When two businesses or organizations at different levels of production merge, vertical integration occurs. Its primary goal is actually to boost the overall efficiency and to cut down costs all throughout the supply chain, therefore improving profitability and competitiveness. Due to the increasing advancements and sophistication of technology within the management system of this sector, lots of commercial organizations are continuing to gain closer relationships with some other members of the supply channel.
Vertical integration also allows companies to obtain unparalleled amount of influence over them, and if you have a company and are thinking about using it in your organization as a business strategy, it is important to know its advantages and disadvantages beforehand.
List of Advantages of Vertical Integration
1. It allows you to invest in assets that are highly specialized.
Vertical integration can give you a great advantage over your competitors, allowing you to invest and develop the products that you are currently offering. By being able to acquire highly specialized assets, you will be able to differentiate your business from the rest of your industry, with a highly competitive advantage. As such, you can raise your share within the market and see increased profits.
2. It gives you more control over your business.
One great benefit that is sought by companies that are getting into vertical integration is more control over the value chain. When retailers decide to develop or acquire a manufacturing business, they would gain more control over the production aspect of their distribution processes. In the same manner, when manufacturing companies perform retailing or distribution, they would have more control over how they present their products and how much they would sell them on the market.
3. It allows for positive differentiation.
This business strategy can give an organization important access to more production inputs, process and retail channels, and distribution resources. Each of these elements can offer great opportunities to the company to distinguish itself from competition with the use of effective marketing tactics. For a retail business, it can adopt more quickly to the changing consumer needs by owning a production or manufacturing firm that can create its products. For manufacturers, they could sell through the web and take advantage of online advertising techniques to drive traffic to their sites and build market credibility.
4. It requires lower costs of transaction.
This can be realized through inter transactions that can be made between subsidiaries that typically have a central communication and management system that is inexpensive to employ.
5. It offers more cost control.
Typically, vertical integration can offer a significant ability to control costs in the distribution of products, particularly the traditional one, where every step in the movement of goods involves mark-ups, so the reseller can earn more profit. Through direct selling to end-buyers, manufacturers can get rid of the middleman, which means a step or more removed in the process along the way. A single entity that manages the distribution process will also have more ability to optimize the utilization of resources and avoid wasted costs. Not only these, but lower transportation costs will also be common.
6. It ensures a high level of certainty when it comes to quality.
Since subsidiaries are employing a quality control system, it is more likely that they can produce high-standard products.
7. It provides more competitive advantages.
Some businesses get into vertical integration with the sole purpose to increase their advantages over their competitors and block them from gaining access to important markets and scarce resources. For example, a retailer might purchase a manufacturing firm to gain access to resources, patents and proprietary technology that are only available in the firm’s local area. For manufacturers, they may enter retailing and distribution to get direct access to customers in a highly competitive market, before its competitors do.
List of Disadvantages of Vertical Integration
1. It can have capacity-balancing problems.
A good example of this situation is when a business needs to establish excess upstream capacity to ensure its downstream operations will get sufficient supply under any demand condition. This might even result in retaliation of the business’s former suppliers, potentially endangering its main production.
2. It can bring about more difficulties.
Take note that vertical mergers will have less economies of scale, as most of their production processes are at different levels. Moreover, there is still scope for monopoly power or even monoposony power. For example, tied pubs could charge higher prices to consumers, while having less choices on beer.
3. It can result in decreased flexibility.
The main contributors to this problem are the upstream and downstream investments the business is making.
4. It can create some barriers to market entry.
Manufacturing businesses that have control over access to crucial raw materials and components that are quite scarce due to vertical integration would often create some barriers to market entry. They have the ability to limit competition and would establish a strong position in the market to protect their customer base. However, they might face anti-trust regulators who think that they are influencing market concentration.
5. It can cause confusion within the business.
Retail and product development are distinct businesses, and doing both could require more work to be done. Also, a lot of entrepreneurs who are often trying to think of too many things would confuse, distract and harm their bottom line.
6. It requires a huge amount of money.
For a great vertical integration to happen, a company should have an extremely large amount of capital to invest. After all, they might have to purchase new facilities, hire a large number of new employees and control their new facilities, making this strategy nearly impossible for smaller companies to employ.
7. It makes things more difficult.
In addition to running your business’s retail front, which is not simple at all, you also have to learn to run a whole new sector of the corporate world, when you jump head first into things that are new to you, such as production. This can be a lot to handle and would become detrimental of the company.
Considering the advantages and disadvantages listed above, do you think vertical integration is the best strategy to use in your business? You need to think of them and weigh your options down to reach the ultimate decision, which is crucial towards your success.
Brandon Miller has a B.A. from the University of Texas at Austin. He is a seasoned writer who has written over one hundred articles, which have been read by over 500,000 people. If you have any comments or concerns about this blog post, then please contact the Green Garage team here.