What’s Vertical Integration

During these days I keep hearing about Vertical Integration and that the companies that stand a stronger chance of a bold comeback out of the crisis, are the ones adopting it. So let’s see the 🔑 points.

Vertical Integration Flowchart

Vertical integration is a strategy whereby a company owns or controls its suppliers, distributors, or retail locations to control its value or supply chain.

Vertical integration benefits companies by allowing them to control the process, reduce costs, and improve efficiencies.

However, vertical integration has its disadvantages, including the significant amounts of capital investment required.

Netflix is a prime example of vertical integration whereby the company started as a DVD rental company supplying film and TV content. The company’s executive management realized they could generate more revenue by shifting to original content creation.

Today, Netflix uses its distribution model to promote their original content alongside films from major studios.

Understanding Vertical Integration

Vertical integration occurs when a company assumes control over several of the production steps involved in the creation of its product or service in a particular market.

In other words, vertical integration involves purchasing a part of the production or sales process that was previously outsourced to have it done in-house.

Companies can integrate by purchasing their suppliers to reduce the costs of manufacturing or invest in the retail or sales end of the process by opening physical locations as well as service centers for the after-sales process.

Controlling the distribution process is another common vertical integration strategy, meaning companies control the warehousing and delivery of their products.

🔑 Takeaways

• Vertical integration is when a company owns or controls its suppliers, distributors, or retail locations to control its value or supply chain.

• Vertical integration benefits companies by allowing them to control the process, reduce costs, and improve efficiencies.

• Backward integration is when a company expands backward on the production path into manufacturing.

• Forward integration is when companies control the direct distribution or supply of their products. 

Types of Vertical Integration

There are various strategies that companies use to control multiple segments of the supply chain.

Two of the most common methods of vertical integration include backward and forward integration.

Backward Integration

Is when a company expands backward on the production path into manufacturing, meaning a retailer buys the manufacturer of their product.

Forward Integration

Is a strategy that companies use to expand by purchasing and controlling the direct distribution or supply of a company’s products. 

A clothing manufacturer that opens its own retail locations to sell its product is an example of forward integration.

Forward integration helps companies cut out the middleman by removing distributors that would typically be paid to sell a company’s products—reducing their overall profitability.

Although vertical integration can reduce costs and create a more efficient supply chain, the capital expenditures involved can be significant.

Advantages and Disadvantages of Vertical Integration

Vertical integration can help companies reduce costs and improve efficiencies. However, there are some disadvantages to implementing a vertical integration strategy.

Advantages

• Decrease transportation costs and reduce delivery turnaround times

• Reducing supply disruptions from suppliers that might fall into financial hardship

• Increase competitiveness by getting products to consumers directly and quickly

• Lower costs through economies of scale, which is lowering the per-unit cost by buying large quantities of raw materials or streamlining the manufacturing process

• Improve sales and profitability by creating and selling its own brand

Disadvantages

• Companies might get too big and mismanage the overall process

• Outsourcing to suppliers and vendors might be more efficient if their expertise is superior

• Costs of vertical integration such as purchasing a supplier can be quite significant

• Increased amounts of debt if borrowing is needed for capital expenditures

Raffaele Felaco

Published by Raffaele Felaco

I am an enthusiastic leader with strong background in direct and indirect sales with an exten- sive experience in both retail and wholesale business. I have been fortunate to have worked alongside teams in structured environments both in Italy and abroad over the last 20 years, en- abling me to develop strong leadership skills, a natural approach in effective communication, the ability of positively influencing others and master complex business negotiations.

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