Vertical
integration
Vertical integration is the degree to which a firm owns its upstream
suppliers and its downstream buyers.
vertical integration is takes place when one firm is engaged in
different parts of production
e.g. growing raw materials, manufacturing, transporting, marketing,
and/or retailing.
Backward
integration
A company exhibits backward integration when it controls subsidiaries that produce some of the
inputs used in the production of its products.
For example, an automobile company may own a tire company, a glass
company, and a metal company.
Forward
integration
A company tends toward forward integration when it controls
distribution centers and retailers where
its products are sold.
The combination or any one of the integration is called vertical integration
Benefits of Vertical Integration
Vertical integration potentially offers
the following advantages:
•Reduce
transportation costs if common ownership results in closer geographic
proximity.
•Improve
supply chain coordination.
•Provide
more opportunities to differentiate by means of increased control over inputs.
•Capture
upstream or downstream profit margins.
•Increase
entry barriers to potential competitors, for example, if the firm can gain sole
access to a scarce resource.
•Gain
access to downstream distribution channels that otherwise would be
inaccessible.
•Facilitate
investment in highly specialized assets in which upstream or downstream players
may be reluctant to invest.
Drawbacks of Vertical Integration
Vertical integration potentially has the
following
disadvantages:
•Capacity
balancing issues. For example, the firm may need to build excess upstream
capacity to ensure that its downstream operations have sufficient supply under
all demand conditions.
•Potentially
higher costs due to low efficiencies resulting from lack of supplier
competition.
•Decreased
flexibility due to previous upstream or downstream investments. (Note however,
that flexibility to coordinate vertically-related activities may increase.)
•Decreased
ability to increase product variety if significant in-house development is
required.
•Developing
new core competencies may compromise existing competencies.