Next video:
Loading the player...

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.

Related Articles
  1. Insights

    Cable Veteran Leo Hindery Jr. Casts Doubt on AT&T/Time Warner Merger (T, TWX)

    The former CEO of TCI and Liberty Media joins a growing group of skeptics who warn regulatory hurdles will doom the merger between AT&T and Time Warner.
  2. Personal Finance

    Common Interview Questions for Data Integrity Analysts

    Prepare for a data integrity analyst job interview by identifying some of the key questions commonly asked and developing winning responses.
  3. Personal Finance

    Supply Chain Management Jobs Are Booming

    There has been huge growth in supply chain management, both in the number of positions open and the range of responsibilities assigned to those positions.
  4. Insights

    Leo Hindery on ATT, Time Warner

    Leo Hindery spoke with Investopedia about the future of vertical integration in the telecom industry.
  5. Investing

    Brean Capital Sees Bright Future for 3D Systems In Healthcare

    An analyst highlights 3D's cultivation of the healthcare segment as a blueprint for success.
  6. Insights

    What Are Economies Of Scale?

    Is bigger always better? Read up on the important and often misunderstood concept of economies of scale.
  7. Investing

    Explaining Economic Integration

    Economic integration reduces or eliminates trade barriers among nations, and coordinates monetary and fiscal policies.
  8. Insights

    What Is "Chained CPI?"

    Chained CPI is one of many ways to approximate the impact of rising or falling prices to consumers' pocketbooks.
  9. Investing

    Target Tells Suppliers To Move Faster Or Pay-Up (TGT)

    Target has begun cracking down on its vendors in an attempt to increase its supply chain efficiency, says a report.
Hot Definitions
  1. North American Free Trade Agreement - NAFTA

    A regulation implemented on Jan. 1, 1994, that eventually eliminated tariffs to encourage economic activity between the United ...
  2. Agency Theory

    A supposition that explains the relationship between principals and agents in business. Agency theory is concerned with resolving ...
  3. Treasury Bill - T-Bill

    A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations ...
  4. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
  5. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure typically used by analysts to identify companies that generate ...
  6. Majority Shareholder

    A person or entity that owns more than 50% of a company's outstanding shares. The majority shareholder is often the founder ...
Trading Center