Instead, you control every aspect of the supply chain from the cost of materials to production practices to the timing of shipping and production. Usually, this independence from relying on others increases efficiency and productivity.
When you own all the companies in the supply chain, you're able to set costs much lower than you would if you were working with separate companies. These cost savings often translate into lower prices for customers and higher profits for the company overall. An economy of scale is the reduction in cost to create a product as the facilities in which the product is made grow in size.
When you control every step in production, you're able to scale the size and cost of your operation to meet your business's needs.
When working with a supplier, it can be a challenge to know exactly how their company functions and the details of their production practices.
As an owner, you gain knowledge and insights about every niche step in the production process and can apply that knowledge to help create a superior product. With increased knowledge of your production and supply chain, you can maximize your marketing efforts. You can comfortably refer to any stage in your production process and use any unique competitive selling points to help establish your product in the marketplace.
Usually, very large companies and corporations have the capital and structure to acquire the companies along their supply chain. When they do so, they often cut off competitors' access to certain materials or resources, giving the vertically integrated company larger control of the overall market. Vertically integrated companies can offer their products at a much lower price than companies that must pay every organization in their supply chain for their work.
Lower prices often increase demand, leading to better brand recognition amongst consumers and higher profits for the parent company. Related: Guide To Supply Schedules. There are two primary types of vertical integration—backward integration and forward integration:. When a company integrates backward, they are moving up in their supply chain. A company that sells merchandise directly to consumers who purchase from the manufacturer that makes the company's products would be implementing backward integration.
When a company integrates forward, they are moving down in their supply chain. A materials source or manufacturer who sells their products to another company rather than to consumers who then acquires the business that sells to customers would be practicing forward integration.
Vertical integration impacts costs for all stakeholders—which includes both the internal parent company and external consumer as explained below:.
The parent company, or the company that purchases all the other companies in the supply chain, sees an initial increase in costs as they acquire the other companies in their supply chain and adjust best practices and methods. However, once they've completed the acquisition, they no longer have to pay additional fees for the labor or products that the other companies in the chain provide. They own those organizations and their products, increasing the company's value and lowering all costs.
Consumers who purchase the finished product or merchandise will likely see lower prices following vertical integration. Since the parent company saves money at each step of production, they can afford to offer their product at a lower price to their customers.
Related: What Is a Business Vertical? There are three types of integration, each with several shared advantages and disadvantages when merging two businesses in different stages of production. 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. An example of a company that is vertically integrated is Target, which has its own store brands and manufacturing plants.
They create, distribute, and sell their 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 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. 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.
Additionally, vertically-integrated companies are often not able to switch to foreign producers or factories who may have lower operating costs or exchange rates. Because vertical integration largely erodes specialization, it can be hard to manage as well due to the different kinds of companies or moving parts within the overarching organization.
For example, if a CEO once managed a retail company before deciding to vertically integrate with a manufacturer, they now have to learn how to manage both businesses -- which, as has been seen, is no simple feat and can often be an enormous challenge.
While perhaps not as critical a factor as some of the others, the conflict between retail and manufacturing cultures is still something to consider as a negative to vertical integration. And, it only makes sense that combining well-established cultures that are dichotomous -- like a marketing and sales-driven organization with a production and manufacturing-driven outfit -- can instigate some problems.
Additionally, poor management may contribute to communication issues down the long chain of command that inherently comes with combining multiple companies under one head. Regardless of how successful a vertically-integrated company is, there are still other concerns that can arise when said company has a dominant position in its market. While controlling production and the market is certainly a plus for vertical integration, it can also lead to the creation of market entry barriers for new companies to access the product space -- which could possibly lead to antitrust issues.
By hoarding consumers, large, vertically-integrated companies could potentially face conflict or even retribution for crowding the market. While vertical integration is the combining of multiple companies along the same supply chain as in a raw goods producer with a retailer who will sell the finished product , horizontal integration entails a company acquiring other companies similar to it often competition to increase customer base, market size, or diversify its products in the same industry.
Horizontal integration often occurs within the same industry, but may also occur in different or related industries. Additionally, horizontal integration may occur to increase product differentiation or expand market control. So, while its intention is not necessarily to reduce costs by controlling more of its own supply chain, companies that horizontally integrate often do so in the hopes of increasing consumer base, assets and resources, or increasing revenue.
Still, much as vertical integration is in danger of creating antitrust issues, horizontal integration can spiral into oligopolies, or clusters of companies that comprise the most market share of a certain industry. So, horizontal integration is typically closely watched by the Federal Trade Commission in order to prevent too little competition in an industry.
MAR Report acquisition of Sheraton both hospitality companies. LYV Report acquisition of Ticketmaster, which is an example of a company that specializes in the creation and promotion of concerts with a company specializing in selling tickets. While there are countless examples of companies that are vertically integrated, there are several that stand out for their success in harnessing the strategy to their advantage.
Apple Inc. Still, Apple has also utilized a forward integration structure as well, keeping a tight hold on its distribution channels -- which, apart from some exceptions like vendor-partner Best Buy, mostly are owned and operated by the company itself. Another strong example of successful vertical integration is mega "fast-fashion" giant Zara.
GPS Report have resorted to purchasing clothing from outside suppliers, Zara has been able to combine the design, manufacturing and retail parts of its supply chain to create an ultra-quick production and distribution channel that has allowed them to make and sell many more collections a year than its competitors.
In fact, the flexibility that Zara's vertical integration has provided the brand has given it a step up on competitors due to how fast it can turn out new product and go with the flow of consumer trends. LYV Report that has combined the media promotion of concerts with the sale of tickets to customers.
On the Live Nation side, the company manages artists and helps produce and promote shows, while the Ticketmaster side sells tickets to customers. Combined, the vertically-integrated company takes care of both the production and retail sides of the industry -- and has done so successfully. According to Billboard , Live Nation is the biggest promoter in the world.
Still, like many vertically-integrated companies, as it has dominated the ticketing world, the Live Nation-Ticketmaster duo has faced some scrutiny -- notably at the hands of The New York Times.
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