What are examples of vertical businesses

Strategy Train

Before deciding whether the introduction of vertical integration is relevant to your company, it is important to take a look at the topics of costs and control. 1

Your company incurs costs due to your interactions with suppliers and customers. Find out what costs and amounts would be incurred for your company if you were to produce what is currently still being supplied to you. How high would the investments be and when would the break-even point be reached? Of course, there will still be costs. However, these will decrease as activities that were previously carried out by external suppliers can now be carried out internally (if you are doing backward integration). 2

You can further reduce your costs by lowering transportation costs. You no longer have to transport the product to / from your supplier and even if you manufacture / refine the product in different locations, the transport should be shorter than without vertical integration. In addition, costs are also reduced by the fact that you can now control your supplier's profit margins.

An additional benefit of vertical integration is increased control. Take, for example, a company that has contractually agreed the purchase of a certain quantity of a certain product with a supplier. If the company needs an even larger quantity of the product in the short term, it has to negotiate again with the supplier. The supplier has a stronger negotiating position and can refuse to deliver more. If the company now produces this product itself, it can easily increase production. - It can decide for itself how much it will produce and when.

Another advantage of vertical integration is that you can continuously improve your production facilities and thus stand out from your competitors and achieve a competitive advantage. This way you can increase yours and make even more profits.

You can also increase your market share by using sales channels that would otherwise not have been available to you. It can be very much to your advantage that you can now decide for yourself who, how and in what way to distribute your product.

If you gain sole access to a scarce resource (product or raw material) by using vertical backward integration, you have erected a high barrier to potential competitors. With this you have created another advantage.

By integrating the work that was previously done by an external supplier into your company, that of your employees is also expanded. This leads to an enrichment of the employees and as a result to more satisfaction and motivation, i.e. to an increase in benefits for employees and the company.

EXERCISE: Imagine doing vertical integration in your company, either backwards or forwards. Just choose one of the two alternatives. How can your company benefit from this?

Vertical integration not only offers advantages, it can also have disadvantages 3 arise. The latter must be explored before deciding to use this particular strategy. It's important to align them: your organization may need to build additional capacity, which in turn comes at a cost. It could also happen that backward integration on its part leads to disagreements among their suppliers, which can put your main production at risk.

When doing vertical integration, there is a need to invest more in your business. These investments, be they for backwards or forwards integration, can lead to a reduction in flexibility in production, at least for a certain period of time (depending on the investment). This can have serious consequences, especially if you are operating in a market environment that is changing rapidly. So reduced flexibility in production can reduce your market share, especially in highly competitive industries.

Another disadvantage of vertical integration can be that the diversity of your products decreases, caused by their efforts to integrate different tasks into your company. More work is required and this reduces the time available for innovation and which could be used to create a greater variety of products.

As you integrate additional activities into your company, new key competencies will be developed which, as stated earlier, has positive effects. However, this can also have negative effects if the new skills impair existing skills and employees are reluctant to perform their new functions. This can lead to reduced employee satisfaction and motivation and ultimately to reduced productivity in your company.

Although vertical integration should lead to a reduction in costs, in some cases the opposite can occur, e.g. an increase in administrative costs. Backward integration can also lead to a reduction or even elimination of competition among suppliers, which may reduce efficiency and increase costs.

EXERCISE: Recall the type of vertical integration you chose earlier. What disadvantages could this result? Can you think of any other disadvantages than those mentioned above?