What is Vertical Integration?
Vertical Integration involves the merger of two or more companies that serve different functions in the supply chain. In such a case, the entire (or most) of the supply chain is controlled by the company. Thus, the company receives increased oversight and control over the internal processes, which should theoretically eliminate operating inefficiencies.
Vertical Integration: Merger Strategy (Step-by-Step)
Vertical integration consists of a company taking control over at least two steps in a given value chain, such as the production, distribution, or selling of the finished good or service, as opposed to outsourcing certain tasks.
The vertical integration of a supply chain implies that each step of the process is owned and closely controlled by a combined entity.
If a company publicly announces its plans to control and own aspects of its supply chain rather than relying on external suppliers as it did in the past, the shift is called “vertical integration”.
Furthermore, the merged company possesses a greater proportion of the total market share, which directly causes its buyer power to increase and gives it more negotiating leverage over its suppliers and distributors.
The end goal for pursuing vertical integration is to streamline the operational process from start to finish, i.e. having more ownership over all the various stages in a production process.
Companies often opt to outsource or rely on external 3rd parties in an effort to reduce spending, yet sub-par production and quality issues can cause real damage to the branding of the company and diminish the trust of their customer base.
Therefore, vertical integration consists of a company possessing ownership over most, if not all, stages of the production cycle, including the suppliers and distributors.
Vertical Integration: Pros and Cons Analysis
- Greater Control + Less Reliance on 3rd Parties: Normally, the supply chain process starts with purchasing raw materials from suppliers – followed by a wide range of potential steps depending on the context – until the final product reaches the customer. The strategy of vertical integration implies the company controls multiple stages in its supply chain, thereby reducing or even eliminating the need for reliance on any third parties.
- Improved Operating Efficiency: Vertical integration can result in the production process becoming more efficient with reduced costs (and higher profit margins).
- Initial Outlay: The drawback, however, is that there is a great number of initial costs that are required to build the infrastructure and purchase the necessary equipment. Until the company recoups the initial cost, the integration would remain unprofitable.
- Increase in Responsibilities: Obtaining ownership of the supply chain from start to finish might initially sound appealing, but more control over the process does not necessarily result in higher quality. While factors such as communication may be improved, the management team must have a thorough plan in order to be capable of managing every step of the production process. Having an inept management team responsible for overseeing the complex supply chain can be very risky.
