Vertical Integration

Vertical integration is best known as "a strategy that allows a company to streamline its operations by taking direct ownership of various stages of its production process rather than relying on external contractors or suppliers," as stated by Adam Hayes.

    Instead of outsourcing its suppliers, manufacturers, distributors, or retail locations, a company can achieve vertical integration by acquiring or setting up its own. However, vertical integration may be risky due to the significant initial capital investment required. 

     How vertical integration works is it allows a company to become more self-reliant on other aspects of the process rather than sticking to a single point along the process. A manufacturing company might, for instance, prefer to directly source its raw materials or sell directly to customers.

    Companies use vertical integration because it gives businesses more control over a manufacturing process's supply chain. The manufacturer can control the timing, procedure, and aspects of additional stages of development by performing specific tasks internally. As opposed to purchasing outsourced goods at marked-up costs, owning a larger portion of the process may also result in long-term cost savings.

    Hayes uses Netflix as an example to better explain vertical integration: "The company started as a DVD rental business before moving into online streaming of films and movies licensed from major studios. Then, Netflix executives realized they could improve their margins by producing some of their own original content."

    He also added that they "produced some bombs, like 2016's The Get Down, which reportedly cost the company $120 million. 1 Today, Netflix uses its distribution model to promote its original content alongside programming licensed from studios. 2 Instead of simply relying on the content of others, Netflix performed vertical integration to become more engaged in the entertainment development process earlier."    

        

    There are three types of integration: forward, backward, and balanced. The writers of Wallstreetmojo define forward integration as "when a company has an in-house manufacturing unit, it can merge or acquire distribution centers or retail outlets. Thus, the company moves ahead in the supply chain, i.e., from raw material to retail." 

    Then backward integration as the "strategy is undertaken by companies with in-house units built for the final stages of the supply chain—retail. Such firms can engage in the initial stages—production and procurement of raw material." 

    Lastly, that balanced integration "firms generally use a combination of Forward Integration and Backward Integration strategies. This is applicable to businesses engaged in the mid-supply chain function. They expand their operations upward and downward." 

    Hayes lists the main takeaways of vertical integration are that "vertical integration requires a company's direct ownership of suppliers, distributors, or retail locations to obtain greater control of its supply chain. The advantages can include greater efficiencies, reduced costs, and more control along the manufacturing or distribution process. Vertical integration often requires heavy upfront capital that may reduce a company's long-term flexibility."

    Overall, the business arrangement in which a company controls various stages of the supply chain is known as vertical integration. To have better control over the production process, the company strives to bring processes in-house rather than relying on external suppliers. Even though vertical integration may require more initial capital, the long-term objective is to streamline processes for more controlled and efficient operations.