In business management, vertical integration is an arrangement in which the supply chain of a company is owned by that company. Usually each member of the supply chain produces a different product or (market-specific) service, and the products combine to satisfy a common need. Vertical integration has also described management styles that bring large portions of the supply chain not only under a common ownership, but also into one corporation.

Vertical integration and expansion is preferred because it secures the supplies needed by the firm to produce its product and the market needed to sell the product. Vertical integration and expansion can become unattractive when its actions become anti-competitive and hinder free competition in an open marketplace. Vertical integration is one method of avoiding the delay problem. A monopoly produced through vertical integration is called a vertical monopoly. For example, Google purchased “Motorola Mobility” in 2012 as a dedicated Android partner which enabled Google to supercharge the Android ecosystem for enhancing competition in mobile computing. The deal didn’t end here. In 2014m Chinese firm Lenovo acquired the Motorola Mobility smartphone business from Google for $2.91 billion in a cash-and-stock deal. The acquisition would strengthen Lenovo’s position in the smartphone market and grow its presence in the USA.

A company that undergoes vertical integration acquires a company that operates in the production process of the same industry. Some of the reasons why companies choose to integrate vertically include strengthening their supply chain, reducing production costs, capturing upstream or downstream profits, or accessing new distribution channels. To do this, one company acquires another that is either ahead or behind it in the supply chain process.

Vertical Integration strategy is important for many companies for several more reasons. Not only does it increase profits from the newly acquired operations by selling its products directly to consumers, it also guarantees efficiencies in the production process, and cuts down on delays in delivery and transportation.

For example, Ikea furniture to gain control over its raw materials for its flat pack furniture, purchased woodland in Romania and the Baltics to coordinate its own forestry management and wood production. The Swedish company’s investment will allow the retailer to stabilize its timber costs, at a time when prices are on the rise.

Companies can integrate vertically in two ways: backward or forward. Backward Integration occurs when a company decides to buy another company that makes an input product for the acquiring company’s product. For example, Apple retails most of its apps online through Apple Store.

Forward Integration occurs when a company decides to take control of the post-production process. For example Amazon.com Inc’s acquisition of grocery store chain ‘Whole Foods Market’ for $13.7 billion will help them dominate grocery sales both offline and online. However, so far the deal markedly expanded Amazon’s reach offline.

Advantages of Vertical Integration: 

Helps in avoiding supply disruption: The first benefit is that the company can avoid supply disruption. By controlling its own supply, it can avoid the problems of sluggish suppliers. It also in neglecting the frequent strikes and labor disputes from companies those are in socialist countries such as China, Vietnam.

Avoid monopoly suppliers: Second, a company benefits by avoiding suppliers with a lot of market power and their dictations. It gets all the more critical if the supplier has monopoly in market. If the company can go around these providers, it reaps many benefits. It can lower internal costs and have better delivery of needed items. It’s less likely to be short of critical elements.

Economies of scale: Third, vertical integration gives a company better economies of scale. That’s when the size of the business allows it to cut costs. For example, it can lower the per-unit cost by buying in bulk. Another way is to make the manufacturing process itself more efficient. Vertically integrated companies eliminate overhead by consolidating management.

Imitation becomes easier: A retailer with vertical integration knows what is selling well. It can easily “knock off” the most popular brand-name products; because it copies the ingredients or manufacturing process. It creates similar, store-branded products with similar marketing messages and packaging. Only powerful retailers can do this. The manufacturers of those brands cannot afford to sue for copyright violation. They are unwilling to risk losing distribution through a major retailer.

Lower the cost: The fifth advantage is the one that is most obvious to consumers. That’s low prices. A company that is vertically integrated can lower costs. It can transfer those savings to the consumer as lower prices. The best example is of Wal-Mart.  The store keeps costs low by using a sophisticated and largely automated supply-chain management system, Wal-Mart has huge bargaining power when it comes to its suppliers. Many brands depend on Wal-Mart sales to stay in business, while even larger, established companies can little afford to be removed from Wal-Mart’s passageway or WebPages.

Disadvantages: The biggest disadvantage of vertical integration is the expense. Companies must invest a great deal of capital to set up or buy factories. They must then keep the plant running to maintain efficiency and profit margins.

Secondly, it reduces flexibility. Vertically integrated companies get entangled in the profitability of its operations. Retailers can’t follow consumer trends that take them away from their factories. They also can’t change factories to countries with lower exchange rates. Also, vertically integrated suppliers must manage inventory by keeping sufficient stock products in their stores. A third problem is a loss of focus. Running a successful vertically integrated business requires a different set of skills; it’s difficult to find capable staff.

There are two types of integration strategies: horizontal and vertical.

Horizontal integration: When a company wishes to grow through a horizontal integration, it looks out to acquire a similar companies in the same industry in which it operates. The acquisition or merger helps the main acquiring company to increase its size, diversify its product offerings or services, achieve economies of scale, help in gaining access in a new market, and of course reduce competition. One of the biggest examples of horizontal integration is of Facebook’s acquisition of Instagram in 2012 for about $1 billion. Both Facebook and Instagram work in the same sector of social media and were in similar business such as photo-sharing services. Facebook was looking to strengthen its position in the social sharing space; it saw the acquisition of Instagram as a brilliant opportunity to grow its market share by accessing new audiences. The acquisition resulted into a high level of synergy.

Another horizontal integration is example is of Tata Steel’s acquisition of Corus in 2007, which made Tata Steel a new steel giant in the world. The acquisition helped Tata Steel to tap European mature market; and the cost of acquisition was lower than setting up of green field plant and marketing and distribution channel. TATA manufactures low value, long and flat steel products while Corus produced high value stripped products.

A company can also opt to go the horizontal integration via internal expansion, through acquisition or merger. This process helps a company to monopolise the market if it successfully captures the majority of the market for that product or service.

Vertical Integration:  Vertical integration is a business strategy used to expand a firm by gaining ownership of a company that operates in the production process of the same industry. It can be a supplier, a distributer, packaging firm any of these. Through a vertical integration a company tries to strengthen its supply chain, reduce production costs, and also access new distribution channels.

There are two types of vertical integration: the first is forward integration, a method of vertical integration in which a firm will gain ownership of its distributor. The second is backward integration, a method of vertical integration in which a firm will gain ownership of its supplier. Forward and backward integrations are two integration strategies which are adopted by organizations to gain competitive advantages in the market and to gain control over the value chain of the industry under which they are operating. These strategies are one of the major deliberations when developing future plans for an organization. Together these two strategies are known as vertical integration.

Forward integration is a business strategy that involves a form of vertical integration whereby business activities are expanded to include control of the direct distribution of a company’s products. This type of vertical integration is conducted by a company moving down the supply chain. Example of forward integration: The US retailing giant Amazon made key investments in 2017 of buying the Whole Foods Market organic grocery chain at $42 per share, or a total of $13.7 billion. With this acquisition Amazon gained its investment in brick & mortars retail and laid its hands on a large data of customers’ grocery buying habits and patterns and preferences. Also, it helped Amazon in correlating between purchases of different products and even different categories in making grand strategies.

Backward Integration is a strategy in which a company acquires supplier of its raw materials, or sets up its own facilities to ensure a more reliable or cost-effective supply of inputs. Example of a backward integration is in 2014, the Ferrero Group, one of the market leaders of the chocolate confectionery industry acquired Otlan group for $ 500 million. Otlan is the global leader for supplying hazelnuts. By acquiring Otlan, Ferrero improved quality of its product the hazelnut chocolate that gives a unique taste to many of its popular products, such as Nutella, Ferrero Rocher and Kinder Bueno. Another example of backward integration is Ikea furniture buying an entire Romanian forest to help to secure its timber supplies. The purchase of the 83,000-acre woodland in north-eastern Romania is the first time that the furniture company will manage its own forest operations. It is thought to have cost €100 million. Ikea said the deal would allow it to manage wood sustainably at affordable prices. Romanian Government welcomed the Ikea deal but conservationists are concerned that it may pave the way for encroachment into areas such as the foothills of the Carpathian Mountains.

Information technology (IT) has become a vital and integral part of every business integration strategy because of the multiple usages of it. In numerous companies, email is the principal means of communication between employees, suppliers and customers. Email was one of the early drivers of the Internet, providing a simple and inexpensive means to communicate. Inventory is managed by IT to track the quantity of each item a company maintains, triggering an order of additional stock when the quantities fall below a pre-determined amount. Today, most companies store digital versions of documents on servers and storage devices. These documents become instantly available to everyone in the company, regardless of their geographical location. Progressive companies use that data as part of their strategic planning process as well as the planned execution of that strategy. MIS (management information system) enables companies to track sales data, expenses and productivity levels.  Even in customer relationship management (CRM), IT helps capture every interaction a company has with a customer, so that a more enriching experience is possible.