What is Vertical Integration

Vertical integration is a type of management control. Companies forming part of supply chain are working for a common owner in vertical integration. This helps in achieving better control of production process and hold-up situation can be avoided due to common control.

Vertical integration allows company to get better hold of the market as dependence on outsiders is very limited. Vertical integration can be explained by taking an example. Production houses in motion pictures achieve vertical integration by venturing into businesses of supplies, distribution and opening of music companies to promote the music of their films. Such venturing into various departments involved in film-making can make the process of film-making a smooth process.

Vertical integration helps to control production loopholes. It also encourages monopoly in the market due to self-dependence. Another beautiful example is a car manufacturing company expanding its interests into tire manufacturing. This makes possible process integration to a large extent.

American companies since long time were dependent on foreign material suppliers to meet their industry needs. An apparel company in this country changed the norm by venturing into yarns and knitting units. This has actualized their dreams of holding a pure American product in their hands. Secondary activities like photography, PR and promotion has been assigned to sister concerns and thus a complete business model is brought into shape.

The cost involved in outsourcing process steps sometimes prove to be more painful in terms of on time delivery and meeting quality levels. Lot of money is saved in terms of transportation and rejections. This makes vertical integration a fanciful concept.

Vertical integration can be back stream, forward and balanced. Back stream integration involves production of inputs required in production of main product. A motorbike company engaged in production of steel body can be a fair example of this type of integration. Forward integration is controlling retail chains where the products will be sold. A garment manufacturing company opening their own retail stores can display the concept of forward integration.

American Apparel is the classic example of balanced integration. It not only owns knitting yarns (back stream integration) but also has a chain of retail stores selling the apparels. Vertical integration saves time and projects are completed in much lesser time span than in outsourced business models.

Vertical integration ensures low transaction costs. Uncertainty factor is greatly reduced and production path is more concise and clear. Local market flourishes and provides strict competition to foreign entrants. Synchronization in supply and demand does not leave any scope for confusion. Maximum profits are reaped by marginalizing the costs involved resulting into being monopolistic state. Vertical integration has some cons too. Quality may not be at par with that of specialized suppliers. Coordination costs may also be a big hindrance.