What is the term for when a company owns all stages of production and distribution?

What is Vertical Integration?

Vertical-integration is an expansion strategy where businesses acquire additional levels of the supply chain. The acquisition could be raw materials, production, distribution, retail, etc. It is a decision to have it done in-house instead of outsourcing.

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• What is Vertical Integration?
• Vertical Integration Explained
• Vertical-Integration Example
• Vertical-Integration Types
• Disadvantages
• Frequently Asked Questions (FAQs)
• Recommended Articles
• What is it called when a company owns all steps of production?
• When a company owns all levels of production?
• What is a vertically integrated company?
• What is horizontal integration of a company?

By integrating various levels of the supply chain, companies can control supplies, reduce costs, ramp up production and increase efficiency. In addition, vertical integration facilitates economies of scale—eliminating supply disruption and supplier dominance. Vertical Integration is both expensive and irreversible—it takes time for the new members to function smoothly with the existing team.

• Vertical-integration is a strategy where a business undertakes control over various supply chain stages—raw material, production, distribution, sales, or customer support.
• Companies can implement forward integration to align their supply chain facilities towards the final consumers.
• Alternatively, backward integration is acquiring supply chain stages in reverse order. A retailing firm could start procuring stages all the way to raw materials.

Vertical Integration Explained

Companies adopt a vertical-integration strategy to win over their competitors by strengthening their supply chain. The supply chain begins with the procurement of raw materials and the production of finished goods. Then, it extends all the way to distribution and sale. This system comprises suppliers, producers, distributors, vendorsA vendor refers to an individual or an entity that sells products and services to businesses or consumers. It receives payments in exchange for making items available to end-users. They constitute an integral part of the supply chain management for providing raw materials to manufacturers and finished goods to customers.read more, retailers, and consumers.

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Vertical-integration, therefore, ensures superior command over the supply chain. It facilitates economies of scaleEconomies of scale are the cost advantage a business achieves due to large-scale production and higher efficiency. read more—increased production and lower costs. Such a business does not outsource raw materials, distribution, retail, or customer service. These companies try to own all the levels of the chain. They merge with or acquire supply chain partners. Sometimes they go all the way and develop new supply chain units. However, management should be conscious of the high cost of such expansions. Companies can lose focus and relinquish existing strengths in the pursuit of synergiesSynergy is a strategy where individuals or entities combine their efforts and resources to accomplish more collectively than they could individually.read more.

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Owning levels of the supply chain should not be confused with horizontal integrationHorizontal Integration is a merger that takes place between two companies operating in the same industry. These companies are usually competitors and merge to gain higher market power and economies of scale, an extensive customer base, higher pricing power, and lower employment cost.read more strategy. Horizontal integration emphasizes the mergerMerger refers to a strategic process whereby two or more companies mutually form a new single legal venture. For example, in 2015, ketchup maker H.J. Heinz Co and Kraft Foods Group Inc merged their business to become Kraft Heinz Company, a leading global food and beverage firm.read more or acquisitionAcquisition refers to the strategic move of one company buying another company by acquiring major stakes of the firm. Usually, companies acquire an existing business to share its customer base, operations and market presence. It is one of the popular ways of business expansion.read more between the firms engaged in the same business line (often competitors). Moreover, horizontally integrated businesses function at the same supply chain level.

Vertical-Integration Example

Tesla inc. is an efficient example of vertical-integration. On Jan 4, 2021, the company gained an edge over the competition by overcoming supply chain problems in the global automobile industry.

During the 2020 Covid pandemic, there was a shortage of chips used in cars. Tesla’s competitors curtailed production, expecting a fall in demand. However, Tesla proceeded with an optimistic forecast of the rapid rise in automobile demand. The company directly connected with its chip suppliers to keep track of its orders.

It was possible because Tesla designs more hardware and software than its rivals—who rely on external suppliers. Compared to the competition, the company is more vertically-integrated. It ultimately increased its supply of cars and increased prices to fund newly developed levels of the supply chainA supply chain refers to a process beginning with the procurement of raw materials and the production of finished goods and ending with their distribution and sale.read more.  

Vertical-Integration Types

The direction in which the firm merges along its supply chain determines the type of vertical-integration it opts for:

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#1 – Forward Integration

When a company has an in-house manufacturing unit, it can merge or acquire distribution centers or retail outlets. Thus, the company moves ahead in the supply chain, i.e., from raw material to retail.

#2 – Backward Integration

This strategy is undertaken by companies with in-house units built for the final stages of the supply chain—retail. Such firms can engage in the initial stages—production and procurement of raw materialRaw materials refer to unfinished substances or unrefined natural resources used to manufacture finished goods.read more.

#3 – Balanced Integration

Such firms generally use a combination of Forward IntegrationForward integration is a strategic approach where the companies move ahead in the supply chain and take over the distribution and retail activities. The purpose of this vertical integration is to achieve cost efficiency.read more and Backward IntegrationBackward Integration is a vertical integration type in which a Company buys or integrates with its supplier firms to improve efficacy, save costs, & gain more control over the production process.read more strategies. This is applicable to businesses engaged in the mid-supply chain function. They expand their operations upward and downward.

For example, Hershey relies on cocoa bean suppliers and distributors like Walmart and Target. Hershey can acquire both cocoa bean suppliers and distributors—balanced integration.

Advantages

The benefits of owning various levels of the supply chain are as follows:

1. Competitive Advantage: Company will have an edge owing to low-priced products or services. And all this is achieved with improved product quality.
2. Eliminates Supply Disruption: When companies rely on the vendors for supplies, they can fail to deliver on time. Thus, developing an in-house supply chain level improves efficiency.
3. Discourages Supplier Dominance: If the suppliers have autonomy, they can dictate the terms as well. Therefore, vertical-integration can certainly lower costs and eliminate supplier dominance.
4. Economies of Scale: Vertically-integrated companies produce in bulk—cost per unit reduces.
5. Increases Profitability: There is a simultaneous increase in manufacturing capacity and decrease in production costsProduction Cost is the total capital amount that a Company spends in producing finished goods or offering specific services. You can calculate it by adding Direct Material cost, Direct Labor Cost, & Manufacturing Overhead Cost. read more— profitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more accelerates.
6. Expansion: A larger corporation owning more levels of the supply chain can develop a unique selling point (USP).

Disadvantages

The disadvantages of expansion are as follows:

1. Capital Expenditure: Mergers and acquisitionsMergers and acquisitions (M&A) are collaborations between two or more firms. In a merger, two or more companies functioning at the same level combine to create a new business entity. In an acquisition, a larger organization buys a smaller business entity for expansion.read more incur a huge amount of capital. In addition, the upkeep of newly acquired assets also cost a lot.
2. Loss of Focus: In the pursuit of new levels, companies can lose core competencyThe core competencies in business refer to its resources and unique fundamental capabilities that distinguish it from market competitors. It is an essential component of marketing strategy leading to brand recognition and business growth. The concept serves to be useful for companies focusing on multiple product lines and operating more than one business unit at a time. read more. It is unchartered territory for the management; decision-making becomes challenging.
3. Requires Efficient Management: The company has to hire a new team. There could be problems in hiring the right talent. Even if all goes well, a new group of individuals take time to function smoothly.
4. Cultural Difference: The new company culture may not be compatible with the old.
5. Risk of Failure: It is an irreversible decision. If management fails, the losses can be huge.

Frequently Asked Questions (FAQs)

What does vertical-integration mean?

Vertical-integration is the process of expanding supply chain ownership. A company engaged in one stage of the supply chain can either merge or acquire other stages—raw materials, production, distribution, sales, or customer service.

How does vertical-integration affect society?

Vertical-integration makes the market efficient. Previously smaller, less competent firms come together to form a large corporation—more productive. But, on the other hand, it can be a threat to society since it may wipe out multiple competitors. With more vertical integration, small organizations can go out of business.

What are some examples of vertical-integration?

Some of the prominent examples are as follows:
1. Ikea is a furniture brand that incorporated supply chain integration. So now, Ikea owns everything—purchasing raw materials to directing product sales.
2. Zara is an apparel retailer that acquired production, design, and distribution units.

Recommended Articles

This article has been a guide to what is Vertical–Integration & its Definition. Here we explain vertical-integration along with examples, types, advantages, disadvantages, and supply chain integration. You may learn more about financing from the following articles –

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