In every business, there will be times to take drastic decisions to gain more profit or reputation. Integration is one such process in which you decide to alter your business concerning the market needs. But vertical integration is sometimes an unnecessary risk that may put various aspects of a business in jeopardy. Know more about vertical integration.
In this article, we will be seeing the risk elements of vertical integration. In the wider picture, vertical integration can cause the elimination of healthy competition in a marketplace. This may one day lead to issues in the global economy as well. We will also answer the question “when should we do vertical integration and when should we not do it” through this article.
What is Vertical Integration?
In management terms, vertical integration is a strategy where a company is taking direct ownership in all the stages of production. For example, in a coffee manufacturing company, there are various stages namely, growing the coffee plant, packaging and shipping the seeds, roasting coffee seeds, brewing coffee, and providing it to the customer. In this business, the company can buy roasted coffee seeds from a provider but instead, the company chooses to decide to produce the seeds on its own. This is called backward vertical integration.
If a coffee seed manufacturer decides to expand his/her business by adding coffee brewing and customer service to his company. It is called forward vertical integration. There are several reasons by which you have to take up these vertical integration techniques and there are risks involved with both.
Reasons to vertically integrate
There are some situations where a company is required to vertically integrate. It is important to know these reasons to know whether to approach the market with this strategy or not.
- The market is unreliable.
- There is a need to ensure the quality of products.
- Other companies have more market power than your company.
- The market needs to be saved from deterioration or the market is too young and needs to be developed by integration.
- Need to improve customer experience.
Risks associated with Vertical Integration
Before jumping to any conclusions, the possible risks that come with vertical integration have to be analyzed.
- Negative effects on previously established distribution channels.
- Loss or lack of profit in the outcome.
- Difficulty in understanding new technologies.
- Labour issues.
- Deviation of focus from actual business.
Disadvantages of Vertical Integration
Apart from all the risks we analyzed, It can have adverse effects on a company and the economy as a whole. Here are some common disadvantages of its process can bring in an independent firm.
- May result in decreased flexibility.
- Can create barriers to market entry.
- Can introduce capacity balancing issues.
- Chance for confusion in a business.
In the case United States v. E. I. duPont de Nemours & Co held in 1956, the judges ruled that it was illegal as a company could end up with too much market power that its competitors would not stand a chance. Even though this happened years back, we can find the implications rather evidently even today.
Hence, distribution of the marketplace is always suggested when compared to integrating everything into one giant firm. The continuous integration might affect the economy negatively and in due time create much more problems.
Frequently Asked Questions
- Is Netflix vertically integrated?
Netflix is a perfect example of backward vertical integration. At first, they provided tv shows and movies produced by various other companies and now they have their original shows. Their content creation is not completely vertically integrated but parts of it are.
- How does McDonald’s use vertical integration?
McDonald’s is famous for its self-production of raw materials like meat, spices, and vegetables. They have contracted producers and create unique mixtures of various spices for their products.
- What is the difference between vertical and horizontal integration?
Horizontal integration is the strategy where a company is acquiring another similar company at the same point of the supply chain. It is the acquisition of other companies playing different roles in the production or manufacturing.
- What are the alternatives to vertical integration?
There are some alternative strategies you can try out instead of it if a demanding situation comes up. They include:
- Long-term contracts.
- Collaborated ventures.
- Implicit contracts.
- Unification of facilities into common locations.
Conclusion
In this article, we have seen the general idea of integration and how it can affect businesses. Its effect on a much larger scale can be considered later, but what you need to analyze is whether you need this strategy or not. It is important to understand its implications in the short and long term and balance the good against the bad. If you are in a situation that requires the deployment of it, then try the other alternatives first. This strategy is to be kept as the last option.
