There are many business strategies out there. Companies adopt these plans to increase their revenue and the overall dominance in the marketplace. If we talk about supply chain, you will see two main types of business integrations: Vertical integration and horizontal integration.
In this article, we will tell you what vertical integration is, its main examples and some benefits.
Vertical Integration Explained
Vertical integration in simple language is getting more control over the processes of a company by eliminating the role of outsiders. Every product passes through some phases such as the provision of raw materials and supply of a product to the customer.
A company normally doesn’t handle all the processes itself. The usual pattern is that companies get the raw materials from a vendor, manufacturing, and then hand them over to the distributors for final supply.
Real-Life Examples
- If we talk about pharmaceutical companies, they get raw materials from specified vendors and manufacture products in their plants. After manufacturing, the medicines are shifted to the distribution houses. The distributors are responsible for the final supply of these products to the retailers.
- If we talk about the fashion industry, there are so many challenges a manufacturer has to face. They usually do forward vertical integration to open their outlets for easy access to the public to their latest trends and designs in no time. They can strategize their plans to market their products in a better way.
- In the shipping industry, there are many pillars and stakeholders involved. If you are a manufacturer of a product and having difficulty sending your products to the customers, you can integrate the business. You can also control the shipping process in a better way by getting involved in the whole process including the courier and handling at port.
3 Types of Vertical Integration
Backward Integration
If you are running a retail shop and have a direct connection to your customers, you can backward integrate to open your distribution house. In this way, your profit ratio will be increased and you will be able to scale your business to a different level.
If you are a distributor, you can also do manufacturing to avoid your dependence on the manufacturer.
Forward Integration
It is the type of integration, where a manufacturer takes over the control of their supply process to the final customers. In recent times, it has been observed that some distributors blackmail the manufacturers by doing self-shortage of the products. Manufacturers do forward integration to prevent any mishandling in their supply processes.
Balanced Integration
In this type of integration, a company integrates itself in both forward and backward ways. For example, Apple started to open its retail outlets throughout the world, and they also started manufacturing their semiconductors themselves.
Although, it requires huge investment and management, however, a beneficial way to get complete control of your business. In this way, you can ensure the quality of your product and also handle clients successfully.
Pros and Cons of Vertical Integration
Benefits/Pros
- Strong control over the integrated processes. This gives more freedom to work with more dedication and introduces innovation.
- A significant cut in cost due to self-managing the whole system.
- Quality improves because continuous connection and communication with the end user helps to do better in every aspect.
- It causes the quick supply of the latest models to the public.
- It improves the marketing strategy to sell products, the company knows very well, when and how it should start to sell at discounts.
Drawbacks/Cons
- It always brings more operational challenges because vertical integration carries a lot of logistical and market-related problems.
- Requires heavy investments to integrate business forward or backward. It also needs so much patience to get back your investment, as it needs sufficient time to break even.
- The company loses grip on its core strengths while facing extra challenges regarding vertical integration.
Degrees of Vertical Integration
Full Vertical Integration
FVI refers to getting control over all the processes a company is involved in from raw material to the final supply. It can also mean to get complete control over a single process either forward or backward. It includes the buildings, assets, transport required, and machinery if needed. It gives you full control over the integrated processes.
Quasi Vertical Integration
It is a kind of vertical integration in which the company doesn’t control all the things itself. However, it finds ways to successfully do vertical integration with the help of other stakeholders. In this sort of integration, joint ventures and franchising systems play a major role. The company doesn’t need to invest heavily in this mode of integration.
Long-Term and Spot Contracts
In long-term contracts, companies sign purchasing deals for longer periods to get more stability and benefits. While in spot contracts, companies operate and purchase for shorter periods. These are two different approaches to operating companies. Both have their pros and cons.
FAQs
What is the Difference Between Vertical and Horizontal Integration?
Vertical integration is getting full control of supply chain processes by replacing the other companies and doing all the processes themselves. Horizontal integration is getting control of supply chain processes by merging with other companies and doing business in collaboration.
Who Introduced Vertical Integration?
Andrew Carnegie, the owner of Carnegie Steel introduced vertical integration in 1800. The company took all the processes under control by backward and forward integration.
What Are the 4 Stages of Vertical Integration?
- Identification: First make a decision, that which part of the supply chain you want to get control over.
- Acquisition: Acquire the company involved in the process, or set your infrastructure to get control over the specific part.
- Integration: Integrate your current business with the supply chain process and do all the tasks under your supervision.
- Optimization: Remove the flaws and make your integration perfect to optimize your business growth.
What Are the Pillars of Vertical Integration?
There are 4 pillars of vertical integration.
Raw Material Provision: To manufacture a particular product, you always need raw material to produce it.
Manufacturing: The 2nd step is manufacturing and all the steps involved in this process.
Distribution: The final products are then distributed to the retailers through distributors.
Final Supply through Retailers: Retailers then supply the final products to the customers.
Wrapping It Up
So, that was all about vertical integration and its stages. We hope you also learned the basic difference between horizontal and vertical integration. Now you can decide easily which is more suitable for your business. If you need any help in logistics and supply chain management in China, we are here to help. Contact us and talk to our team.
