What is Vertical Integration? Definition of Vertical Integration, Vertical Integration Meaning and Concept
Through vertical integration, companies enter into activities related to the production cycle of a product or service.
Like horizontal integration, it is a growth strategy within the strategic direction of companies and is common in all types of markets. Vertical integration always exist in any company. Although, it must be said, it is difficult to find companies without any degree of integration and fully vertically integrated companies. In other words, they cover each of the phases of the complete production cycle.
By betting on vertical integration, the company in question covers a greater number of profits. Thus, from an initial phase in the development and production of a product to the supply of customers, there are different processes that can be used by the same firm.
The company makes the decision. That is, it decides which goods or services they are going to offer and, within the processes relating to them, which parts of the chain they are going to do by themselves and which to buy or hire outside. This practice usually has an impact on the creation of economies of scale and synergies between companies that operate under the same matrix.
As a decision, the company must assess whether vertical integration is beneficial for its results, or whether it is better to outsource the services in question to other companies.
The reasons for vertical integration are summarized in:
- Greater economies of scope. Derived from a better use of resources that can be shared.
- Reduction of intermediate processes. For example, logistics.
- Reduction of transaction costs.
- Obtaining higher margins and thus a better profitability of the business.
A particularly prominent case of vertical integration is exerted by Apple, which takes care of a large part (almost all) of the steps to offer its products. It designs, produces electronic components, assembles them in its factories, promotes them on its communication channels and distributes them in its own establishments.
Types of vertical integration
It is a simple scheme that in reality becomes somewhat more complex but is useful when it comes to understanding the nature of vertical integration. Its three classes can be observed. Each class will depend on the nature of the activities that were done in the beginning and which are progressively addressed:
- Backwards : Addressing processes prior to the elaboration of the good. This is the case of components and assembly.
- Forward : If it is in charge of post-production processes of the good. For example, regarding marketing, distribution and sales.
- Compensated : Carrying out the two previous cases together.
There are many examples in the economy in which vertical integration is a successful tool for companies, such as oil companies that extract, process, distribute and market diesel.
