Vertical Integration: Definition, Types, Tips and Examples in Business

Regardless of whether we realize it, many companies practice vertical integration at one point or another. In fact, some of the world’s most popular businesses have mastered the production and distribution of their products through vertical integration.

In this article, we will define vertical integration, go through two different strategies to achieve it, compare it with horizontal integration, list the advantages and disadvantages of vertical integration, and give some real-world examples of the process.

Table Of Contents

1 What is Vertical Integration?
2 Types of Vertical Integration
2.1 Forward integration
2.2 Backward integration
3 Vertical Integration and Horizontal Integration
4 Advantages of Vertical Integration
5 Disadvantages of Vertical Integration
6 Examples of Vertical Integration in Business
6.1 Example 1
6.2 Example 2
6.3 Example 3
6.4 Example 4
6.5 Example 5

What is Vertical Integration?

When an organization or company controls one or more stages in the production process, it is called vertical integration. Also known as the supply chain, the production process refers to the transformation of raw materials into finished goods, which are then available to customers. According To Business School 101 Vertical Integration (With Real-World Examples) | From A Business Professor

There are four main phases of the supply chain:

  • Raw materials, also known as commodities
  • Production
  • Distribution
  • Retail

A company is vertically integrated when they gain control over some of these stages of production. This often involves one company buying another company, such as a retailer, distributor or supplier, that is involved in the supply chain of the same market or industry.

Generally, vertically integrated companies try to gain control over the supply chain stages either directly before or immediately after their place in the production process. Companies choose to integrate vertically for a variety of reasons, including:

  • Access to new distribution channels
  • Reduce production costs
  • Reinforced supply chain
  • Profits increase
  • Production efficiency improvement
  • Reduced distribution delays

Vertical Integration Type

There are two main ways for companies to gain control over various aspects of the supply chain and integrate vertically effectively:

Forward integration

Forward integration refers to when a company gains control over a more distant stage in the production process, also known as downstream.

For example, organizations can take control of the post-production process by handling their own distribution or opening their own retail stores. It increases the profitability of the organization by eliminating the need for intermediary companies.

Backward integration

Backward integration is when a company takes control of the stage that precedes them in the production process, also referred to as upstream. For example, a retailer may purchase a company that handles the manufacture of its products.

Vertical Integration and Horizontal Integration

Vertical and horizontal integration are strategies that businesses use in their production or industrial processes. As we have already mentioned, vertical integration refers to when a company gains control over the stages of the supply chain that go up or down from them in the production process.

Horizontal integration, on the other hand, is when a company gains control over organizations of the same value and level within the same industry. Horizontal integration occurs for several reasons, including:

  • Access to new markets or customers
  • Eliminate competition
  • Increase company size
  • Diverse services and products
  • Increased profitability
  • Reduced costs spent on things like distribution, production, and marketing

Horizontal integration eliminates competitors, and this is great for the company. However, it also means that consumers have fewer choices available in that market.

This can lead to what is known as a monopoly, which is when one firm controls the supply, price, and availability of services and products in a particular industry. In most countries in the world, anti-trust laws have been enacted to protect consumers and prevent monopolies.

Advantages of Vertical Integration

Companies choose to integrate vertically for a variety of reasons. There are a number of advantages to vertical integration, such as:

  • Reducing production costs: Without the need for inflation, companies can cut production and distribution costs by keeping them at home.
  • Ability to access new distribution channels: The ability to distribute its own products allows the company to reach new markets.
  • Improved production efficiency: Vertical integration means that there are fewer delays and errors when products change hands.
  • Cost reduction due to economies of scale: This refers to reducing the cost per unit by being able to purchase raw materials in bulk or by streamlining the production process.
  • Increased profit: Lowering production and distribution costs leads to increased profitability for the company.
  • Reduced distribution delays: Distribution becomes more efficient without using a third-party company.
  • Development of more competitive markets: Vertically integrated companies can offer their products at lower prices, providing consumers with a more competitive market.

Disadvantages of Vertical Integration

While vertical integration can be very beneficial for a company, it has some drawbacks, such as:

  • Increased costs and debt
  • Inability to keep up with consumer trends by producing products away from their factories
  • Split focus because basically running multiple businesses
  • A divisive corporate culture
  • Increased likelihood of mismanagement
  • Lack of expertise in the acquired production process

Example of Vertical Integration in Business

Here are some examples of vertical integration and their advantages:

Example 1

Large retailers can offer their own store brands because they have taken control of production and distribution while retaining control of retail. This allows the company to manufacture products that are similar to the brand name offered but at a more competitive price.

Example 2

A company that manufactures shoes has decided to open its own flagship retail store that offers a wider selection of products than you can buy from a traditional retailer.

They have also decided to open an outlet store that sells discounted products from the previous season. Instead of having to visit traditional retailers, consumers can visit these stores for a wider selection of brands and at lower prices.

Example 3

A streaming service that provides access to TV shows and movies from major studios has decided to start creating original content. Now they can provide subscribers with movies and shows among their own original content.

Example 4

A company that develops cutting-edge technology devices for consumers has decided to vertically integrate upstream by purchasing the manufacturers and laboratories that make their devices.

This has given them the freedom and flexibility to research and create new products. Although they now have control over the production area, they still have suppliers for the raw materials needed for manufacturing.

Example 5

The same technology companies have also vertically integrated downstream by opening and buying retail stores that exclusively sell their products. This allows them to control their distribution as well as their manufacturing and provides consumers with a place they are guaranteed to find the product they are looking for.

People also ask FAQ’s Questions:

1. What is Vertical & Horizontal Integration?

Ans: Horizontal integration is an expansion strategy adopted by a company that involves the acquisition of another company in the same business line.

2. What are the three types of vertical integration?

Ans: backward (upstream) vertical integration, forward (downstream) vertical integration, and balanced (both upstream and downstream) vertical integration.

3. What is vertical integration’s advantages and disadvantages

4. Types of vertical integration

Ans: There are three varieties of vertical integration: backward (upstream) vertical integration, forward (downstream) vertical integration, and balanced (both upstream and downstream) vertical integration.

5. What is vertical integration vs horizontal integration

Ans: Horizontal integration involves acquiring or merging with competitors while vertical integration occurs when a firm expands into another production stage like acquiring a supplier or distributor. As such, vertical integration is the process of acquiring business operations within the same production vertical.

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