Vertical Integration

Introduction

Many companies make use of vertical integration to gain control over their supply chain. When firms use it as a corporate strategy, one of the key points they take into consideration is the level of integration existing in the company. Among the things that can be considered when analyzing the organization’s vertical integration is to what extent it takes part in the production activity (Loertscher & Reisinger, 2014). It brings a lot of benefits for a business as it influences their business performance and the competitive advantage in the market (Grant, 2016). Moreover, many enterprises have been practicing vertical integration to cut costs. In fact, companies feel motivated to integrate when there are lower costs of internal production as opposed to relatively higher expenses on outsourcing the product from the market. On the other hand, a firm needs to analyze and decide on the most appropriate time to venture into the process. Furthermore, it has to consider a lot of aspects to determine if a company will be partially or fully integrated or not undergo the procedure at all. Overall, vertical integration (forward, backward or balanced) in the business world is important because it makes the business to enjoy economies of scale and competitive advantage, have uninterrupted supply chain and total and complete control over the organization.

The Definition of Vertical Integration

There are few different ways to define vertical integration depending on the area of studies. For example, in management and microeconomics, it is considered as a phenomenon where the company owns its supply chain and combines the products produced at different levels and integrates them to satisfy a common market need (Blair & Kaserman, 2014). Another definition states that it is a situation when companies own and control various steps of the business activities ranging from production and manufacturing to retail and eventual distribution of the same (Blair & Kaserman, 2014). It is necessary to highlight that when businesses are vertically integrated, the middlemen are eliminated (Grant, 2016). As a result, vertical integration is a primary strategy for many organizations because it aids to strengthen the competitive advantage and make the firm dominant in the market.

Types of Vertical Integration

In the modern economy, vertical integration is a holistic approach that is used to explain the distribution and marketing strategies that are in existence. Speaking about the given type of integration, one has to say that a company can opt for a whole or partial integration. In case an enterprise is wholly integrated, it owns and controls all the steps in the production chain (Loertscher & Reisinger, 2014). If it is partially integrated, it means that it possesses and supervises only some stages of the production path (Loertscher & Reisinger, 2014). There have been distinguished three types of vertical integration: backward, forward, and balanced.

Forward Integration

Vertical integration is said to be forward when the company has engaged in the management and/or control of the production path and supply chain. It is also called downstream and occurs when the firm owns the production, manufacturing, distribution, sale, and transportation of goods (Loertscher & Reisinger, 2014). It is a kind of diversification that results in the enterprise enjoying the economies of scale. As a rule, a firm ventures into forward integration if it engages into the manufacturing services and merges with or acquires other businesses that are in the distribution line (Lahiri & Narayanan, 2013). Speaking about the forward integration, the focus of the company is the end users of the product or the customers. Therefore, downward integration is a kind of monopoly on its own, especially in the manufacturing industry.

Backward Integration

Unlike the forward integration where the focus is placed on the customers, in the backward integration, the company integrates away from them. It particular, the organization concentrates on areas relating to the sources of raw materials as well as the production line. It is also referred to as an upstream strategy as it moves upwards away from the customers (Lahiri & Narayanan, 2013). An example of the given kind of integration can be a car manufacturer who would merge with a company in the tire making business or the one in manufacturing of electrical as tires and electrical appliances are parts of the raw materials used in the making of a car. All in all, upstream integration results in a monopoly in retailing. Therefore, it is a move to ensure that raw materials are readily available to guarantee the continuity of the production path.

Balanced Integration

Some organizations find it tricky to undergo forward or backward integration. As a result, most of the firms tend to have a mixture of the two. Such a combination of two kinds is referred to as balanced integration. In such a case, the focus is both on the customers (downstream) as well as acquiring raw materials for the production (upstream). The given kind of integration increases the competitiveness of the firm and results in the expansion of the business thereby enjoyment of economies of scales.

Benefits of Vertical Integration

Vertical integration in the market is a new strategic management and control path of accelerating growth and success of a company (Loertscher & Reisinger, 2014). It brings about numerous benefits not only for the company but also for the customers and other players in the industry. The main advantages of the phenomena include the acquisition of competitive advantage, economies of scale, total and complete control over many processes. In addition, the processes conducted by the business become free from various issues and interruptions.

Competitive Advantage

The objective of vertical integration is to provide the firm with a competitive advantage over its rivals. Obviously, a company which has a stronger competitive advantage will have its products demanded more in the market as compared to the ones that are not vertically integrated (Lahiri & Narayanan, 2013). Furthermore, a vertically integrated enterprise is in a position to lower the cost of its products and ensure high quality. All this in unison gives the company the competitive advantage within the market and hence dominance.

Economies of Scale

Vertical integration is a form of expansion in itself, and when the company employs it, there are benefits it enjoys from this expansion (Loertscher & Reisinger, 2014). They are called economies of scales. For example, when a firm vertically integrates, it can lower costs of production per item. It implies that an organization can find itself in a position to make bulk purchases and production. Furthermore, since integration involves merging of businesses, there is a reduction of overhead costs of manufacturing as most units are merged (Lahiri & Narayanan, 2013).

Freedom from Interruptions

Vertically integrated enterprises can be characterized by smooth supply and distribution chains. By eliminating intermediaries, for instance, they are free from underlying possible disruption they can face from the distributors. It, therefore, ensures there is a readily available supply of the commodity in question and hence continuity in the production path.

Total and Complete Control

A vertically integrated business will have a high level of control in many aspects. In particular, enterprises are in a position to determine the kind of quality they need and can even be price leaders in the market (Lahiri & Narayanan, 2013). This is especially true in a situation when the vertical integration leads to pure monopoly. In a case when a company controls the market, it is assured of sales and hence growth of its profits.

Pros and Cons for an Organization

Vertical integration is a double-edged phenomenon as it is both good and bad for an organization. It is beneficial for enterprises because it is a move that is aimed at consolidating the business operations. Moreover, it makes the company enjoy a competitive advantage, economies of scales, as well as have control and command of the market within its operation. Additionally, it is advantageous because, in most cases, the move is profitable (Blair & Kaserman, 2014). Finally, the organization has a full control of businesses in its line of production.

Conversely, vertical integration may turn out to be not advantageous for the firm. Firstly, it is more of a monopoly, and therefore, it eliminates competition in the market (Grant, 2016). Secondly, it is a risky operation which is termed as complicated and expensive and is difficult to reverse. Therefore, the organization aiming to integrate vertically has to analyze to determine the viability of the strategy.

Conclusion

To sum up, vertical integration as one of the management and control strategies is a move that needs a critical analysis before an organization ventures into it. Its implementation can be partial or whole, and one can distinguish forward, backward or balanced kinds of it. It has been in practice for quite some time, and today, almost any business that needs to expand and succeed has to embrace vertical integration. Even though it is termed as a risky move, it is well-known in business that the higher the risk, the higher the returns. Thus, companies should not shy off from implementing vertical integration for the success of their business.