Meaning Vertical Integration
Vertical integration is essential for an organization because, depending on its industry of operations, Vertical integration may be the only way by which an organization can compete effectively as well as operate in a more efficient and productive manner by minimizing costs within the supply chain. Simply, Vertical integration is part of main company’s strategy for diversifying its operations by expanding within its supply chain of operations. The aims of vertical integration are to minimize costs and improve efficiency of all stages in the manufacture process of a product.
Definition of Vertical Integration
A vertically integrated supply chain includes suppliers of raw materials and components, intermediate manufacturers of the final product, and logistics suppliers or distribution channels who deliver components to the assembly plant and customers who uses finished products. In single sentence vertical integration can be defines as “all aspects of a product’s manufacture from raw materials to distribution”.
Two Type of Vertical Integration
- Backward integration. Backward integration refers to downstream expansion of a company’s activities
- Forwards integration. Upstream expansion of activities refers to forward integration.
Advantages & Factors Favoring Vertical Integration
There are distinct advantages of vertically integrating for a company. This can reduce in transportation costs, especially if a company operates in different geographical areas. There is also an improvement in coordination within the supply chain. The company also becomes in the position to offer more differentiation by having more control over inputs within the supply chain.
The acquisition of both upstream and downstream profit margins becomes also attainable due to vertical integration. Due to vertical integration a company will tap into those profits and areas which previously were out of its scope.
Vertical integration also provides chances to access new distribution channels. As a company become able to concentrate its expertise in providing better products or services due to which core competencies of a company also expanded.
Here are some factors that may favor a company to go for vertical integration
- Government imposition of tax and regulations on market transactions
- obstacles for the formulation of business contracts and there monitoring
- Economies of scale by which a company can get benefit of large production
Disadvantages Of & Factors Discouraging Vertical Integration
Vertical Integration can also have some setbacks such as it reduce operational flexibility and limit access to the best suppliers. A company may experience a reduction in the product or services quality due to decentralization of core business operations. Costs may be increased due to low efficiencies resulting from lower supplier competition.
Here are factors that may discourage a company to go for vertical integration
- Suppliers may order less than the lowest cost-efficient scale needed to produce the product
- Product is widely available and costs are greatly reduced as overall quantity increases
- The core competencies between the activities are different
Summing up all the above we can say that vertical integration always has a significant impact on an organization unit’s position in its industry with respect to cost, differentiation and, other strategic issues but at the other hand it may have some drawbacks, so the companies may opt others tools according to their specific requirements.