With a vertical integration strategy, a company takes control of a larger part of its supply chain. This type of integration is broken down into backward and forward vertical integration, with backward integration involving merging with, acquiring, or tightening relationships with downstream suppliers, and forward integration with upstream distributors.
An example of backward vertical integration would be a retail business that sold bagged gourmet coffee beans purchasing a company that roasted and bagged the beans. A company that made high quality chocolate acquiring a retail confections business would be an example of forward vertical integration.
Pros and Cons of Vertical Integration
Vertical integration gives a company more control over the various aspects of the value chain from the raw materials to the consumer. It usually results in lower costs and improved quality control, as the company in question oversees a wider range of activities and can set their own prices raw materials.
The drawback to vertical integration is lack of resilience and flexibility. If a farm that normally supplies you with goods is struggling, you can always switch to a new supplier. If you own the farm, those problems are yours now, and your struggling farm will put you at a competitive disadvantage in your industry.
Horizontally integration involves merging with or acquiring other companies that provide the same goods or services. If you owned a health food store, for example, you would acquire more health food stores in different locations. In similar fashion, a guitar string manufacturer in Chicago might merge with one in Cleveland to create a more robust company. Often times, companies acquire their competitors in this way to grab a larger share of the market.
Pros and Cons of Horizontal Integration
Horizontal integration is a cost-effective way of expanding, as it is less costly to purchase an existing business than to start another one from scratch. Horizontal integration becomes more lucrative as a company grows in size, as the relative cost of acquiring new businesses becomes a smaller percentage of total revenues.
One disadvantage of horizontal integration is that losses from a recently acquired business may cut into the profits from an existing one. For this reason new acquisitions must be made only after careful scrutiny. Buying up every competitor in sight may seem like a great idea, but without due diligence it could easily backfire.
A decision to expand via vertical or horizontal integration should only be made after careful consideration of all available options and their potential risks and rewards.