The majority of companies depend on a number of partners and suppliers to produce and distribute their products; some use a vertical integration strategy whereby they acquire or merge with the smaller companies involved in their supply chain. One of the major vertical integration benefits is that it gives the company more control over its supply chain processes by bringing more of the processes in-house. This in turn can can yield financial and competitive advantages over the long term.
Vertical integration is, therefore, a business strategy wherein a company takes ownership of two or more stages in the supply chain. In this article, we will discuss the benefits of vertical integration and what it is about.
See also: Different Types of Production
Vertical integration explained
When there are disruptions in the supply chains (processes involved in the production and distribution of a product), it can prevent customers from getting the product they want, when they want them. This, in turn, hurts the finances of the company and damages its reputation. In order to avert this, some companies implement the vertical integration strategy to exert more control over their supply chains, whereby they take ownership of the majority of the steps involved in the production and sale of their products and services.
Vertical integration is a strategy wherein a company takes ownership of more stages in manufacturing and selling its goods and services. That is, instead of relying on external contractors or suppliers, the company takes direct ownership of the various stages of its sale and production process. This business strategy allows a company to streamline its operations by taking direct ownership of distributors, suppliers, or retail locations to obtain greater control of its supply chain.
The supply chain usually consists of one or two subsidiary companies involved in different stages of production. Therefore, a company that is vertically integrated will own multiple (or all) parts of its supply chain. This is done by the company acquiring or establishing its own manufacturer, distributor, suppliers, or retail locations instead of outsourcing them. There are several benefits of vertical integration; companies such as Amazon, Tesla, and Apple, for instance, are examples of companies that use vertical integration to varying degrees.
What are the benefits of vertical integration?
In as much as vertical integration requires sizable capital investments, it has some benefits. The advantages of vertical integration include helping companies secure more aspects of the production, supply, distribution, and sale of their goods and services. Thus, resulting in greater efficiencies, reduced costs, and significant competitive advantage, as in the case of Tesla. This strategy gives companies greater control over their supply chain and makes it possible for them to offer lower prices while increasing market control. Let’s further discuss some of the benefits of vertical integration below.
Vertical integration benefits
- Vertical integration establishes independence
- This strategy helps in cost control
- It establishes economies of scale
- Vertical integration strategy improves product knowledge and marketability
- It increases market control
- Companies that are vertically integrated can offer their products at a much lower price
We will discuss each of these advantages of vertical integration. Companies that make use of vertical integration strategy to manage their entire production process benefit in several ways because they are able to increase the overall size of their operations to meet their business needs better. Here are some of the vertical integration benefits:
Vertical integration establishes independence
One of the prominent vertical integration benefits is that it establishes independence. Once a company owns the suppliers in its supply chain, it is no longer dependent on suppliers or the costs and unpredictability that may come with them. Rather, the company manages every aspect of its supply chain, such as the cost of materials, the production practices involved, and the shipping and production schedules.
This independence helps companies increase their productivity levels and efficiency, thus preventing production delays. As a company streamlines the process of obtaining supplies for its product, manufacturing it, and selling it, the company becomes more time efficient. It has shorter turnaround times on product orders.
Also, another benefit of vertical integration is that it makes the companies immune to supply disruptions such as poor management or labor strikes. As the processes of production, distribution, and sales run smoothly, the possibility of a supply hiccup is definitely eliminated.
This strategy helps in cost control
When an organization has ownership of all the companies in the supply chain, it is usually able to lower costs materially more than it would have if it worked with separate companies involved in the production process. This is one of the vertical integration benefits.
The vertical integration strategy allows companies to eliminate additional costs or expensive markups associated with brokers or wholesalers. As the company vertically integrates, it can control costs more carefully and offer lower prices, resulting in increased consumer demand and higher profits over time.
It establishes economies of scale
Another benefit of vertical integration is that it establishes economies of scale more easily as vertically integrated companies are able to lower their costs. An economy of scale is the cost reduction that occurs when a company’s production becomes efficient.
A vertical integration strategy, in the right circumstances, helps to streamline a company’s production and sale processes; from raw materials to the delivery of a product to a customer. This makes production efficient and reduces costs. Also, having ownership of all the smaller companies in the supply chain makes a company larger, and the larger it gets, the more cost-effective it is in producing its goods.
Vertical integration strategy improves product knowledge and marketability
Another advantage of vertical integration is the ability to understand the market for a product and create a unique version. Companies that are vertically integrated can easily sort out products that are selling well, create their own versions for less, and meet market demands. When a manufacturer partners with a retail company along the supply chain, they can produce look-alike products (of competitors’ products) and distribute them through their retail channels.
Vertical integration strategy helps to increase companies’ knowledge of the supply chain which enables them to maximize their marketing efforts. Companies that are vertically integrated can differentiate themselves from their competitors by establishing themselves as retailers and rendering unique experiences to customers. By implementing this strategy, they can develop more competitive prices and sell directly to customers. This is one of the inconspicuous vertical integration benefits.
It increases market control
One of the vertical integration benefits is that it increases market control for vertically integrated companies. When a company has the capital to acquire the smaller companies involved in its supply chain, it may be able to reduce the access of its competitors to certain resources and materials. This benefit of vertical integration can give the company greater market power, wherein it has the ability to influence the demand and supply for a product by manipulating its prices.
When a company further down the supply chain (like a retailer merging with a manufacturer or producer), the company is going to have more control over the producer’s materials and products. Having greater market power over competitors can help the company influence the market that they operate in, more easily. Also, by acquiring a producer or the like, a vertically integrated company could inherit resources, permits, copyrights, and emerging technologies that give it an advantage over its competitors.
See also: Amazon’s Vertical Integration
Companies that are vertically integrated can offer their products at a much lower price
One of the notable vertical integration benefits is that companies that are vertically integrated can offer their products at a much lower price. When implementing vertical integration, the company reduces costs on transportation, overhead, and other operational expenses. Due to this, the company can offer lower prices for products in order to attract customers.
The product prices of such companies are often lower compared to companies that pay each company in their supply chain for their work. These lower prices usually increase customer demand and higher profits for the parent company. This advantage of vertical integration leads to better brand recognition among consumers which makes it easier for the parent company to protect its trade secrets and attract new customers.
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Obotu has 2+years of professional experience in the business and finance sector. Her expertise lies in marketing, economics, finance, biology, and literature. She enjoys writing in these fields to educate and share her wealth of knowledge and experience.