Vertical Integration

What is Vertical Integration?

Vertical Integration refers to a strategy adopted by a company or firm wherein it goes on to control over its supply chain by acquiring its suppliers or maybe even its distribution and adding up value.

Explanation

There are times when a company desires that it will tend to gain efficiency by acquiring other businesses in the supply chain, and it happens to go ahead with such a move. It refers to having to purchase the part of the production or the sales process an thus have it done in-house rather than outsource it, unlike how it was done pre-acquisition. Such a strategic move by the company helps it to control supplies, reduce costs, and thereby bring about more efficiency in all of its operations that it plans to undertake.

Vertical Integration

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Types of Vertical Integration

Given below are the 3 broad types  –

#1 – Backward Integration

This takes place when a company goes on to acquire its subsidiaries that would use some of the inputs which are used in the product production process. A good example would be an automobile company that would acquire another company that produces tires.

#2 – Forward Integration

When a company goes on to acquire or take control of its distribution centers or even the retail outlets, such acquisitionAcquisitionAcquisition refers to the strategic move of one company buying another company by acquiring major stakes of the firm. Usually, companies acquire an existing business to share its customer base, operations and market presence. It is one of the popular ways of business expansion.read more is known as forward integrationForward IntegrationForward integration is a strategic approach where the companies move ahead in the supply chain and take over the distribution and retail activities. The purpose of this vertical integration is to achieve cost efficiency.read more. A good example would be a brewing company that goes on to acquire outlets or pubs

#3 – Balanced Integration

Firms that would generally use a combination of both forward and also backward integrationBackward IntegrationBackward Integration is a vertical integration type in which a Company buys or integrates with its supplier firms to improve efficacy, save costs, & gain more control over the production process.read more is known as a balanced integration strategy.

Example of Vertical Integration

A good example would be of content streaming company-Netflix. What began as a DVD rental company that would continue to supply film and TV content has now gone on to use a distribution model that would also manufacture and promote its content alongside other studio companies.

Problems and Benefits

Benefits

Problems

  • There are possibilities that the company may lose focus on its core competencies.
  • The culture of the new company may not be compatible, and there may be problems in operations.

Advantages

  • Competitive Advantage: The company will now have a competitive advantage because consumers can choose their products because costs are lower, and the product quality will undoubtedly be better due to the company’s direct control.
  • Avoidance of Supply Disruption: Since the supply is under its control, it can have autonomy in the way the vendor runs the scheme as opposed to poorly run supply, should there have been one. It also needs to bother about strikes and worker disputes if it were present in a socialist country.
  • Avoidance of Supplier Market Power: If the suppliers have total autonomy, they would be in a position to dictate the various terms. However, if the company adopts the route of vertical integration, it can certainly lower the various internal costs and security for better delivery.
  • Economies of Scale: The company will be able to cut costs as it will be able to buy in bulk and lower the cost per unit. Thus the large scale of operations would go a long way in having to lower the cost of the product owing to the advantage of economies of scale.

Disadvantages

Difference between Horizontal and Vertical Integration

 Alternatives to Vertical Integration

Instead of preferring a vertical integration, companies may, at times, also engage in various routes such as franchise agreements, joint venturesJoint VenturesA joint venture is a commercial arrangement between two or more parties in which the parties pool their assets with the goal of performing a specific task, and each party has joint ownership of the entity and is accountable for the costs, losses, or profits that arise out of the venture.read more, co-location, long term explicit contracts, etc.

Conclusion

It is an infamous strategy adopted by companies to bring about efficiency in their operations to have control over its supply chain and add value by being a low-cost producer. And owing to economies of scale, the same can no doubt be achieved. However, it becomes essential to bear in mind that there are significant costs associated with this. Hence, the company may lose focus and miss out on its core competency undertaking while having to achieve synergies through vertical integration. Thus it becomes all the more critical for companies to undertake a thorough and careful analysis and study to ensure there is success in the long run before having to adopt the system of vertical integration.

Recommended Articles

This article has been a guide to what is Vertical Integration. Here we discuss an example and 3 types of vertical integration (Backward, Forward, and Balanced) along with their differences, benefits. You may learn more about financing from the following articles –

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