Vertical integration

by Admin
Updated: August 19, 2020

Vertical integration brings sections of your supply chain under your direct control

Vertical integration is the process of creating or acquiring operations (business) that are suppliers to or customers of the core business. Owning more links in the supply chain, in other words.

Consider a supply chain of: A → B → C → D → E.

In the case of a product make for iron for example, it could be something like, A = mining, B = smelting, C = manufacturing, D = wholesale, E = retailing.

There are three approaches:

  1. Forward/Downstream e.g. where D acquires or creates E.
  2. Backward/Upstream e.g. where B acquires or creates A.
  3. Disconnected e.g. where C acquires or creates E.

Advantages

In the case of disconnected ownership, although there may not be many obvious direct benefits, it can be used to influence the behavior of the intermediate parties, e.g. D, when C acquires E.

The principal advantages are generally types of streamlining:

  • Improved efficiency (profitability) from cutting out some of the intermediate processes involved in trading with an external business
  • Improved efficiency (profitability) from more dependable supply lines, e.g. ability to implement Lean/Just-in-time.
  • Direct internal communication, which can benefit marketing, research & development etc.
  • More control over margins/pricing.
  • More security against market foreclosure.
  • Reduced distraction caused by uncertainty and the need to make contingency plans.

Downsides

Vertical integration typically goes wrong when the management team lacks the relevant expertise or experience to manage the additional processes.

Most of the disadvantages relate to the removal of competition:

  • Loss of, or failure to acquire, skills related to the new processes.
  • Complacency because links in the chain are no longer separate enterprises competing against each other.
  • Reduced innovation caused by restrictive corporate mentality (based on the modes of the parent business).

Alternatives

Through the power of contracts, negotiation and influence, it is possible to achieve the desired effects of vertical integration without the cost or the risk of complete ownership.

Vertical dis-integration

Instead of merging all operations into a single monolithic entity, it often makes more sense to maintain the separate operations as pseudo-independent entities.

In addition to overcoming many of the disadvantages of vertical integration, this approach allows the parent to easily divest itself of distinct operations as viable business should situations change.

More info

“Vertical integration” at quickmba.com and investopedia.com.

“Advantages And Disadvantages Of Vertical Integration” at vittana.org and scu.edu.

“When and when not to vertically integrate” at mckinsey.com.

Internal links

Copper Just in time Winners and losers Go to Articles
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