Vertical Integration

Reviewed by Sweta | Updated on Aug 27, 2020

Introduction

Vertical integration refers to the take over by a company of a portion of the production process previously outsourced. The company normally assumes control of the many production steps which lead to the production of their product. The company brings in a portion of the production process in-house. The common form of vertical integration is the purchase of suppliers by a company.

Understanding Vertical Integration

  • A company uses different types of integration due to different segments in a supply chain. Generally, a company uses backward integration and forward integration. Backward integration occurs when a company expands backwards into its production process. An example of backward integration is retailer buying the company manufacturing a product. Forward integration occurs when a company purchases to control the distribution of its products.
  • The advantages of vertical integration include a reduction in transportation costs and speed in delivery time. It helps reduce disruptions in the supply of goods from third parties. Forward integration helps in reducing the delivery time to ultimate consumers. The vertical integration helps in achieving economies of scale and increases manufacturing efficiency.
  • The disadvantages of vertical integration include the inability to manage the production process due to technical difficulties or lack of appropriate staff. Vertical integration can increase the overall operating costs for a company. In case a company does not have the resources to manage the size of operations, the vertical integration can fail.
  • The usual supply chain consists of the purchase of raw materials and ending with sale to the ultimate customer. The other forms of vertical integration include a company taking ownership or control of distributors or the retail sellers. The benefits of vertical integration include a reduction in costs, quality management with control over production and an overall improvement in production.

Conclusion

Example of vertical integration is an automaker buying out a supplier of its key component. In other cases of the forward integration, a company may open its own showrooms and supply the products from its own warehouses. Vertical integration thus essentially allows a company complete control over the source of raw materials or the distribution of its products to ultimate customers.