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What Is Vertical Integration?
Vertical integration is a competitive strategy companies use to secure total control over the production and distribution of a product. For example, a company that buys their own supply of raw materials for a product along with the tools to make and transport that product would be employing vertical integration. The goal of this strategy is to own as many parts of the supply chain as possible and minimize transaction costs typically spent on outsourcing.
3 Differences Between Vertical and Horizontal Integration
Vertical integration and horizontal integration are business models designed to help companies increase profitability, but they do this in different ways.
- Resources purchased: Horizontal integration involves one company buying another company within the same industry, while vertical integration involves buying a range of companies up and down the supply chain.
- Competitive strategy: When a vertically integrated company owns all or several parts of the supply chain, they become independent from suppliers. This allows the company to increase efficiencies, lower costs, and compete with other companies by offering a cheaper product. Horizontal integration involves buying competitor companies within the same industry that are similar in size. Buying out the competition not only creates a larger company, or conglomerate, but creates economies of scale, increases market power among suppliers and distributors, and opens up new markets for the company.
- Challenges: A horizontally integrated company has to stitch together similar companies, maintaining cohesion as the company expands. Vertically integrated companies must stitch together several different working parts of the supply chain, ensuring each disparate part is working as efficiently as the next.
3 Types of Vertical Integration
There are three ways a company can employ vertical integration.
- Forward integration: Forward integration is a type of vertical integration in which a company in the supply chain merges with a distribution channel.
- Backward integration: Backward integration is a type of vertical integration that’s considered an “upstream” business move. It involves a company expanding backward by purchasing and controlling earlier stages of the supply chain. This allows them to control the raw materials needed to create the final product.
- Balanced integration: As the name suggests, balanced integration means that the vertical integration strategy contains components of both forward and backward integration strategies.
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