Vertical Integration is when a company control / owns its' suppliers, distributors, or retail locations to have complete control over their supply chain. This can be done forward or backward... see the diagram below.
As you can see from the above image, forward integration is when the company takes control of the steps in the supply chain that happen after distribution. In other words, they have complete control going forwards.
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| Diagram of Vertical Integration |
Backward Integration is the opposite. This is when the company takes control of all of the steps that happen before getting to the distribution phase of the supply chain.
Their are five main advantages of Vertical Integration, according to an article on The Balance. The first being that the company can avoid supply disruption because they are their own suppliers. The second advantage is that company can avoid suppliers with a lot of market power. This is helpful because those suppliers are more likely to dictate terms, so without them, that becomes a non-issue. The third advantage is vertical integration gives a company better economies of scale. This basically means they can lower costs per unit by buying in bulk. The fourth advantage is that a retailer who is vertically integrated knows what is selling well. They can make profitable decisions directly based on what people want to buy. Lastly, the fifth advantage to vertical integration is that is created low prices.
On the other hand, there are four major disadvantages to vertical integration, coming from the same article. The first disadvantage and the biggest one is the capital expense. Obviously, for a company to vertically integrate, it has to invest tons of money. The second disadvantage is that the process reduces flexibility. Companies are only tied to their own profitability. Third, there is a problem of lack of focus. When a company is in charge on so many parts of the puzzle, it is easy to lose individual focus on each part. Lastly, it is very unlikely that a company with have the culture that supports owning both a factory and retail stores. Again, this means spreading yourself very thin and across lots of different areas. There is separation of powers for a reason, and this process does the opposite.
That's all for today, folks! If someone asks you what Vertical Integration means, you now have the answer!
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