Vertical Integration: Definition, Benefits, Types, Examples

Definition of Vertical Integration

Vertical integration is where the company obtains the ownership and control of more than one stage of the supply chain. The type of vertical integration could be to move forward to the end consumer, or else, move backward to raw materials production.

The goal of vertical integration is to expand and gain control of the entire supply chain. This refers to the process of acquiring or starting the business operations within the same production vertical to take control over one or more stages in the value chain.

How does Vertical Integration Work?

Companies achieve vertical integration in two ways,

  1. Take ownership and control of more than one stage of the supply chain. Simply this means getting control of business activities that are behind in the company’s value chain. To move backward to raw materials production.
  2. Take ownership and control of more than one stage of the distribution chain. Simply this means getting control of business activities that are ahead in the company’s value chain. To move forward toward the end consumer.

The company can either choose one of the above options or can choose both options to move forward with the vertical integration.

Key Benefits of Vertical Integration

The main benefit of Vertical Integration for a company is to synergize the business operations and increase revenue. This is possible with the control they have over the value chain. Also, the company can increase the barriers to entry for newcomers to avoid the risk of competition.

Why do Companies Follow Vertical Integration?

Companies follow vertical integration for various reasons as stated below,

  1. Gain competitive advantage by bringing down the cost of sourcing and distribution with the forward and backward integration and with improved control over the supply and distribution network.
  2. Synergize business operations by having more control of the company’s supply and distribution chain.
  3. Reduce the price of products/services. There are many options for the company to control costs in procurement and distribution with vertical integration. Having good control over supply and/or distribution will provide more ability for the company to optimize cost utilization and avoid waste.

Types of Vertical Integration

There are two types of Vertical Integration,

  1. Backward Integration
  2. Forward Integration

Backward integration is a strategy where the company gains control of the business activities that were behind in their value chain. Forward integration is a strategy where the company gains control of the business activities that are ahead in the value chain.

Real Industry Examples for Vertical Integration

1. Zara Designs Clothes in-house and Manufactures in their Plants.

Zara is a hugely popular globally renowned clothing brand headquartered in Spain. The company changes its clothing designs every two weeks on average, while competitors change their designs every two or three months.

The company has done successful vertical integration and operates through its large retail stores across the world. Zara does their design and manufactures in their plants. Due to such vertical integration in their value chain, the company can ensure a change of wardrobe and style based on season and has the fastest inventory turnover. The company had achieved economies of scale as much while enjoying the excellent profit. Zara is having a higher competitive advantage in the industry.

More information: Zara Clothing Company Supply Chain

2. Introduction of “Amazon Publishing”

Amazon started as an online book retailer (internet bookstore) in 1995, procuring books from publishers. Amazon started “Amazon Publishing” in 2009 which allows them to publish books. After the above, Amazon may receive a cut on both as publisher and as bookseller if a reader buys one of its titles.

More information on this acquisition:” The Amazon Publishing Juggernaut” – Article Published in The Atlantic“How To Self-Publish Your Book Through Amazon” – Article Published in Forbes

3. Carnegie Steel Company constructed its Own Blast Furnaces

Carnegie Steel Company is a steel-producing company. The company needs ‘coke’ to produce steel. Several nearby suppliers own ‘blast furnaces’ to produce coke. However, these suppliers were unable to consistently meet the demand for Carnegie’s mills. Then the company moved to construct its own ‘blast furnaces’ for coke production, cutting out the dependency on their suppliers and ensuring reliable and cheap supply.

More information: Article Published about “Carnegie Steel” in Harvard Business School Digital Initiative

4. McDonald’s acquired Dynamic Yield to improve their Digital Customer Experience

In 2019, McDonald’s acquired a tech company called Dynamic Yield. The company was planned to improve its digital customer experience touchpoints with this acquiring. The technology allows menus at McDonald’s drive-thrus to change based on various factors such as weather, current traffic, and more.

More information: Dynamic Yield Joins the McDonald’s Family

5. Introduction of Disney+

The Walt Disney Company was a movie production company. The Walt Disney Company introduced Disney+ in 2019, which enables them to stream on-demand videos directly to their end customers.

More information: Disney+ and the Streaming Revolution

Synergies of Vertical Integration

There can be many situations where the synergies involved in vertical integration are unsuccessful. Successful synergies depend on the company’s mutual understanding of how will both companies need to progress through their share of the supply chain.

Vertical integration can result in a lack of flexibility to respond when market trends change. This is due to the dependency of the value chain, which is strongly linked together.

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