying on external suppliers, the company strives to bring processes in-house to have better control over the production process. Though vertical integration may result in increased upfront capital outlays, the goal of vertical integration is to streamline processes for more efficient and controlled operations in the long-term.
Harvard Library. " The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration ."
Variety. " Inside the Troubled Production of Baz Luhrmann's 'The Get Down,' Netflix's Most Expensive Series Yet ."
U.S. Securities and Exchange Commission. " Form 10-K, Netflix, Inc. ," Page 30.
U.S. Securities and Exchange Commission. " Live Nation and Ticketmaster Entertainment Complete Merger ."
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Vertical Integration: Definition, Examples, and Advantages
Companies can choose many business strategies to meet their supply chain and logistics needs. Each approach has advantages and disadvantages. The best method depends on a company’s specific needs, goals, and circumstances.
Businesses may focus on efficiency and cost-cutting by opting for a lean, streamlined supply chain with minimal inventory and waste. Other companies may focus on flexibility and responsiveness and implement a more agile and adaptive supply chain that can quickly respond to changes in demand or supply.
Many companies opt for vertical integration as one of the best business strategies to ensure cost savings, increased efficiency, and improved supply chain coordination.
What Is Vertical Integration?
Vertical integration is the strategic practice of controlling all operations within a supply chain or logistics organization. It involves organizing a company’s operations to include control over the production and distribution of its products or services. Companies take control of several links in the production chain, including raw materials, manufacturing, marketing, and distribution.
How Vertical Integration Works?
Vertical integration necessitates complete oversight of suppliers, distributors, or retail spaces for a corporation to have more control over its supply chain. The process starts when a company identifies critical areas of the supply chain that it wants to control, such as a specific raw material, a manufacturing process, or a distribution channel.
Companies then achieve vertical integration by acquiring or merging with other companies that are involved in different stages of the production process. Creating internal divisions to handle various aspects of production and distribution also helps companies achieve vertical integration by allowing them to coordinate and control their operations.
The companies also develop new capabilities internally, including purchasing new equipment or hiring a team of experts to manage the unique aspects of the supply chain. This0 brings new expertise and knowledge to the company and increases the efficiency and coordination of the supply chain.
Types of Vertical Integration
Companies can choose different types of vertical integration strategies for their supply chain management and logistical operations. Here are three types of vertical integration.
Backward integration is a vertical integration that runs upstream of the supply chain. Companies expand their operations back to the earlier stages of the supply chain. They take control of the raw material and intermediate products involved in producing the end product that the company makes.
This integration consists of purchasing the supplier outright or entering into a joint venture or partnership with the supplier. A company can also integrate the supplier’s operations into its own. Alternatively, a company may backward integrate by establishing its production facilities for raw materials or intermediate products.
Backward integration gives a company greater control over its operations and supply chain. It can lower costs by eliminating the need to purchase raw materials or intermediate products from other companies.
Forward integration is a business strategy in which a company controls the downstream supply chain operations. It expands its operations by taking control of the distribution and sales of its products.
A company might acquire a company involved in distributing or selling its products, either through a purchase of the company’s assets or through a merger. Alternatively, a company might build its distribution or production facilities by constructing new buildings or acquiring existing ones.
Forward integration can give a company control over the quality of its products and the costs associated with producing them. This integration can help a company to increase its efficiency, improve its profitability, and strengthen its competitive edge in its market by eliminating the downstream intermediaries.
Balanced integration is a vertical integration strategy that controls a supply chain’s upstream and downstream operations. It allows a company to have more control over the entire value chain of its products, from the production of raw materials, assembly, and distribution to sales.
A company can achieve balanced integration by purchasing or merging with smaller companies that provide the raw materials needed to produce its end product. It also connects existing distribution operations as a platform for offering its products to customers. The company gets to acquire suppliers and retailers as the middleman.
Balanced integration allows a company to better control the quality of its products, as it provides more direct control over the production process. It also helps reduce costs by eliminating intermediaries in the production and distribution process. Cost reduction can lead to customer attraction and increase the company’s market share.
Advantages of Vertical Integration
The application of vertical integration has numerous advantages for the supply chain and logistical organizations. Here are some benefits companies can accrue from using vertical integration.
Control of the Supply Chain
Vertical integration gives a company control over the production of raw materials, assembly, distribution, and sales of its products. It allows a company to implement its supply chain, logistics, and operations through centralized management.
A company can reduce its reliance on external suppliers by owning and controlling these operations. Companies that gain control of their supply chain will be able to meet the changing demands of their customers and put more effort into managing their costs. It also gives companies a competitive edge over their competitors.
Lower Operation Costs
Vertical integration helps companies enjoy economies of scale. It can control the quality of raw materials or intermediate products in manufacturing products. This control allows the company to adopt a lean production strategy that reduces waste in the supply chain. It also enables agile and just-in-time production reducing inventory holding costs.
Companies also can lower costs by eliminating redundant supply chain operations and consolidating or streamlining them. Vertical integration allows a company to pass on its savings to the end product that it produces. It also allows a company to reduce costs by eliminating intermediaries within the supply chain.
Through vertical integration, companies can monitor, manage, and control the various operations within their supply chain. This coordination and fluent flow of information through the supply chain allow an efficient process from raw material production to product distribution to customers saving time.
For example, a company that owns its raw material suppliers can ensure that the materials it needs are available when needed, which helps prevent production delays. It can also closely coordinate the distribution and sale of its products, which can help to improve customer satisfaction.
Through vertical integration, companies can get immediate feedback on the performance of their supply chain operations. The information companies receive from their raw materials suppliers and distribution partners is also accurate as they receive it themselves.
Coordination achieved by vertical integration helps a company to improve its response time by reducing the problems arising from delays in communication. Vertical integration also allows companies to increase their responsiveness to and flexibility concerning changes in their customer’s requirements or needs.
Disadvantages of Vertical Integration
A Vertical Integration strategy does not assure your company’s success. Let’s look at some disadvantages of vertical integration in supply chain and logistics organizations.
The process involved in vertical integration causes the supply chain and logistics organizations to be longer-term. A company must maintain its operations for an extended period which provides its competitors a longer time than they need to adjust and make their strategy in response.
The slow process is particularly true if a company acquires or establishes new facilities or business units to house its supply chain operations. This integration would also include training employees who take time to learn and understand the newly integrated processes and procedures.
Heavy Initial Investment
The vertical integration process calls for significant initial capital. For a company to be fully vertically integrated, it may need to invest in new facilities and equipment, such as building a new manufacturing plant or acquiring a supplier. It also needs to integrate new operations into an existing business, such as training employees and incorporating new systems.
Similarly, suppose a company wants to vertically integrate by acquiring a supplier. In that case, it will need to pay for the acquisition and may also need to invest in upgrading or improving the supplier’s operations.
The integration of vertical operations into a single business unit can create rigidity in the supply chain. It can also prevent a company from taking advantage of cost savings and efficiency improvements when its supply chain operations run independently.
A company that owns its distribution channels may need more time to pivot to new tracks. In contrast, a company that relies on external suppliers and distributors may have more flexibility to respond to changes in the market because it is less committed to a particular production and distribution process.
Integrating supply chain operations into a single business unit can make it difficult for companies to balance the tradeoffs between cost and quality. Companies can also experience difficulty dealing with issues like supply shortages or fluctuations in demand.
A company that vertically integrates its production may need help to capture most of the cost savings from using better materials or finding new suppliers. It may also fail to take advantage of other benefits, such as obtaining better feedback on operations or learning to manage issues that arise in the production process.
Business Examples that Use Vertical Integration
Netflix is an example of a company that has successfully implemented a vertical integration strategy. The company offered a subscription-based streaming service but has expanded to produce its content. This approach allows Netflix to control the entire process of creating and distributing its range, from the initial idea to the final product.
Ford Motor Company has incorporated a vertical integration strategy in its operations. The company vertically integrates by producing its components, such as engines and transmissions, and assembling its vehicles. It also operates research and development facilities to design and test new products. Ford can save on costs and improve the quality of its products.
Dell also operates its distribution channels, including its website and a network of retail stores. It originally started as a direct-to-consumer computer manufacturer, selling PCs through its website and phone sales. It is vertically integrated by producing its components, such as motherboards and processors, and assembling its PCs.
Vertical Integration vs. Horizontal Integration
Vertical and horizontal integration are strategies involving expanding a company’s operations. Vertical integration broadens its operations by taking control of the production and distribution of goods or services. Horizontal integration consists of acquiring other companies engaged in the same core competencies.
A key difference between vertical and horizontal integration are the resources involved. A vertically integrated company expands its operations by acquiring or developing its resources, such as raw materials and distribution channels. In horizontal integration, companies acquire other companies with resources in their specific niche in the market.
Vertical integration also allows a company to better coordinate the production and distribution of its products, giving it a competitive advantage . On the other hand, horizontal integration allows a company to expand its market presence and potentially increase its bargaining power with suppliers and distributors.
One challenge of vertical integration is that it can be costly, requiring a company to invest in new facilities and equipment. It also affects the flexibility of a company. In contrast, horizontal integration can be challenging because it requires a company to integrate the operations of the acquired company, which can be complex and time-consuming.
When Should a Company Opt For Vertical Integration?
A company that relies on external suppliers or distributors may need help obtaining the resources it needs timely and cost-effectively. For example, suppose a company cannot secure reliable suppliers, or there are disruptions in the supply chain it may. In that case, it is beneficial to vertically integrate to have more control over the resources it needs.
Businesses can benefit from vertical integration if they operate in an industry subject to taxes or regulations that create trade barriers. A company can more easily navigate these challenges and reduce costs by using vertical integration.
By vertically integrating, a company can easily coordinate the production and distribution of its products and may have more control over the terms of its contracts. This integration will stop a company from having contract challenges, such as difficulties in negotiating favorable terms or problems with enforcing contracts.
When Should a Company Disregard Vertical Integration?
A company may disregard vertical integration in certain situations, such as when the company deals with widely available commodities. In such industries, it may not make sense for a company to invest in its production facilities, as many suppliers can provide the same product at similar or even prices.
Companies can fully or partially incorporate vertical integration or not at all. Depending on their specific needs and goals, they can choose which aspects of their operations to integrate.
Before integration, companies must consider various factors, such as the availability of materials, labor, resources, costs, and risks. This approach will allow the company to enjoy the benefits of vertical integration while maintaining flexibility.
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What are the advantages vertical integration.
In the world of business, there are various strategies that companies can employ to improve their operations and achieve success. One such strategy is vertical integration, which involves merging different stages of a supply chain into one company . This approach has been embraced by some of the biggest names in industry, from Apple to Amazon. But what exactly are the advantages of vertical integration ? And how can you determine if it’s right for your business? In this blog post, we’ll explore these questions and more while delving into real-life case studies of companies that have successfully implemented vertical integration. So whether you’re a seasoned entrepreneur or just getting started on your business journey, read on to discover everything you need to know about procurement through vertical integration!
What is vertical integration?
Vertical integration refers to the practice of merging different stages of a supply chain into one company. In other words, it involves controlling multiple aspects of production, from raw materials to finished products. This can include everything from manufacturing and distribution to marketing and sales.
The goal of vertical integration is typically to improve efficiency, reduce costs , and increase profits. By bringing various functions under one umbrella, companies can streamline their operations and eliminate some of the inefficiencies that come with outsourcing or working with third-party suppliers .
There are two main types of vertical integration: backward integration and forward integration. Backward integration involves taking control over suppliers, while forward integration involves taking control over distributors or retailers .
Vertical integration is just one of many strategies that businesses can use when looking to boost their bottom line. However, it’s important for companies to carefully weigh the pros and cons before committing fully to this approach.
The advantages of vertical integration
Vertical integration is a business strategy that involves the integration of various stages in the production and distribution process . This means that a company controls one or more stages of the supply chain , from raw materials to finished products.
One of the main advantages of vertical integration is cost savings . By owning different parts of the supply chain , businesses can reduce costs by cutting out middlemen and controlling their own inputs. They can also improve efficiency by streamlining operations and reducing duplication.
Vertical integration also provides greater control over quality. When a company owns its suppliers, it has more influence over their processes and can ensure consistent quality across all stages of production . This results in higher-quality products for customers.
Another benefit is increased flexibility in responding to market changes. With complete control over different parts of the supply chain , companies can quickly adapt to changes in demand or new product opportunities without relying on outside parties.
Vertical integration offers a competitive advantage by creating barriers to entry for competitors who do not have access to similar resources or capabilities.
The disadvantages of vertical integration
Although there are many advantages to vertical integration in business , it’s important not to overlook the potential disadvantages. One of the biggest drawbacks is increased complexity and risk. When a company integrates vertically , it takes on more tasks and responsibilities which can lead to higher costs and greater risks.
Another disadvantage is that vertical integration can reduce flexibility. By bringing more functions in-house, companies may find it harder to adapt quickly to changes in the marketplace or customer demands . This could put them at a competitive disadvantage compared with firms that outsource some activities.
Vertical integration can also lead to reduced innovation as companies become focused on maintaining their existing operations rather than exploring new ideas or markets . This could limit growth opportunities over time .
Vertical integration may result in antitrust concerns if a company becomes too dominant within its industry . Regulators may view such dominance as anti-competitive behavior which could result in legal action against the firm.
While there are clear benefits of vertical integration for businesses seeking greater control over their supply chain and operations, caution should be exercised when deciding whether this approach is right for your particular organization.
How to decide if vertical integration is right for your business
When considering vertical integration, it’s important to assess whether or not it aligns with your business goals and values. You should also evaluate the potential benefits and drawbacks that come along with this strategy.
Firstly, consider if vertical integration is necessary for your particular industry. Are there any cost savings or efficiencies that could be gained by bringing certain processes in-house? Additionally, think about how integrating vertically would impact your supply chain relationships and overall business structure.
Next, weigh the potential advantages against the disadvantages. While vertical integration can lead to greater control over production and distribution processes, it can also require significant investments in resources such as equipment and personnel. It may also result in less flexibility when responding to changes in market demand .
Consult with experts such as procurement specialists who can provide insight into the feasibility of implementing a vertical integration strategy within your organization. By taking a comprehensive approach to decision-making regarding vertical integration, you will be better equipped to determine its suitability for your business needs .
Case studies of businesses that have successfully implemented vertical integration
One of the most notable examples of successful vertical integration is by tech giant Apple. In 2010, they acquired a microchip manufacturer which allowed them to control the production and design of their devices’ hardware. This move helped them streamline their supply chain , reduce costs, and improve efficiency.
Another example is Amazon’s acquisition of Whole Foods in 2017. By integrating with a brick-and-mortar store, Amazon was able to expand its grocery delivery service while also gaining access to valuable customer data. By controlling both online and physical sales channels , Amazon can offer greater convenience for customers while also reducing costs.
A less well-known example is US-based poultry producer Perdue Farms who vertically integrated by acquiring feed mills and hatcheries. This gave them greater control over breeding programs and quality standards leading to improved product consistency.
These case studies show that vertical integration can bring significant benefits such as increased control over the supply chain , reduced costs through economies of scale, improved quality control, competitive advantage through differentiation strategies and increased market share. However, it requires careful consideration before implementation as there are potential drawbacks such as higher initial investment costs or dependence on one supplier or customer base.
Vertical integration can be a powerful strategy for businesses that want to control their supply chain and gain a competitive advantage. By bringing different parts of the production process in-house, companies can reduce costs , improve efficiency, and enhance quality control.
However, it is important to weigh the advantages against the disadvantages before making a decision about whether or not to pursue vertical integration . The risks associated with this strategy include increased capital expenses, higher operational costs and potential conflicts of interest.
Ultimately, each business must determine if vertical integration aligns with its overall goals and objectives. By carefully evaluating the pros and cons of this approach and analyzing market conditions within their industry sector , organizations can make an informed decision about how best to manage procurement processes while maintaining optimal cost management strategies .
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Is Vertical Integration Profitable?
- Robert D. Buzzell
Vertical integration, or the lack of it, can have a significant impact on business performance. While some observers claim that adequate vertical integration can be crucial to survival, others blame excessive integration for causing corporate failure. Examples of the reasons behind moves toward integration and of their success or failure aren’t hard to find: In […]
Vertical integration, or the lack of it, can have a significant impact on business performance. While some observers claim that adequate vertical integration can be crucial to survival, others blame excessive integration for causing corporate failure. Examples of the reasons behind moves toward integration and of their success or failure aren’t hard to find:
- RB The authors, senior faculty at the Harvard Business School, concentrate on consumer marketing. Robert D. Buzzell is the Sebastian S. Kresge Professor of Marketing,
- Search Search Please fill out this field.
- US & World Economies
- Economic Theory
What Is Vertical Integration?
Erika Rasure is globally-recognized as a leading consumer economics subject matter expert, researcher, and educator. She is a financial therapist and transformational coach, with a special interest in helping women learn how to invest.
Definition and Examples of Vertical Integration
Types of vertical integration, pros and cons of vertical integration, vertical integration vs. horizontal integration, frequently asked questions (faqs).
Marko Geber / Getty Images
Vertical integration is a business strategy in which a company controls multiple stages of its production process and supply chain, minimizing or eliminating the need for outside entities.
Vertical integration is a strategy businesses can use to reduce some costs and control the quality of the products and services they provide. By merging various stages of the production processes and supply chain into its own operations, a company can create a competitive advantage.
Depending on the source of information, there are generally six accepted stages of a supply chain . The stages relative to vertical integration are materials, suppliers, manufacturing, and distribution.
One example of a company that is vertically integrated is Target, which has its own store brands and manufacturing plants. It creates, distributes, and sells its products—eliminating the need for outside entities such as manufacturers, transportation, or other logistical necessities.
Manufacturers can also integrate vertically. Many footwear and apparel companies have a flagship store that sells a wider range of their products than are available from outside retailers. Many also have outlet stores that sell last season's products at a discount.
There are more than a few types of vertical integration. All types involve a merger with another company in at least one of the four relevant stages of the supply chain. The difference depends on where the company falls in the order of the supply chain.
When a company at the beginning of the supply chain controls stages farther down the chain, it is referred to as being integrated forward. Examples include iron mining companies that own "downstream" activities such as steel factories.
Backward integration takes place when businesses at the end of the supply chain take on activities that are "upstream" of its products or services. Netflix, a video streaming company that distributes and creates content, is an example of a company with backward integration.
A balanced integration is one in which a company merges with other businesses to attempt to control both upstream and downstream activities.
There are five noteworthy benefits of vertical integration that give a company a competitive advantage over non-integrated competitors.
A vertically integrated company can avoid supply disruption . By controlling its own supply chain, it is more able to control and deal with any supply problems itself.
A company benefits by avoiding suppliers with market power . These suppliers are able to dictate terms, pricing, and availability of materials and supplies. When a company can circumvent suppliers such as these, it is able to reduce costs and prevent production slow-downs caused by negotiations or other aspects external to the company.
Vertical integration gives a company better economies of scale . Large companies employ economies of scale when they are able to cut costs while ramping up productions—they take advantage of their size. For example, a company could lower the per-unit cost by buying in bulk or by reassigning employees from failing ventures. Vertically integrated companies eliminate overhead by consolidating management and streamlining processes.
"Economies of scale" is the concept of producing more to lower prices. This increases supply, lowers fixed and variable costs per unit, and makes a product more attractive to consumers.
Companies keep themselves informed on their competition. Retailers know what is selling well. If a company was vertically integrated with a retail store, manufacturing plant, and supply chain, they would be able to create "knock-offs" of the most popular brand-name products. A knock-off is a copy of a product—a similar product but company-branded with company marketing messages and packaging. Only powerful retailers can do this. Brand-name manufacturers can't afford to sue for copyright infringement, as they would risk losing major distribution through a large retailer.
Lower pricing strategies can be used. A company that's vertically integrated can transfer the cost savings they create to the consumer. Examples include Best Buy, Walmart, and most national grocery store brands.
The biggest disadvantage of vertical integration is the expense. Companies must invest a great deal of capital to set up or buy factories. They must then keep the plants running to maintain efficiency and profit margins .
Vertical integration reduces a company's flexibility by forcing them to follow trends in the segments they integrated. Suppose a company acquired a retailer for their product and created an outlet store that carried the old merchandise as well. That retailer's competition began using a new technology which boosted their sales. The new parent company would now need to acquire that technology to stay relevant in that market.
Rapidly changing technology can have a major effect on integration. Different technologies across the various stages of supply can also make integration difficult and more expensive.
Another problem is the loss of focus. Running a successful retail business, for example, requires a different set of skills than a profitable factory. It's difficult to find a management team that's good at both. Integration can cause management to focus less on their core competencies, and more on the newly acquired assets.
Culture clash is an issue. It's also not likely that any company will have a culture that supports both retail stores and factories. A successful retailer attracts marketing and sales types. This type of culture isn't responsive to the needs of factories and the clash can lead to misunderstandings, conflict, and lost productivity.
Vertical integration involves acquiring or developing one or more important parts of a company’s production process or supply chain. For example, Netflix’s shift from licensing shows and movies from major studios to producing its own original content is an example of vertical integration.
In contrast, horizontal integration involves acquiring a competitor or other related business with the goal of expanding its customer base or reducing competition. Walt Disney Company’s acquisition of Pixar Animation Studios is an example of horizontal integration.
- Vertical integration is a business strategy in which a company controls multiple stages of its production process and supply chain.
- Companies that are vertically integrated can minimize or eliminate the need to rely on outside entities such as manufacturing and transportation
- Advantages of vertical integration include resilience to supply chain disruptions, market power, and economies of scale.
- Drawbacks of vertical integration include high costs, less flexibility, and loss of focus.
What is the difference between vertical and horizontal integration?
In horizontal integration, a company expands its customer base and product offerings, usually through the purchase of a competitor or another complementary brand. It's designed to increase profitability via economies of scale rather than through expanding operational controls, as vertical integration does.
Who created vertical integration?
The concept of vertical integration has been around since the Industrial Revolution. Andrew Carnegie was one of the first to employ it broadly. His company, Carnegie Steel, controlled the iron mines that were used for mining steel resources, the coal mines that provided the fuel to create the steel, the railroads for transporting materials, and the steel mills themselves.
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The National Bureau of Economic Research. " Do Prices Determine Vertical Integration? "
University of Minnesota. " 8.3 Vertical Integration Strategies ."
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The benefits and risks of vertical integration
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8 February 2022
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