A:

Vertical integration makes sense as a strategy, as it allows a company to reduce costs across various parts of production, ensures tighter quality control, and ensures a better flow and control of information across the supply chain. The core intention of the approach is value creation and greater profit potential through better control over its operations. The types of costs that can be reduced or removed in vertical integration include transportation costs, transaction costs and business-to-business marketing costs.

In addition, an organization may also feel that its existing suppliers or buyers are exhibiting too much power over them. Through vertical integration, the organization can reduce or eliminate the leverage that suppliers or buyers have over the firm. The process allows a company to improve profitability by stripping out the middleman, sometimes taking the form of wholesalers and retailers.

Taking ownership of at least part of the supply chain can provide added flexibility for the firm. This can be important in times of challenging market conditions, where margins would more likely come under pressure.

A firm can take ownership of its upstream suppliers and downstream buyers through mergers or acquisitions of specific parts of the chain. However, the organization can also choose to expand without necessarily consolidating an operation, as would be the case when a company builds out its own retail network. The oil and gas industry has been particularly active in vertical integration, as firms in the sector tend to have control over their exploration, production, marketing, and refining operations.

Vertical integration can come in the form of a “backward integration”, “forward integration” or “balanced integration”. Backward integration involves the acquisition of a supplier or the control of subsidiaries that produce some of the inputs used in the production of its products. Forward integration concerns the purchase or building of a distributor, allowing the company to move closer to the consumer through distribution centers and retailers. Balanced integration is a combination of the two.

The acquisition of media and content provider Time Warner by America Online in 2000 is an example of backward integration. High-profile backward integrations within the technology sector include Google’s acquisition of Motorola Mobility Holdings and eBay’s purchase of PayPal. The 2003 purchase of OfficeMax, an office products manufacturer, by paper company Boise Cascade, is illustrative of forward integration.

Beauty products firm Avon is another company that pursued backward integration. The organization did this by venturing into the production of some of its cosmetics, rather than just focusing on the sales and marketing of the product. Meanwhile, clothes manufacturer Levi Strauss & Co. has become more forward integrated by opening retail stores to market its products.

Horizontal integration differs from vertical integration. A horizontal merger takes place between two organizations in the same industry. Examples of that include the mergers of household products names Procter & Gamble and Gillette in 2006, and oil companies Exxon and Mobil in 1999.

A major vertical integration disadvantage is that the strategy concentrates all the resources and prospects on the one approach. The “all the eggs in one basket” strategy can be risky in an uncertain market environment. In addition, the organizational and coordination costs may also be high.

RELATED FAQS
  1. What is the difference between horizontal integration and vertical integration?

    Horizontal integration refers to acquiring a company in the same industry; vertical integration refers to a company acquisition ... Read Answer >>
  2. What are the most famous instances of backward integration?

    Learn more about backward integration in the supply chain and see how two famous examples, Carnegie Steel and Apple, used ... Read Answer >>
  3. What are the legal barriers to vertical integration?

    Learn how embarking on a vertical integration through a merger is liable to run into legal barriers if the integration is ... Read Answer >>
  4. When is outsourcing preferable to vertical integration?

    Deciding between outsourcing and vertical integration can be challenging. Understand the benefits of each to make the most ... Read Answer >>
  5. What business structures expose entrepreneurs to unlimited liability?

    Understand the advantages and disadvantages of a horizontal integration. Learn when a company would want to integrate horizontally. Read Answer >>
  6. How are direct costs allocated differently than indirect costs?

    Learn about some great examples of horizontal integration. Understand what constitutes a horizontal integration and why companies ... Read Answer >>
Related Articles
  1. Small Business

    Vertical Integration

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

    What Investors Can Learn From M&A Payment Methods

    How a company pays in a merger or acquisition can reveal a lot about the buyer and seller.
  3. 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.
  4. Investing

    Understanding Vertical Analysis

    In vertical analysis, each line item on a company’s financial statements is presented as a percentage of a larger number.
  5. 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.
  6. Investing

    The Wonderful World Of Mergers

    While acquisitions can be hostile, these varied mergers are always friendly.
  7. Insights

    A Year Later, Microsoft's Nokia Acquisition Makes Sense

    On the surface, Microsoft acquiring Nokia may mean very little to industry leaders such as Apple and Samsung. However decreased transaction and unit costs combined with a larger global distribution ...
  8. Investing

    Top 5 Vanguard Energy Fund You Need to Know!

    Discover an analysis of the top five holdings in the Vanguard Energy Fund Investor Shares, and learn about their characteristics and year-to-date performance.
  9. Investing

    Energy Sector: Industries Snapshot (XLE, XOM)

    Discover the two industries that form the energy sector of the S&P 500 index, and learn which companies may be the right stock for your portfolio.
RELATED TERMS
  1. Vertical Market

    A vertical market is a group of companies that serve each other's ...
  2. Horizontal Acquisition

    A horizontal acquisition is when one company acquires another ...
  3. Vertical Well

    A well that is not turned horizontally at depth, and which allows ...
  4. Horizontal Merger

    A merger occurring between companies in the same industry. Horizontal ...
  5. Vertical Equity

    Vertical equity is a method of collecting income tax in which ...
  6. Supply Chain

    A supply chain is a network of entities and people that work ...
Hot Definitions
  1. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  2. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  3. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  4. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
  5. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company has sold and replaces inventory over a period.
  6. Watchlist

    A watchlist is list of securities being monitored for potential trading or investing opportunities.
Trading Center