Business
Vertical Integration
Vertical integration refers to a business strategy where a company controls multiple stages of the production and distribution process for its products or services. This can involve owning or controlling suppliers, distributors, and retail outlets. By integrating vertically, a company seeks to gain more control over its supply chain, reduce costs, and improve efficiency.
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10 Key excerpts on "Vertical Integration"
eBook - PDFStrategic Management
Concepts and Cases
- Jeffrey H. Dyer, Paul C. Godfrey, Robert J. Jensen, David J. Bryce(Authors)
- 2020(Publication Date)
- Wiley(Publisher)
What Is Vertical Integration? 119 This chapter will examine why companies choose to conduct an activity within the firm; the benefits of outsourcing, and the conditions when it might be advantageous; and the dan- gers of outsourcing as well as the risks of Vertical Integration. In the Strategy Tool at the end of the chapter, we provide a tool, the “Make Versus Buy Assessment,” that can be used to decide whether to make versus buy. The Value Chain The different aspects of the value chain have been covered in earlier chapters, but they warrant a more in-depth discussion here as a clear understanding of the value chain is critical to the “make versus buy” decision. The value chain for an industry is the sequence of activities that transforms raw materials into finished products. Each key activity “adds value” to the prior activity—hence the term value chain. 9 To illustrate, let’s walk through the industry value chain for gasoline. To get gasoline to the consumer, we first need to explore for crude oil, then drill, then ship, then refine the crude into gasoline, then ship again, then finally sell gasoline to the end consumer, as outlined in Figure 7.1. Companies have their own value chains that are usually distinct from an industry value chain. Companies that participate in many or all stages of the industry value chain from explo- ration to final sale are highly vertically integrated. 10 Companies that participate in only one activity (such as shipping crude oil) are vertically specialized. 11 Activities closer to the beginning of the industry value chain, or the raw materials used to create a product, are referred to as upstream activities and those toward the end, or final products that consumers purchase, are downstream activities. 12 Forward Integration and Backward Integration If a company wants to grow by moving forward in the value chain—that is, downstream—we say that company engages in forward integration.
eBook - ePubMaximizing Corporate Value through Mergers and Acquisitions
A Strategic Growth Guide
- Patrick A. Gaughan(Author)
- 2013(Publication Date)
- Wiley(Publisher)
One of the benefits of being vertically integrated is that it can lower some of the risks a company faces in the marketplace. Buying a supplier can allow a company to have greater certainty in access to supplies. It may also allow these supplies to be more dependably available at more predictable prices. When getting access to key supplies is a major risk factor, companies may be able to lower this risk through Vertical Integration. By acquiring a supplier, they may be able to get a dependable source of inputs while possibly being able to gain a competitive advantage by preventing these supplies from being available to the competition. This competitive advantage may carry with it antitrust ramifications, but as markets have become increasingly globalized, most deals, especially vertical ones, tend to move through the antitrust approval process without a great deal of opposition.Vertical Integration AS A PATH TO GLOBAL GROWTH
When a company manufactures a product, it obviously has to get that product to its ultimate consumers. Even if a company has superior products, if competitors have the distribution channels locked up, the company may be at an insurmountable disadvantage. Sometimes, M&A can be the solution to this dilemma.Many industries have different layers or stages with some being more competitive than others. For example, the petroleum industry has multiple stages from exploration and extraction to transportation and refining to the retail stage. Some stages are more profitable than others. We discuss later in this chapter how U.S. companies reacted to the changing profitability in the refining business to become less vertically integrated and to sell off their refining businesses. However, for other industries, being vertically integrated is a way of making sure that your products have a clear path to the consumer and that you will not be adversely affected by the actions of competitors. Companies may want to try to control as many outlets for their products as possible to ensure that they can maintain prices that allow them to extract maximum economic rents for their products. Often, such efforts are thwarted by regulators. One prominent example of how this was done in the United States, but also in the global, market without attracting resistance from antitrust regulators was that of eyeglass manufacturer and marketer Luxottica. We discuss this company's very successful use of a Vertical Integration strategy in the case study that follows.
eBook - PDF- Robert M. Grant(Author)
- 2021(Publication Date)
- Wiley(Publisher)
D. Chandler, Strategy and Structure (Cambridge: MIT Press, 1962). 238 PART IV CORPORATE STRATEGY the relative efficiencies of firms relative to markets. For most of the 19th and 20th cen- turies, new technologies—including innovations in management and organization— have favored large firms. Around the mid-1970s, this trend went into reverse: a more turbulent business environment and new information and communications technol- ogies favored more focused enterprises coordinated through markets. Yet, during the 21st century, a new phase of global consolidation has seen the traditional benefits of scale and market dominance reasserting themselves. The Benefits and Costs of Vertical Integration So far, we have considered the overall scope of the firm. Let us focus now on just one dimension of corporate scope: Vertical Integration. The question we seek to answer is this: Is it better to be vertically integrated or vertically specialized? With regard to a specific activity, this translates into: To make or to buy? First, we must be clear what we mean by Vertical Integration. Vertical Integration is a firm’s ownership and control of multiple vertical stages in the supply of a product. The extent of a firm’s Vertical Integration is indicated by the number of stages of the industry’s value chain that it spans, and can be measured by the ratio of its value added to sales revenue. 4 Vertical Integration can be either backward (or “upstream”) into its suppliers’ activ- ities or forward (or “downstream”) into its customers’ activities. Vertical Integration may also be full or partial. Some California wineries are fully integrated: they produce wine only from the grapes they grow, and sell it all through direct distribution. Most are partially integrated: their homegrown grapes are supplemented with purchased grapes; they sell some wine through their own tasting rooms but most through independent distributors.
eBook - PDFStrategic Networks
Creating the Borderless Organization
- J. C. Jarillo(Author)
- 2014(Publication Date)
- Butterworth-Heinemann(Publisher)
The aim here is not to defend any competitive advantages, but to obtain them, partly thanks to integration. This happens, for example, in the case of a company that, by becoming integrated, increases the volume of production of some subcomponent it was using in the manufacture of other products or in other processes and so achieves economies of scale in other areas of its operations. It is also quite usual for a company to opt for Vertical Integration as the best policy when its general strategy is to underline the high quality of its products compared to others on the market, and so it believes that it is the only company that can manufacture components of sufficient quality for its requirements, or when it only wants to sell through its own shops, as it sees this as the only way to maintain the quality and image of the product. If this is true, then it is clear that a strategy of Vertical Integration, if it is carried out well, can turn a business into an unassailable competitor. Vertical Integration can be used as a learning device. Sometimes it is crucial for a company to understand under-lying technologies in some of the components it uses, for changes in those may actually affect the competitiveness of the activities it is involved with. In addition, integrating forward may be a way to understand the rest of its clients better: it makes sense for McDonald's to own a number of its restaurants, so it understands the business better, thus increasing its competitiveness. Vertical Integration to lower coordination costs Vertical Integration can also 'save' the company money when the relation between company and supplier is particularly costly, either because the information that must be passed on to the supplier is substantial or continuous, or may change. In these cases there would be an 'economy in the transaction' that could be quite a significant saving. If working with a
eBook - PDFStrategic Management
Concepts and Cases
- Jeffrey H. Dyer, Paul C. Godfrey, Robert J. Jensen, David J. Bryce(Authors)
- 2021(Publication Date)
- Wiley(Publisher)
The need to coordinate these activities effectively leads to Vertical Integration of these activities. Control The third C is control, which refers to a firm’s desire to maintain control over a valuable activity or input in the value chain. In other words, an organization’s leaders must ask: To what extent should we maintain control over a crucial step in the value chain by conducting this activity ourselves? A company might want to vertically integrate in order to control some scarce and valu- able resource, particularly if it is a differentiator of its final product. 26 The choice to backward integrate might be made in order to control access to important raw materials or inputs that are highly customized to downstream activities. Some producers of aluminum have purchased land that is rich in bauxite—a key raw material that is necessary to make aluminum. They want to ensure that they have control of that key input so they developed bauxite-mining operations. In a similar vein, it might make sense to maintain control over investments in assets or equip- ment that provide key inputs at lower cost. For example, suppose that crude oil is best shipped to an oil refinery through a pipeline. Let us say the cost of shipping a barrel of crude oil by truck is $1.00 per barrel, whereas transporting by pipeline would be only $0.50 per barrel. Once built, the owner of the pipeline could opportunistically raise the shipping price up to $0.99 since the only real alternative is to ship the crude in trucks. Likewise, the owner of the refinery could refuse to pay a fair price to the pipeline owner—or any price, for that matter—if there is no other alternative use for the pipeline. In this case, the pipeline is a transaction-specific asset, meaning it is specialized or custom- ized to a particular transaction (transporting oil to the refinery) and has little value when redeployed to its next-best use.
eBook - PDF- Robert M. Grant(Author)
- 2018(Publication Date)
- Wiley(Publisher)
J. White and J. Yang, “What Has Been Happening to Aggregate Concentration in the U.S. Economy in the 21st Century?”Stern School of Business, New York University, 2017. S. Kim “The Growth of Modern Business Enterprises in the Twentieth Century,” Research in Economic History 19 (1999): 75–110. 256 PART IV CORPORATE STRATEGY relative efficiencies of firms relative to markets. For most of the 19th and 20th centuries, new technologies—including innovations in management and organization—have favored large firms. Around the mid-1970s, this trend went into reverse: a more turbulent business environment and new information and communications technologies favored more focused enterprises coordinated through markets. The Benefits and Costs of Vertical Integration So far, we have considered the overall scope of the firm. Let us focus now on just one dimension of corporate scope: Vertical Integration. The question we seek to answer is this: Is it better to be vertically integrated or vertically specialized? With regard to a specific activity, this translates into: To make or to buy ? First, we must be clear what we mean by Vertical Integration. Vertical Integration is a firm’s ownership and control of multiple vertical stages in the supply of a product. The extent of a firm’s Vertical Integration is indicated by the number of stages of the industry’s value chain that it spans, and can be measured by the ratio of its value added to sales revenue. 4 Vertical Integration can be either backward (or upstream) into its suppliers’ activ-ities or forward (or downstream) into its customers’ activities. Vertical Integration may also be full or partial . Some California wineries are fully integrated: they pro-duce wine only from the grapes they grow, and sell it all through direct distribution. Most are partially integrated: their homegrown grapes are supplemented with pur-chased grapes; they sell some wine through their own tasting rooms but most through independent distributors.
eBook - PDF- J. Jarillo(Author)
- 2003(Publication Date)
- Palgrave Macmillan(Publisher)
Moreover, in this way they can obtain sales data in real time that they can use later to manufacture and distribute in a much more efficient way than a competitor that sells through wholesalers and retailers and has only a distant knowledge of what is going on in the market. Vertical Integration can also be used as a learning tool. In some cases, in order to carry out one activity well, it is important to have in-depth knowledge of another one, as in the case of design and manufacturing, basic technology and sales or when knowing the technology that is implicit in a component can facilitate its utilization. McDonald’s, whose basic strategy is not owning the restaurants but being a franchiser, owns some restaurants in order to learn first hand what the problems of the activity are, which is fundamental in order to be able to train the fran- chisees later. From the Activity to the Enterprise 113 Vertical Integration to Lower Transaction Costs Lastly, Vertical Integration can save money when the relationship between the buyer and the supplier is especially costly. Sometimes, it is expensive to maintain the flow of information between the buyer and the supplier, perhaps because there is a lot of fast changing information, it is highly sensitive or difficult to transmit. In these cases, integration would save a lot of the necessary transaction costs. If working with a supplier implies constant changes in the specifications, joint training, contacts on many levels and so on, a company can reach the conclusion that it is easier to integrate and absorb the supplier. Thus there are three main reasons that Vertical Integration can be prof- itable: a decrease in costs for technological reasons (if the joint perfor- mance of two activities lowers their total costs); protection of a profitable activity, or learning about it; and the lowering of transactions costs. In most other cases, not integrating will probably be the best strategy.
- Trefor Jones(Author)
- 2004(Publication Date)
- Wiley(Publisher)
2 How ¢rms committing themselves to such a strategy should consider alternative means that might achieve the same objectives. Chief among these are long-term contracts of various kinds which tie ¢rms together in exclusive relationships. However, such arrangements can lead to di⁄culties associated with incomplete contracts. 3 The circumstances in which Vertical Integration can be bene¢cial: where there are strong technological linkages, high transaction costs, problems relating to asset speci¢city and incomplete contracts. 338 PART V g STRATEGIC DECISIONS REVIEW QUESTIONS Exercise Try to identify from your reading of current events an instance of a ¢rm seeking to vertically integrate either by acquisition or by organic expansion. In addition, try to identify the motives and advantages claimed for such a development. Discussion questions 1 What do you understand by the term ‘‘Vertical Integration’’? 2 Explain and evaluate the saving of production costs argument for Vertical Integration. 3 How does Vertical Integration reduce costs? 4 Explain and evaluate Williamson’s model of Vertical Integration. 5 If a competitor buys a supplier of a key input for your enterprise, what factors should your ¢rm consider in deciding whether to copy the integration? 6 In what circumstances does a strategy of Vertical Integration increase the pro¢ts of the ¢rm? 7 Consider the relationships between motor car manufacturers and motor dealerships and between brewers and pubs, identifying the nature of their vertical relationship. 8 What alternative arrangements can give the ¢rm the advantages of Vertical Integration without the disadvantages of ownership? 9 In what ways does Vertical Integration increase the monopoly power of the ¢rm? 10 Try to identify a recent merger or business venture that might be classi¢ed as Vertical Integration. In addition, try to identify the main advantages expected from such a strategy. REFERENCES AND FURTHER READING Besanko, D., D. Dranove and M.
No longer available |Learn moreStrategic Management
Theory & Cases: An Integrated Approach
- Charles Hill, Melissa Schilling, Gareth Jones(Authors)
- 2019(Publication Date)
- Cengage Learning EMEA(Publisher)
Horizontal integration often significantly improves the competitive advantage and profitability of companies whose managers choose to stay within one industry and focus on managing its competitive position to keep the company at the value creation frontier. 9-3a Benefits of Horizontal Integration In pursuing horizontal integration, managers invest their company’s capital resources to purchase the assets of industry competitors to increase the profitability of its single-business model. Profitability increases when horizontal integration (1) lowers the cost structure, (2) increases product differentiation, (3) leverages a competitive advantage more broadly, (4) reduces rivalry within the industry, and (5) increases bargaining power over suppliers and buyers. Lower Cost Structure Horizontal integration can lower a company’s cost structure because it creates increasing economies of scale . Suppose five major competitors e op-erate a manufacturing plant in some region of the United States, but none of the plants operate at full capacity. If one competitor buys another and closes that plant, it can operate its own plant at full capacity and reduce its manufacturing costs. Achiev-ing economies of scale is very important in industries that have a high-fixed-cost struc-ture. In such industries, large-scale production allows companies to spread their fixed costs over a large volume, and in this way drive down average unit costs. In the tele-communications industry, for example, the fixed costs of building advanced 4G and LTE broadband networks that offer tremendous increases in speed are enormous, and to make such an investment profitable requires a large volume of customers. Thus, AT&T and Verizon purchased other telecommunications companies to ac-quire their customers, increase their customer base, increase utilization rates, and reduce the cost of servicing each customer.
- Charles Wankel, Charles B. Wankel(Authors)
- 2007(Publication Date)
- SAGE Publications, Inc(Publisher)
For example, a low-com-plexity product with low margins designed and manufac-tured by a company with high infrastructure costs may be outsourced. Comparatively, a highly complex product with high margins and high infrastructure costs may have value added by a strategy that attracts services from a customer, thereby adding further value to itself. Hayes, Wheelwright, and Clark (1988) stated that the most important step in developing and pursuing an integra-tion strategy is to identify the capabilities that are required to support the firm’s desired competitive advantage. In for-mulating its strategy, a firm must position itself along two key dimensions—one relating to products and the other to production processes. This approach assigns dimensions to decision making along one axis only—horizontal. Hill took this theory further by pointing out the impor-tance of process positioning, which considers the width of a firm’s internal span of process, the degree and direc-tion of vertical-integration alternatives, and its links and relationships with suppliers, distributors, and customers. The introduction of directional Vertical Integration and the incorporation of customers and distributors are in line with the concept of the horizontal axis having a relationship with both the upstream and downstream vertical axis. Lehtinen (1999) pointed out that the literature on process positioning had until this point concentrated on the prob-lems of make or buy decisions (upstream vertical), largely ignoring the managerial questions, which followed from the changes in a firm’s span of process (product range). He further pointed out that changes in the span of process would invariably lead to a change in the total management task within a business and that changes to span of process would bring corresponding changes in the task of manufac-turing management (infrastructure). This further reiterated the relationship between the vertical and horizontal axes.
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