Think about what your current supply chain for any one of your products looks like.
Chances are, it looked something like this:
Manufacturer → Wholesale Distributor → Retailer → Customer
While this more common method of fulfillment certainly isn’t going away anytime soon, a decent amount of companies in a variety of industries have begun bucking this more traditional route as of late.
In fact, many companies have experienced major success upon implementing vertical integration into their business.
In this article, we’re going to dig into what vertical integration is, and go over some of the reasons you might want to consider vertically integrating your business at some point in the future.
Without further ado, let’s get started.
What Is Vertical Integration
Vertical integration occurs when a company assumes responsibility for one or more processes along the supply chain (in addition to the company’s original responsibilities).
They do so either by absorbing or merging with the partner company in question. For example, a computer company may buyout the manufacturer of specific hardware, or a wholesale company and one of its partner retailers may decide to pursue a vertical merger.
As we just alluded to, vertical integration can occur either “forward” or “backward.”
Forward vertical integration occurs when a company absorbs one or more companies to “move up” in the supply chain. For example, Amazon’s 2017 acquisition of Whole Foods meant that Amazon would assume the responsibility of distributing and selling products to customers (as opposed to just wholesale distribution).
Backward vertical integration is just the opposite: A company absorbs or merges with a company (or companies behind them) in the supply chain. Apple, for example, is well-known for its purchasing of many of the companies that manufacture the parts used in its various products.
A Note on Horizontal Integration
Before we dig into the benefits of vertical expansion, we need to quickly differentiate it from its horizontal counterpart.
Horizontal integration is the absorption of or merging with one company on the same level of the supply chain as the other. Without going too far into this, just think of horizontal integration as your typical merger between two customer-facing companies (such as two hotel or fast-food chains merging into one).
While business integrations can be a bit of both (such as with Amazon and Whole Foods), we’re going to focus specifically on vertical mergers and integrations throughout the rest of this article.
Key Benefits of Vertical Growth
Whether going forward or backward in the supply chain through vertical integration, there are several benefits to doing so.
Here, we’ll take a look at some of the most prominent examples and benefits of vertical integration, from a variety of perspectives. As you’ll see, most of these benefits revolve around the notion of control.
Control of Product
Perhaps one of the main reasons companies decide to embark on a vertical growth strategy has to do with having control of the product offered.
Looking backward, a retailer or wholesaler might wish to take control of the manufacturing of a product for two main reasons:
For one, it will allow the retailer/wholesaler to develop the product in a way they know their customers want. Moreover, it will give the retailer/wholesaler ownership over proprietary products or materials created by the manufacturer.
Going back to the example of Apple, since the electronics giant owns the companies that develop certain technologies, this means that Apple can ensure the technology used to develop products is up to the company’s standard (rather than simply choosing from the best available technology or materials provided by a selection of developer/manufacturers).
Looking forward, a manufacturer or wholesaler might be unhappy with how a retailer is presenting their products, and may look into buying out said retailer. Once the manufacturer or wholesaler is vertically integrated with the retail company, it can then showcase their products however they see fit within the retailer’s brick-and-mortar and online stores.
Control of Costs
Sometimes, vertical integration is simply about simplifying and streamlining processes to reduce costs.
In this regard, it doesn’t matter if we’re talking forward or backward vertical integration—the end goal is the same: Minimize productivity and maximize friction.
Think about it:
In the traditional supply chain, the next-in-line is reliant on the previous one to come through for them. Needless to say, any hangup on one end can potentially cause disaster for all subsequent parties involved in the process moving forward. By integrating into a single company, the “host” company takes control of all of these processes—and can ensure these processes run exactly as planned.
And, even if things do go 100% smoothly when operating within the traditional process, there’s still a variety of costs inherent with doing business with a third-party company in the first place. So, if a retail company were to take ownership of the entire supply chain through vertical mergers, it wouldn’t have to pay the price set by its wholesalers or manufacturers—it would just need to pay for the cost of actually going through these supply chain processes internally.
In either case, the money and resources saved over the long run can then be reinvested into the company’s various processes, allowing it to grow even more over time.
Control of Market
It’s pretty simple:
If a company has complete control over the quality of its products, as well as full control over the cost of running its business efficiently, they can pretty much control the market.
Take Netflix, for example. While less than 20 years ago, the company was just getting off the ground by distributing content created by a variety of third-party producers, the media giant is now investing billions into creating a ton of proprietary content (in addition to still offering content created by others). For consumers, this means they’ll need to pay for at least a month’s subscription to check out Netflix’s latest original movie or show.
Also, if you want to watch this original content, you have to pay whatever Netflix asks for. While Netflix is still in the middle of disrupting the cable industry (and, therefore, still offering its services at bargain-basement prices), you can be sure that the service’s rates will continue to creep up the more in-demand the service becomes. And it wouldn’t have been able to do so had it simply kept offering content its audience could get anywhere else.
Potential Challenges to Consider Before Becoming a Vertically Integrated Business
Now, you probably don’t need us to tell you that integrating with other companies within the supply chain isn’t exactly a simple process.
While the benefits of doing so can be huge for your company, you also need to consider the potential pitfalls you may encounter along the way, such as:
For the acquiring company, vertical integration is a rather expensive ordeal.
First of all, there’s the cost of actually purchasing the smaller company—along with the cost of ensuring a smooth transition overall. Along with the more overt “price tag” of the company will come the more hidden costs involved in actually going through the acquisition process.
The other main upfront cost that acquiring companies will occur is in immediately implementing any changes needed to improve the company in some way. Using some of our previous examples, this means immediately getting to work on things like:
- New marketing initiatives
- Product development and iteration
- Streamlining fulfillment processes
Of course, all of these costs—and more—probably won’t be one-off deals.
Ongoing Investment and Management
Vertically integrating multiple companies entails being in charge of maintaining various companies over time.
Depending on how and why a merger occurs, this may be as simple as making the above-mentioned improvements, and allowing the absorbed company to continue running relatively autonomously. In other cases, a more hands-on approach may be required to keep the acquired company moving forward.
(It’s worth mentioning, also, that organizations on two different levels of the supply chain are likely vastly different “animals,” so to speak. In other words, there will likely be a great many differences between how each company needs to be run; if you’re not prepared for these differences, the cost of implementing them could become astronomical.)
In any case, the main thing to consider before (and after) vertically integrating with another company is whether or not you’ll have the bandwidth to run both companies successfully. Without the proper resources to invest in both companies on an ongoing basis, even business integrations that seemed like a perfect fit can entirely fall apart.
Potential Negative Reaction
One thing we haven’t talked about yet is how vertically integrating your companies will affect the consumer.
While you know that the ultimate goal of merging with another company is to improve the customer experience in some way or another, they won’t always see it like that.
Case in point, when Amazon merged with Whole Foods, many of the latter’s customers accused the grocery chain of “selling out.” While the negative reaction to the merger was short-lived—and possibly even overblown—it stands as a warning to companies thinking about merging with another company in any form:
Be wary of your customers’ perception of your business decisions. Even if integrating with another company will allow you to better provide for your customers, you need to ensure they see this value up front for it to matter.
(And, it hopefully goes without saying, but you should never think about vertically integrating in a way that serves your business without adding value for your customers.)
Vertical integration provides a way for companies that feel “held back” in any way by the companies they work with throughout the supply chain to take charge, and make the changes they know will allow their business to run as they had planned.
Now, vertical integration isn’t a silver bullet that guarantees success in acquiring companies. In fact, if approached in a non-strategic or ill-prepared manner, vertical integration can actually sink acquiring companies altogether.
To end on a more positive note, though, vertical integration absolutely can allow your company to experience success beyond anything that would be possible had you not taken more control over your processes. As long as you can maintain a steady course toward the vision you had when deciding to merge, vertical integration can be just the ticket to the top of your industry.