In microeconomics and management, vertical integration is where the supply chain of a
company is owned by that company.
Usually each member of the supply chain produces a different product or service, and the products
combine to satisfy a common need.
It is contrasted with horizontal integration.
Vertical integration has also described management styles that bring large portions of the supply
chain not only under a common ownership, but also into one corporation.
Vertical integration is one method of avoiding the hold-up problem.
A monopoly produced through vertical integration is called a vertical monopoly.
Nineteenth-century steel tycoon Andrew Carnegie's example in the use of vertical integration
led others to use the system to promote financial growth and efficiency in their businesses.
Three types Vertical integration is the degree to which
a firm owns its upstream suppliers and its downstream buyers.
Contrary to horizontal integration, which is a consolidation of many firms that handle
the same part of the production process, vertical integration is typified by one firm engaged
in different parts of production.
There are three varieties: backward vertical integration, forward vertical integration,
and balanced vertical integration.
A company exhibits backward vertical integration when it controls subsidiaries that produce
some of the inputs used in the production of its products.
For example, an automobile company may own a tire company, a glass company, and a metal
company.
Control of these three subsidiaries is intended to create a stable supply of inputs and ensure
a consistent quality in their final product.
It was the main business approach of Ford and other car companies in the 1920s, who
sought to minimize costs by integrating the production of cars and car parts as exemplified
in the Ford River Rouge Complex.
A company tends toward forward vertical integration when it controls distribution centers and
retailers where its products are sold.
Examples One of the earliest, largest and most famous
examples of vertical integration was the Carnegie Steel company.
The company controlled not only the mills where the steel was made, but also the mines
where the iron ore was extracted, the coal mines that supplied the coal, the ships that
transported the iron ore and the railroads that transported the coal to the factory,
the coke ovens where the coal was cooked, etc.
The company also focused heavily on developing talent internally from the bottom up, rather
than importing it from other companies.
Later on, Carnegie even established an institute of higher learning to teach the steel processes
to the next generation.
Oil industry Oil companies, both multinational and national
often adopt a vertically integrated structure.
This means that they are active along the entire supply chain from locating deposits,
drilling and extracting crude oil, transporting it around the world, refining it into petroleum
products such as petrol/gasoline, to distributing the fuel to company-owned retail stations,
for sale to consumers.
Telephone Telephone companies in most of the 20th century,
especially the largest were integrated, making their own telephones, telephone cables, telephone
exchange equipment and other supplies.
Reliance The Indian petrochemical giant Reliance Industries
has integrated back into polyester fibres from textiles and further into petrochemicals,
beginning with Dhirubhai Ambani.
Reliance has entered the oil and natural gas sector, along with retail sector.
Reliance now has a complete vertical product portfolio from oil and gas production, refining,
petrochemicals, synthetic garments and retail outlets.
Media industry From the early 1920s through the early 1950s,
the American motion picture had evolved into an industry controlled by a few companies,
a condition known as a "mature oligopoly".
The film industry was led by eight major film studios.
The most powerful of these studios were the fully integrated Big Five studios: MGM, Warner
Brothers, 20th Century Fox, Paramount Pictures, and RKO.
These studios not only produced and distributed films, but also operated their own movie theaters.
Meanwhile, the Little Three studios: Universal Studios, Columbia Pictures, and United Artists
produced and distributed feature films, but did not own their own theaters.
The issue of vertical integration has been a main focus of policy makers because of the
possibility of anti-competitive behaviors affiliated with market influence.
For example, in United States v. Paramount Pictures, Inc., the Supreme Court ordered
the five vertically integrated studios to sell off their theater chains and all trade
practices were prohibited.
The prevalence of vertical integration wholly predetermined the relationships between both
studios and networks and modified criteria in financing.
Networks began arranging content initiated by commonly owned studios and stipulated a
portion of the syndication revenues in order for a show to gain a spot on the schedule
if it was produced by a studio without common ownership.
In response, the studios fundamentally changed the way they made movies and did business.
Lacking the financial resources and contract talent they once controlled, the studios now
relied on independent producers supplying some portion of the budget in exchange for
distribution rights.
Certain media conglomerates may, in a similar manner, own television broadcasters, production
companies that produce content for their networks, and also own the services that distribute
their content to viewers.
Bell Canada, Comcast, and BSkyB are vertically integrated in such a manner—operating media
subsidiaries, and also both provide "triple play" services of television, internet, and
phone service in some markets.
Apple Apple Inc. is an example of a vertically integrated
company.
Specifically, it controls many elements of the ecosystem for the iPhone and iPad, such
as the processor and hardware designs, operating system and application software, and related
cloud services.
Hardware itself is not typically manufactured by Apple, but is outsourced to contract manufacturers
such as Foxconn or Pegatron who build Apple's branded products to Apple's specifications.
Apple's hardware and software are sold directly to consumers primarily through the company's
own brick-and-mortar and online retail stores, while cloud services are available through
the devices themselves.
Agriculture industry Vertical integration through production and
marketing contracts have also become the dominant model for livestock production.
Currently, 90% of poultry, 69% of hogs, and 29% of cattle are contractually produced through
vertical integration.
The USDA supports vertical integration because it has increased food productivity.
However, ". . . contractors receive a large share of farm receipts, formerly assumed to
go to the operator's family.”
Under production contracts, growers raise animals owned by integrators.
Form contracts contain detailed conditions for growers, who are paid based on how efficiently
they use feed, provided by the integrator, to raise the animals.
The contract dictates how to construct the facilities, how to feed, house, and medicate
the animals, and how to handle manure and dispose of carcasses.
Generally, the contract also shields the integrator from liability.
Under marketing contracts, growers agree in advance to sell their animals to integrators
under an agreed price system.
Generally, these contracts shield the integrator from liability for the grower’s actions
and the only negotiable item is price.
Problems and benefits There are internal and external society-wide
gains and losses stemming from vertical integration.
They will differ according to the state of technology in the industries involved, roughly
corresponding to the stages of the industry lifecycle.
Static technology This is the simplest case, where the gains
and losses have been studied extensively.
Internal gains Lower transaction costs
Synchronization of supply and demand along the chain of products
Lower uncertainty and higher investment Ability to monopolize market throughout the
chain by market foreclosure Strategic independence
Internal losses Higher coordination costs
Higher monetary and organizational costs of switching to other suppliers/buyers
Weaker motivation for good performance at the start of the supply chain since sales
are guaranteed and poor quality may be blended into other inputs at later manufacturing stages
Benefits to society Better opportunities for investment growth
through reduced uncertainty Local companies are often better positioned
against foreign competition Losses to society
Monopolization of markets Rigid organizational structure, having much
the same shortcomings as the socialist economy Vertical expansion
Vertical expansion, in economics, is the growth of a business enterprise through the acquisition
of companies that produce the intermediate goods needed by the business or help market
and distribute its product.
Such expansion is desired because it secures the supplies needed by the firm to produce
its product and the market needed to sell the product.
The result is a more efficient business with lower costs and more profits.
Related is lateral expansion, which is the growth of a business enterprise through the
acquisition of similar firms, in the hope of achieving economies of scale.
Vertical expansion is also known as a vertical acquisition.
Vertical expansion or acquisitions can also be used to increase scales and to gain market
power.
The acquisition of DirecTV by News Corporation is an example of forward vertical expansion
or acquisition.
DirecTV is a satellite TV company through which News Corporation can distribute more
of its media content: news, movies, and television shows.
The acquisition of NBC by Comcast Cable is an example of backward vertical integration.
In the United States, protecting the public from communications monopolies that can be
built in this way is one of the missions of the Federal Communications Commission.
See also Conglomerate
Vertical market Exclusive dealing
Insourcing Strategic management
Keiretsu and Zaibatsu Chaebol
Horizontal integration Economic calculation problem
Vertical disintegration Alfred DuPont Chandler, Jr.
Tapered integration References
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