What Are The Advantages And Disadvantages Of Vertical Integration?

In this story, We will discuss What Are The Advantages And Disadvantages Of Vertical Integration? But before that, We will have a brief discussion of what is vertical integration and what are the types of it.

So, Let's start.

Vertical Integration is a process in which the company controls its supply chain. It happens when a company assumes control over several of the production steps which was involved in the creation of the product in that industry.

The control in the supply chain is usually done through the acquisition of companies or starting a new segment in the company.

Vertical Integration is the opposite of Horizontal Integration in which the company expands at the same level of the supply chain.

In simple words, vertical integration involves purchasing a part of the production or sales process that was earlier outsourced to have it done in-house.

The prime intention of adaptation of the vertical integration strategy by a company is to gain control over its supply chain and increase its profit margins.

It can also benefit the company by adapting to lower pricing strategies, having a better knowledge of consumer behavior, and providing more facilities to the end consumers.

Types Of Vertical Integration

In Vertical Integration, There are multiple ways in which the company assumes control over its segments.

Generally, there are two types of Vertical integration I.e. Forward Integration and Backward Integration.

Forward Integration

It is the strategy, in which the company expands forward in its supply chain. Here the company focuses on the distribution and supply part of its goods and products.

This strategy helps companies to cut out the middlemen (i.e. distributors) who were required to pay money to sell their products in the market. In this way, the company increases its profit margin.

For example: Due to an increase in the penetration of internet across the world, many consumer goods companies started their own e-commerce stores in which they directly sell to the consumers by cutting out many middlemen and processes in the distribution chain. It is a perfect example of forward integration.

Backward Integration

Backward Integration is the strategy, in which the company expands backward in its supply chain. Here the company focuses on the manufacturing and production part of its goods and products.

In simple words, Here the retailer/owner of the store starts manufacturing its own products and sells it in its store.

For example: Earlier, Netflix was a video streaming platform but in the year 2012, it started producing its own content and distributed exclusively through its own platform. Here, rather buying or licensing somebody’s else content, They produced their own piece.

In this way, their control over the content increases, and their profit margins also increased.

Advantages Of Vertical Integration

Provides More Facilities

Here, the companies can provide more facilities to the end consumers as compared to their competitors. They can reduce transportation costs and reduce delivery timing. They can also cross-sell any of their products in other industries. It is quite evident in the case of Amazon.

Amazon also controls the delivery segment of its products. By controlling the delivery services, it provides delivery in less time. They also provide Amazon Prime Video services and faster delivery with their Prime subscription.

Better Knowledge Of Consumer Behaviour

The companies get to know more about their consumers by getting products to consumers directly and quickly. In this way, the company has a better idea of consumer behavior.

The companies also improve sales and profitability by creating and selling their own brand.

Lower Pricing Strategies

A company that is vertically integrated can transfer the cost savings they create (in various levels of the supply chain) to the end consumer.

This is majorly done by big retail chains such as Walmart, D mart, Big Bazar.

Control Over Supply Chain

A vertically integrated company can avoid supply disruption.

By controlling its own supply chain, the company tackles the problem better than any external supplier or distributor. It also benefits by avoiding suppliers with market dominance.

Generally, The dominant suppliers try to dictate the market terms, pricing, and availability of materials and supplies according to their needs.

Once the company is not solely dependent on the external suppliers, the company will better able to negotiate with the suppliers and hence increasing its profits, market share, and other external factors.

Increase Profit Margins

Large Companies lower their costs through economies of scale, which is lowering the per-unit cost by buying large quantities of raw materials or streamlining the manufacturing process.

The economy of scale describes the situation in which cost advantages are gained by the company due to the heavy production of goods.

Companies can achieve economies of scale by increasing their level of production.

In vertical integration, this happens by controlling the supply chain in most steps I.e making the products in house, rather than outsourcing it.

Disadvantages Of Vertical Integration

Mismanagement

In vertical integration, the company gets big and sometimes results in the mismanagement of the overall process. It also reduces the flexibility of a company by forcing it to follow the trends in the segments that it integrated.

Company culture also gets hampered in several cases.

For example, A company’s present culture might not likely to support the retail chain and the factories at the same time. This can lead to misunderstandings, conflicts, and loss of productivity.

Outsourcing

Outsourcing might be better in some cases if the expertise of the retailer or supplier is superior to that of the parent company.

If the company produces a product in-house, then it needs to do it efficiently as compared to the external retailers and suppliers.

A Large Amount Of Capital

This is one of the major disadvantages of vertical integration.

To start a new segment or acquire an existing company in the upstream or downstream in the supply chain a large amount of capital is required.

The company must have a great amount of capital to buy or set up a factory.

Further, they need to monitor themselves perfectly to properly maintain efficiency and profit margins.

Loss Of Focus

Running different kinds of business requires different skill sets.

Like the skills required to run a factory is very different from that of a retail outlet.

By expanding into different levels of the supply chain, the company might lose its core values and find it difficult to focus on core competencies rather it focuses on the new segment of the supply chain.

The above are the disadvantages of vertical integration. With more control and dominance in the supply chain, the company also faces these issues.

Here, In this story, we discussed the advantages and disadvantages of Vertical Integration.

Want to know What is Vertical Integration? What is its definition? What are the advantages and disadvantages of it? How it is different from Horizontal Integration?

Then, you can visit my blog and read an article about it. I have discussed all of these in a very precise manner along with proper examples. Click here to visit the article.

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