Vertical Integration

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Vertical integration occurs when a company buys and controls other businesses along its supply chain.

There are two types of vertical integration: backward and forward. In backward vertical integration, a company such as a manufacturer owns companies that supply inputs to the business's manufacturing process. For instance, a hamburger franchise chain owns a potato farm company to ensure that it will have a constant supply of potatoes to make french fries.

In forward vertical integration, a company owns another company to get closer to the ultimate consumer in the supply chain. A manufacturer of electronic devices that buys a chain of electronics retail stores is an example of forward vertical integration.

Vertical integration usually happens because it produces efficiencies in the production process. It also happens because a company finds it can make more money by selling its products directly to consumers than by selling it to retailers. Finally, it can be done to save both time and money. Take the example of Techcon, a technology consulting company. Whenever Techcon has a customer that needs app development services, Techcon hires the relatively small app development company, Appdev, to do the work. Techcon would like to one day develop the apps in-house, but the company projects that it would take five years and cost $50 million to acquire the same expertise as Appdev. If Techcon buys Appdev for anything less than $50 million, Techcon gets an app-building division for less than it would cost to do it on its own. And by purchasing Appdev, Techcon saves five years of time as well.

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