Vertical integration is an approach used by a company to control the supply chain of its products. The supply chain includes all the steps from acquiring the raw materials to when it is turned into a product and delivering the same product to consumers. Vertical integration increases the firm’s supremacy in the market, cut operational costs, and gains supply and delivery channels.
Classifications of vertical integration
There are three classes of vertical integration. They include;
- Forward integration
- Backward integration
- Balanced/combined integration
When a business takes control or gets involved in the advanced stages in the supply chain that is the distribution and selling stage. The company can resolve to expand by setting up its retail stores or regulating its goods vendors. For example, a brewing company that goes ahead to own bars and pubs.
Companies mainly take this approach when they want to do away with counterfeit goods by recommending an authorized outlet. It is also undertaken by businesses that feel the middlemen or vendors of their interests are taking advantage of consumers.
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It involves a business taking control or ownership over its suppliers. The company expands backward in the supply chain. For instance, a company might eliminate the suppliers by buying off the supplier’s business, hence controlling it. For example, a bakery that acquires a wheat field. The approach is used by businesses that feel the need to reduce deficiencies on the supplier’s side by taking total control.
Under this type of integration, a business merges with other companies with the same interest in its supply chain to gain control over both the upstream and downstream activities.
What are the Benefits of Vertical Integration?
1. Maximizes on the upstream and downstream profit margins
It takes over the supply chain and retailing stages of the supply chain. The business capitalizes and procures all profits resulting from all these stages.
Vertical integration enables a business to make more profits without necessarily opening a new business or coming up with a new product.
2. Low priced goods
When a firm has total control of the raw materials, it results in cost-effectiveness and reliability. The firm can pursue the services of an excellent economist to bring down the cost of acquiring materials. It translates to a reduction in production price by a great margin, thus a significant drop in the overall price of goods.
3. Keeps competitors off
Taking control of the raw materials’ supply chain can help a business block the competitor from accessing the raw materials. It is essential if the said raw material is scarce. The competitor is blocked at the source, thus beating them in the business.
The company coordinates the supply chain efficiently without disruptions compared to when suppliers, distributors, and retailers are involved.
The Downside of Vertical Integration
1. Lack of competition
Vertical integration can lead to decreased rivalry among suppliers, causing the whole supply of goods to be less efficient. When there is no competition among suppliers, the qualities of materials supplied might end up being inferior. Ultimately the final product will be of low quality.
2. There is a need to balance backward (upstream) and forward (downstream) activities.
Companies need to deliberate on the effects of upstream and downstream activities during vertical integration to ensure a balance. The focus of vertically integrated businesses is usually stretched; thus, the company needs to have a lot of commitment and money to run efficiently.
3. High overhead costs of vertically integrating
Buying off the suppliers can be very costly. Suppliers might ask for vast sums of money to sell off their company. Therefore, the buying company will need to have a lot of cash, which they might not have or reluctant to spend, thus risking vertical integration.
Although vertical integration might be advantageous to big companies that have strategically positioned themselves in their field, many small businesses cannot afford to take this step. Companies need to keep the business running to retain profit margins and efficiency. Companies that might be considering taking this step should evaluate their financial ability to undertake such a course.
An Example of a Vertically Integrated Business
The tech company possesses manufacturing facilities around the globe for its production. It manufactures its custom LCD, OLED, touch id, and A-series chips screens. Apple is also integrated forward by operating outlets in several countries. The vertical integration has enabled apple to enjoy freedom in manufacturing and control the distribution and sale of their products.