Vertical integration is a type of business strategy used by companies to gain control over the full range of their products or services. It is a form of cooperation between different stages of production, where there is usually a common ownership of the major parts of a process. By controlling the entire production chain from resources to end products, companies create a secure and efficient production process.
Vertical integration is also a strategy used in growing markets; when companies consolidate and gain control of different parts of the production process, like sourcing and distribution, they can have an advantage over their competitors by streamlining operations and adding efficiencies. Essentially, vertical integration occurs when a company elects to take control of any part of the supply chain.
In general, there are four types of vertical integration: backward, forward, internal, and outward.
Backward integration is where a company takes ownership of the upstream production activities or the supply side. This can include raw materials, equipment, and inventories in different stages of production. As an example, a company may choose to open its own raw material supply stores to guarantee quality control.
Forward integration is where a company buys control of their downstream production activities or the demand side. In this type of vertical integration, the company undertakes activities in order to expand their customer base or enter new markets. These activities can include retail sales, distribution, after sales services, and marketing.
Internal vertical integration is when a company buys either its suppliers or customers, essentially merging different production stages. This is a less common form of integration, as internal resources are often more difficult to acquire.
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Outward integration is the acquisition of the production activities of a related business. This can include strategic alliances with other companies to gain access to their resources. An example of this is a computer manufacturer who acquires a memory manufacturer for the purpose of using their own memory in making new computers.
One of the main benefits of vertical integration is that it allows companies to streamline their production process, as all stages are managed in-house. This can help to create more efficient operations, more secure resources, and increased control over quality control. Additionally, owning their own resources means that companies can better manage their resources and reduce their need to outsource produce and materials.
The downside of vertical integration is that it can become expensive and complex to manage; companies need to ensure that they have the right personnel and resources available to them at all times, and should be aware of the potential costs associated with purchasing and managing new resources. Additionally, ownership of resources can make companies less agile, as they lack the flexibility of relying on external suppliers.
When shoring up their supply chain, companies must consider the benefits and drawbacks of vertical integration. The strategy should only be pursued when it can be profitable and provide long-term advantages; otherwise, it can become counterproductive. Companies must carefully weigh the advantages and disadvantages of vertical integration, and determine whether it makes strategic sense for them to establish a new ownership structure.
In order to achieve efficient and effective vertical integration, companies must develop a robust supply chain management system and strategy. This should include having a clear understanding of the resources need to be acquired and how they will be managed; determining the long-term cost savings and other potential benefits; and making sure the right personnel and resources are in place to implement the strategy and carry out the day-to-day activities. Companies must also consider whether their resources are best served through vertical integration, or if outsourcing production activities would be a more cost efficient option.
Vertical integration can be difficult to manage and can be expensive to implement, so companies must carefully consider the impact of this strategy on their operations. However, for companies who do decide to pursue vertical integration, it can offer a range of advantages, from lower production costs, to more secure resources and increased control over their whole production process.