Control is an important concept in business. When your organisation has more control over the various factors affecting your business, it leads to less risk and improved stability. The supply chain is one area where uncertainty can lead to significant losses, whether it is dealing with your raw material suppliers or product distributors.
As a result, vertical integration is a popular strategy for business owners who are seeking maximum control over all or some parts of their supply chain. When effectively deployed, it can lead to massive improvements across your organisation. But quite naturally, it also comes with a fair amount of risk.
To help you decided if it's the right supply chain strategy for your business, here is a list of the various pros and cons of vertical integration.
What Is Vertical Integration?
First, though, it's necessary to establish what exactly this strategy entails. In vertical integration, your business aims to achieve control over the different levels of your supply chain, which is achieved by owning or acquiring the firms that produce and supply the raw materials you require. You can also buy distribution channels or retail businesses that will sell your final product (such as a brewery owning a pub).
Apple is an excellent example of a vertically integrated company. It manufactures the many components required for its devices and has its own retail locations across the world.
Another example would be Starbucks, which has a high degree of control across its entire supply chain. They source coffee beans directly from farmers and process it in-house. Further, they have retail outlets to sell their coffee as well.
Netflix is another great example of successful vertical integration, with the streaming giant producing a lot of original content for its distribution platform.
The Advantages of Vertical Integration
Vertical integration is all about improved and increased control over various aspects of your business. The benefits can be split into these main categories:
1. Reduced Risk in the Supply Chain
When you have more control over the various levels of your supply chain, your organisation is better prepared to deal with any potential disruptions. Often, these can happen when suppliers and vendors face financial hardships. When you own or control these entities, however, this type of risk can be reduced drastically. You can also reduce the turnaround times on deliveries while reducing delays and disruptions.
2. Reduced Costs
Increased control over the supply chain can easily result in lowered costs for your goods and raw materials. You are no longer at the mercy of your suppliers, especially during times of peak demand. By creating subsidiaries at each level of the supply chain, you can achieve significant cost reductions.
3. Better Quality Control
This is an incredibly important aspect, especially in the era of global supply chains. Vendors in foreign markets may be working in markets with lower standards. It is much easier to enforce higher standards when you own or control that vendor. This is not just about getting components or supplies that pass your internal quality requirements, either; it can also prove critical when you need to comply with global standards such as Fairtrade.
4. Lower Prices for Customers
With increased vertical integration, your organisation can aim for economies of scale: buy raw materials in bulk, reduce production costs, improve efficiency, and achieve a lower per-unit cost on the finished product. The outcome of this is the ability to provide goods at lower prices than before to your customers, without any significant negative impact on your profit margins.
5. A Direct Link to the Market
Having your retail distribution network allows you to gauge the pulse of the market more efficiently. You can quickly assess if a product is generating enough sales and ramp up production accordingly. Retail operations also give you increased insights into your final consumers, which can be invaluable for future planning.
6. Advantages Over the Competition
With improved efficiency, better pricing, and an improved value chain, your products are better poised to gain an advantage over your rivals. By investing in retail channels, you can also create unique experiences for your customers, as Apple does within its stores. This is especially important in segments where buyers value a premium shopping experience, as is the case with many modern consumers.
The Disadvantages of Vertical Integration
Control is not a cheap commodity in business, however; it can be expensive to acquire across multiple levels of a supply chain. When not planned and executed with caution, vertical integration can result in the following issues:
1. High Capital Requirements
Vertical integration is not a viable strategy for small and medium enterprises in most cases. It requires significant capital for investment. Mergers and buyouts can be quite expensive – often prohibitively so, if it is a hostile takeover. This is especially true when you are moving upstream, trying to buy out suppliers.
2. Risk of Increased Organisational Inefficiency
Vertical integration leads to a drastic increase in the size of your business. Usually, larger organisations are much harder to manage effectively. This can be mitigated somewhat by creating subsidiaries, but that too results in increased complexity in your corporate structure. There is a higher risk of waste and mismanagement in such cases.
3. No Easy Exits
Given the sheer size of investment required in vertical integration, failure can have serious consequences for your business. Large mergers and acquisitions cannot be easily reversed. Unless the firm is doing exceptionally well, you may even have to sell at a loss, if at all a sale is possible.
4. Lack of Familiarity
Moving up or down the supply chain means getting your firm involved in sectors that may be wholly unfamiliar or alien to your own. For instance, there is a world of difference between a coffee retail outlet and actual coffee farming and processing. Foraying into these fields and succeeding can be hard, due to a lack of prior experience.
5. Reduced Flexibility in the Supply Chain
Stability comes at the cost of choice and flexibility, too – a non-vertically integrated business can choose from different vendors. This is crucial if that vendor is highly specialised and has a technological advantage. Such specialisation can be hard to replicate inside your subsidiaries without significant investments. Often, it is cheaper and more convenient to outsource the manufacture of components for this reason.
As you can see, there are both benefits and drawbacks to this strategy, each of which can affect your business drastically. Therefore, it’s not a process that you should conduct with short term goals in mind, nor is it a strategy that you should enter into lightly.
If you are in a financially strong position and your business is on an upward curve, however, it can be a logical and significant step towards growth, particularly if the nature of your industry or sector is conducive to vertical integration.
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