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What Is Vertical Integration?

Vertical integration is a strategy where a company owns or controls suppliers, distributors, or retailers in their value chain. This allows them to control costs and processes. Netflix is an example - it started as a DVD rental company, then produced its own content for streaming. Vertical integration has advantages like reduced costs, but requires significant capital and could make a company too large.

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366 views

What Is Vertical Integration?

Vertical integration is a strategy where a company owns or controls suppliers, distributors, or retailers in their value chain. This allows them to control costs and processes. Netflix is an example - it started as a DVD rental company, then produced its own content for streaming. Vertical integration has advantages like reduced costs, but requires significant capital and could make a company too large.

Uploaded by

Niño Rey Lopez
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Vertical Integration

What Is Vertical Integration?


Vertical integration is a strategy whereby a company owns or controls its
suppliers, distributors, or retail locations to control its value or supply chain.
Vertical integration benefits companies by allowing them to control processes,
reduce costs and improve efficiencies. However, vertical integration has
disadvantages, including the significant amounts of capital investment required.

Netflix is a prime example of vertical integration. The company started as a DVD


rental business before moving into online streaming of films and movies licensed
from major studios. Then, Netflix executives realized they could improve their
margins by producing their own original content. Today, Netflix uses its
distribution model to promote its original content alongside programming licensed
from studios.1

KEY TAKEAWAYS

 Vertical integration is when a company owns or controls its suppliers,


distributors, or retail locations to control its value or supply chain.
 Vertical integration benefits companies by allowing them to control the
processes, reduce costs and improve efficiencies.
 Backward integration is when a company expands backward on the
production path into manufacturing.
 Forward integration is when companies control the direct distribution or
supply of their products. 
Understanding Vertical Integration
Vertical integration occurs when a company takes control over several of the
production steps involved in the creation of a product or service. In other words,
vertical integration involves purchasing and bringing in-house a part of the
production or sales process that was previously outsourced. Typically, a
company's supply chain or sales process begins with the purchase of raw
materials from a supplier and ends with the sale of the final product to the
customer.

Companies can integrate by purchasing their suppliers to reduce manufacturing


costs. They can also invest in the retail or sales end of the process by opening
physical stores and locations to provide after-sales service. Controlling the
distribution process is another common vertical integration strategy, meaning
companies control the warehousing and delivery of their products.
Types of Vertical Integration
There are various strategies companies use to control multiple segments of the
supply chain. Two of the most common include backward and forward
integration.

Backward Integration
Backward integration is when a company expands backward on the production
path into manufacturing, meaning a retailer buys the manufacturer of their
product. An example might be Amazon (AMZN), which expanded from an online
retailer of books to become a publisher with its Kindle platform.2 Amazon also
owns warehouses and parts of its distribution channel.3

Forward Integration
Forward integration is when a company expands by purchasing and controlling
the direct distribution or supply of its products. A clothing manufacturer that
opens its own retail locations to sell its products is an example of forward
integration. Forward integration helps companies cut out the middleperson. By
removing distributors that would typically be paid to sell a company's products,
overall profitability is improved.

An example of vertical integration is a mortgage company that originates and


services mortgages. The company lends money to homebuyers and collects their
monthly payments, rather than specializing in one of the services.

Another example of vertical integration is a solar power company that produces


photovoltaic products and also manufactures the cells used to create those
products. In doing so, the company moved along the supply chain to assume the
manufacturing duties, conducting backward integration.

 
Although vertical integration can reduce costs and create a more efficient supply
chain, the capital expenditures involved can be significant.

Advantages and Disadvantages of Vertical Integration


Vertical integration can help companies reduce costs and improve efficiencies.
However, there are some disadvantages to implementing a vertical integration
strategy.

Advantages
Below are the benefits of vertical integration:

 Decreased transportation costs and reduced delivery turnaround times


 Reduced supply disruptions from suppliers that might fall into financial
hardship
 Increased competitiveness by getting products to consumers directly and
quickly
 Lower costs through economies of scale. By buying large quantities of raw
materials or streamlining the manufacturing process, per-unit costs are
lowered
 Improved sales and profitability by creating and selling a company-owned
brand

Disadvantages
Below are disadvantages to vertical integration:

 Companies might get too big and mismanage the overall process
 Outsourcing to suppliers and vendors might be more efficient if their
expertise is superior
 Costs of vertical integration such as purchasing a supplier can be
significant
 Increased amounts of debt if borrowing is needed for capital expenditures

Real-World Examples of Vertical Integration


An example of vertical integration is technology giant Apple (AAPL), which has
retail locations to sell their branded products as well as manufacturing facilities
around the globe. For example, in 2012 Apple acquired AuthenTec, which makes
the touch ID fingerprint sensor that goes into its iPhones.4 5  In 2015, Apple
opened a laboratory in Taiwan for developing LCD and OLED screen
technologies. It also paid $18.2 million for a 70,000-square-foot manufacturing
facility in North San Jose that same year. These investments, among others,
allow Apple to move along the supply chain in backward integration, providing
flexibility and freedom in its manufacturing.

However, the company still has suppliers that include Analog Devices (ADI),
which provides touchscreen controllers for iPhones. Also, Jabil Circuit supplies
phone casings for Apple from its manufacturing facilities in China.6

The company has also integrated forward as much as backward. Apart from Best
Buy and other carefully selected retailers, Apple products are almost exclusively
sold at company-owned locations. This allows Apple to tightly control distribution
and sale to the end consumer.

Live Nation and Ticketmaster


The merger of Live Nation and Ticketmaster in 2010 created a vertically
integrated entertainment company that manages and represents artists,
produces shows, and sells event tickets. The combined entity manages and
owns concert venues, while also selling tickets to the events at those
venues.7  The integration is an example of forward integration from the
perspective of Ticketmaster, and backward integration from the perspective of
Live Nation.

Frequently Asked Questions


When is an acquisition considered vertical integration?
Vertical integration occurs when a company acquires a supplier (known as
backward integration) or if it acquires a customer firm (forward integration).
These business combinations will involve companies all involved at different
levels of the same vertical or supply chain.

Is vertical integration good for a company?


This type of integration lowers the cost of doing business along a company's
supply chain and internalizes the management of operations from start to finish.
Sometimes, however, it is actually more cost-effective to outsource or contract
out stages in the production process to nimbler firms or ones with particular skill
or expertise in some facet of production. As a result, one must carefully evaluate
whether or not vertical integration makes sense on a case-by-case basis.

How is vertical integration different from horizontal integration?


While vertical integration involves acquisitions up or down the supply chain,
horizontal integration instead refers to the acquisition of a competitor or a related
business. Horizontal integrations help companies expand in size, diversify
product offerings, reduce competition, and expand into new markets, while
vertical integrations can help boost profit and allow companies more immediate
access to consumers.

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