Is vertical integration right for your business?
Vertical integration is the degree to which a firm owns its upstream suppliers and its downstream buyers with the goal of increasing the company’s power in the marketplace.
There are three varieties of vertical integration:
Backward, where a company controls products used in the production of its products such as a car company owning a tire company.
Forward, where the company owns the distribution and retailing of its products.
Complete, or balanced, meaning a firm that controls all components from raw materials to final delivery.
Some examples of vertical integration are:
Oil companies such as Shell Oil own the entire supply chain starting with the oil wells, refines the oil and retails through their gasoline service stations.
Design-build firm Majestic Realty Company has built a portfolio of over 60 million square feet of buildings as a 100% vertically integrated firm:
A healthcare system that serves the entire range of services from outpatient to hospital and long-term care is a good example of vertical integration.
Some advantages of vertical integration are:
Achieve economies of scale When Walmart eliminated the traditional grocery wholesaler, manufacturers began making direct deliveries to their warehouses. A key part of their success was successfully incorporating state-of-the-art communications and computer tools in the distribution process.
Create new profit centers Internet-based online stores now enable manufacturers to sell direct to customers anywhere, anytime, creating an entirely new center of earnings. Why lease and staff stores when people can buy your product from their homes? Likewise, business-to-business sales (as contrasted to business between a producer and a consumer) have led to successful vertical integrations.
Expand geographically Geographical expansion generally works best when expanding within a firm’s own segment in the supply-distribution spectrum. For example, Proctor and Gamble’s acquisition of Iam’s pet foods expanded Iam’s reach into worldwide markets. Louis Vuitton, the manufacturer of fine leather goods, became a world-wide destination for women after opening their own stores in the fashion capitals of the world.
Maintain quality control If you’re a cake maker and manufacture your own cake mixes, you’re not at risk of a supplier cutting down or substituting the eggs. Or if you’re a manufacturer of salad oil and own your own olive groves, you’re not at risk of mislabeling (which according to a UC Davis study was found to be the case in over two-thirds of extra virgin olive oil sold in stores.)
Protecting proprietary processes or recipes In some cases, secret recipes are so valuable that they are maintained as true trade secrets and outsourcing their manufacture would be unthinkable. KFC and Pizza Hut secret recipes would not be outsourced to just any company.
Vertical integration has many advantages. Is it right for your supply chain?