How Does Vertical Integration Works?
Picture this: a food manufacturer and a chain of supermarkets decided to merge into one. This event is referred as vertical integration. This means merging together two business that happens to have different stages of production. This type of coming together can lead to forward integration which means merging for the development of production process.
The opposite of this one is horizontal integration. This refers to the merging together of businesses which have the same stage of production. Examples for these are the partnership of two food manufacturers or two clothing companies. Then, there is also a backward integration wherein merging happens further back in the production process. An example for this is a food manufacturer collaborating with a farm. The most interesting merging is called conglomerate integration, which takes place between two completely different kinds of business.
In 1990’s, McKinsey & Company, a global management consulting firm, wrote that: historically firms have vertically integrated in order to control access to scarce physical resources, modern firms are internally and externally disaggregated, participating in a variety of alliances and joint ventures and outsourcing even those activities normally regarded as core.
The oil industry is the best known implementor of vertical integration. Around 1970s and 1980s, many companies committed in the discovery and extraction of crude petroleum decided to get hold of downstream refineries and distribution networks. Oil companies like Shell and BP came to be part in the process of acquiring petroleum from its North Sea and Alaskan source to a vehicle’s fuel tank.
It was Dell computer, one of the most successful companies of the 1990s, who took the idea of vertical integration in more sophisticated manner. Founder Michael Dell mentioned that he worked with the concept called “virtual integration”.This is a combination of the conventional vertical integration of the supply chain with the special features of the virtual organization.
This “virtual integration” happens when Dell build computers from other firms’ parts. However, the difference is that Dell has a more binding relationship with these firms instead of just being a the traditional link between a buyer and its supplier. Michael Dell refers to this as a “tightly co-ordinated supply chain”. These firms are not vertically integrated with Dell but they are included in the exchanges of information and on the work to achieve the same goal.
The road to the successful implementation of vertical integration is not that easy. It is at frequent times pricey and irreversible. But when times are good, upstream producers collaborate with downstream distributors to get a market where they can sell their outputs. Unfortunately, many firms opted to cut cut prices to their downstream distributors when demand decreases so as to compensate on the targeted levels of plant utilization.
Example for this took place around 1970 when Apple created a network of independent specialists that produce more outputs but as result vertically integrated computer companies like IBM, Digital and Burroughs were left out.
The vertically integrated giants of the computer industry, firms such as IBM, Digital and Burroughs, were felled like young saplings when at the end of the 1970s Apple formed a network of independent specialists that produced machines far more efficiently than the do-it-all giants.