Vertical integration

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Inmicroeconomics andmanagement, vertical integration is an arrangement in which thesupply chain of a company is owned by that company. Usually each member of the supply chain produces a differentproduct or (market-specific) service, and the products combine to satisfy a common need. It is contrasted withhorizontal 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 (as in the 1920s when theFord River Rouge Complex began making much of its own steel rather than buying it from suppliers).

Vertical integration is one method of avoiding thehold-up problem. A monopoly produced through vertical integration is called avertical monopoly.

Nineteenth-centurysteel tycoonAndrew Carnegie's example in the use of vertical integration led others to use the system to promote financial growth and efficiency in their businesses. There also have another two typical companies likeApple Inc. andBirds Eye. The companies are illustrated how the vertical integration strategy successful apply to the real business situation.

Vertical integration can be a highly important strategy, but it is notoriously difficult to implement successfully and—when it turns out to be the wrong strategy—costly to fix. Management's track record on vertical integration decisions is not good. John (1993) illustrated that the vertical integration is a critical process like synthetic, costly and difficult to defeat. Nowadays, many companies make process it without a suitable dissolution of the ventures. David (1993) said the fundamental information: “do not vertically integrate beside it is totally essential to process or protect value”. Vertical integration is merely a method of integrating the diverse steps of a manufacturing supply chain when two-sided trading is not powerful. However, if the company appear two reasons: resolutions of vertical integrate based on false reasons and leaders fail to concern the rich ranging of “quasi-integration” approaches that could be “higher-up” to full integration in both advantages and costs. Therefore, vertical integration is a strict strategy (John and David, 1993).

Contents

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Three types[edit]

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A diagram illustrating vertical integration and contrasting it with horizontal integration[further explanation needed][citation needed]

Vertical integration is the degree to which a firm owns its upstream suppliers and its downstream buyers. Contrary tohorizontal 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 (e.g., growing raw materials, manufacturing, transporting, marketing, and/orretailing).

There are three varieties: backward (upstream) vertical integration, forward (downstream) vertical integration, and balanced (both upstream and downstream) vertical integration.

A company exhibits backward vertical integration when it controlssubsidiaries that produce some of the inputs used in the production of its products. For example, an automobile company may own atire company, aglass 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 ofFord and other car companies in the 1920s, who sought to minimize costs by integrating the production of cars and car parts as exemplified in theFord River Rouge Complex.

A company tends toward forward vertical integration when it controls distribution centers and retailers where its products are sold.

Case studies:

Initially, the Vertical Integration has three typical models as forward, backward and balanced vertical integration. The Apple company is a kind of forward vertical integration, its owner themselves design and IOS systems but all the other components of products are produced by other companies. It is research and develop products so that it using out sourcing strategy to produce its products. This is the main causes why the APPLE company achieve their maximum profits. However the BIRDSEYE company which it is a kind of backward vertical integration. It rely on their own supply chain and developed their own equipment. Such as few farmers and little producing factory, thus the company need spend large capital to supply whole facilities. There has a high risk if the company be lack of the leadership or poor working capital, it would be face broken. Therefore, It is not a good approach in markeing strategy and also it is a disadvantage of vertical integration. A business and company more vertically integrated, the better of financial and administrative resources required. Vertical integration could bring both profits and risks and reasonable to look froward to explore the strategy of increased integration and compete in business operates.

Examples[edit]

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Birdseye[edit]

During a hunting trip, an American explorer and scientist, Clarence Birdseye, discovered the beneficial effects of quick freezing. For example, fish caught a few days previously that were kept in ice remained in perfect condition.

In 1924, Clarence Birdseye patented the “Birdseye Plate Froster” and set up the General Seafood Corporation. In 1929, Birdseye’s company and patent was bought by Postum Company and the Goldman-Sachs trading Corporation. It later came to be known as General Foods. They kept the same Birdseye name, but it was split into two words (Birds eye) for use as a trademark. Birdseye was paid $20 million for the patents and $2 million for the assets.

Birdseye was one of the pioneers in the frozen food industry. Birdseye Company used vertical integration to manage their business. Because during these times, there was not well-developed infrastructure to produce and sell. So Birdseye developed its own system by using vertical integration. Many members of supply chain such as farmers and small food retailers, they cannot afford high costs to buy equipment. So Birdseye provides equipment to farmers and retailers. Furthermore, Birdseye can make mass market enjoy large economies of scale.

But until now Birdseye has fading slowly because they just have fixed costs associated with vertical integration which named property, plant and equipment cannot be reduced significantly when production need decrease. The Birdseye company used vertical integration, it will created a larger and huger organization structure with more levels of command, slower informational processing time made every parts of company could not react immediately. So Birdseye did not take advantages of the growth of supermarket until ten years after competitions, neither did not develop the catering market. The already-developed infrastructure did not allow Birdseye to quickly react to market changes.

Apple[edit]

Apple has used vertical integration strategy for 35 years and it is one of the most successful companies in smartphone industry. Large company such as Apple may use vertical integration more often than their business as they are more likely to manage each stage such as major expansion and funding. Moving into vertically integrate strategy helps Apple become a leading platform company.[further explanation needed] Vertical integration could let it control the product from producing to the end. Other companies may follow the Apple model, but the success will not happen for a short time. Even if these companies focus on these areas with their core businesses but it still has lots of difficult areas such as manufacturing, supply chains and sell. Apple has forward integrated with their retail stores as their major success. It allows Apple selling their products directly to the customers and allows Apple to control whole sales price of their products.

Alibaba[edit]

In order to obtain more profit and occupy more market. Alibaba a Chinese base company has fully used of vertical integration makes it more than an e-commerce stage. Alibaba industriously built its supremacy by gradually acquiring complementary companies in different areas such as delivery, payments, and to the company is creating a completely vertically-integrated e-commerce powerhouse. The company also has plans to expand abroad. It officially opened an office in San Francisco in 2013 as well as invested in some US tech companies.Vertical integration bring a lot of interest for the company and made it most profitable Internet companies in China.

Steel and oil[edit]

One of the earliest, largest and most famous examples of vertical integration was theCarnegie Steel company. The company controlled not only the mills where thesteel was made, but also the mines where theiron ore was extracted, the coal mines that supplied thecoal, the ships that transported the iron ore and the railroads that transported the coal to the factory, thecoke 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.[full citation needed] Later on, Carnegie even establishedan institute of higher learning to teach the steel processes to the next generation.

Oil companies, both multinational (such asExxonMobil,Royal Dutch Shell,ConocoPhillips orBP) and national (e.g.,Petronas) often adopt a vertically integrated structure, meaning that they are active along the entire supply chain fromlocating deposits, drilling and extractingcrude oil, transporting it around the world,refining it into petroleum products such aspetrol/gasoline, to distributing the fuel to company-owned retail stations, for sale to consumers.[citation needed]

Telecommunications and computing[edit]

Telephone companies in most of the 20th century, especially the largest (theBell System) were integrated, making their owntelephones,telephone cables,telephone exchange equipment and other supplies.[citation needed]

Apple Inc. is an example of a vertically integrated company. Specifically, it controls many elements of the ecosystem for theiPhone andiPad, 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 isoutsourced tocontract manufacturers such asFoxconn orPegatron 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.

Entertainment[edit]

From the early 1920s through the early 1950s, the Americanmotion picture had evolved into an industry controlled by a few companies, a condition known as a "matureoligopoly", as it was led by eightmajor film studios, the most powerful of which were the "Big Five" studios:MGM,Warner Brothers,20th Century Fox,Paramount Pictures, andRKO.[citation needed] These studios were fully integrated, not only producing and distributing films, but also operating their ownmovie theaters; the "Little Three,"Universal Studios,Columbia Pictures, andUnited Artists, produced and distributed feature films but did not own theaters.[citation needed]

The issue of vertical integration (also known as common ownership) has been a main focus of policy makers because of the possibility of anti-competitive behaviors affiliated with market influence. For example, inUnited 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 (United States v. Paramount Pictures, Inc., 1948). The prevalence of vertical integration wholly predetermined the relationships between both studios and networks[clarification needed] 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.

Certainmedia conglomerates may, in a similar manner, own television broadcasters (either over-the-air or on cable), production companies that produce content for their networks, and also own the services that distribute their content to viewers (such as television and internet service providers).Bell Canada,Comcast,Sky plc, andRogers Communications are vertically integrated in such a manner—operating media subsidiaries (Bell Media,Rogers Media, andNBCUniversal respectively), and provide "triple play" services of television, internet, and phone service in some markets (such asBell TV/Bell Internet,Rogers Cable,Xfinity, and Sky's satellite TV services). Additionally, Bell and Rogers own wireless providers,Bell Mobility andRogers Wireless; taking advantage of its vertical integration, Bell also offers its wireless subscribers amobile television service.

Agriculture[edit]

Vertical integration through production and marketing contracts have also become the dominant model forlivestock 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. Farm 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.Jim Hightower, in his book Eat Your Heart Out, discusses this liability role enacted by large food companies. He finds that in many cases of agricultural vertical integration, the integrator [food company] denies the farmer the right of entrepreneurship. This means that the farmer can only sell under and to the integrator. These restrictions on specified growth,Hightower argues, strips the selling and producing power of the farmer. The producer is ultimately limited by the established standards of the integrator. Yet, at the same time, the integrator still keeps the responsibility connected to the farmer.Hightower sees this as ownership without reliability.

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[edit]

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There are internal and external society-wide gains and losses stemming from vertical integration, which vary according to the state of technology in the industries involved, roughly corresponding to the stages of the industry lifecycle.[clarification needed][citation needed] Static technology represents the simplest case, where the gains and losses have been studied extensively.[citation needed] A vertically company usually fails when transactions within the market are too risky or the contracts to support these risks are too costly to administer, such as frequent transactions and a small number of buyer and sellers.

Internal gains[edit]

Lowertransaction costs

Synchronization ofsupply and demand along the chain of products

Lower uncertainty and higher investment

Ability tomonopolize market throughout the chain bymarket foreclosure

Strategic independence (especially if important inputs are rare or highly volatile in price, such asrare earth metals).

Internal losses[edit]

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[edit]

Better opportunities for investment growth through reduced uncertainty

Local companies are often better positioned against foreign competition

Losses to society[edit]

Monopolization of markets

Rigid organizational structure, having much the same shortcomings as thesocialist economy (cf.John Kenneth Galbraith's works)

Vertical expansion[edit]

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Vertical expansion, ineconomics, 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 thefirm 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 islateral expansion, which is the growth of a business enterprise through the acquisition of similar firms, in the hope of achievingeconomies 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 ofDirecTV byNews Corporation is an example of forward vertical expansion or acquisition. DirecTV is asatellite TV company through which News Corporation can distribute more of its media content: news, movies, and television shows. The acquisition ofNBC byComcast 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 theFederal Communications Commission.