Vertical Integration

Diane Mae Garguea

Costumer Service Specialist New Accounts Security Bank Corporation

Vertical integration is the combination of

technologically distinct production, distribution, selling, and/or other economic processes within the confines of a single firm. All the functions we now expect a corporation to perform could be performed by a consortium of independent economic entities, each contracting with a central coordinator.

Vertical Integration vs Horizontal Integration

Horizontal integration - process of merging similar industries, industries that produce similar products ; include tactics like buying competing companies that produce the same goods as you do Vertical integration - process of buying out suppliers of that particular industry.

Upstream firm = Selling Firm Downstream Firm = Buying Firm

Strategic Benefits of Integral Integration

Economies of Integration
-Cost savings in joint production, sales, purchasing, control, and other areas Economies of Combined Operations - By putting technologically distinct operations together, the firm can sometimes gain efficiencies Economies of Internal Control and Coordination - The costs of scheduling, coordinating operations, and responding to emergencies may be lower if the firm is integrated

Strategic Benefits of Integral Integration

Economies of Integration
Economies of Information - Integrated operations may reduce the need for collecting some types of information about the market, or more likely, may reduce the overall cost of gaining information Economies of Avoiding the Market - By integrating, the firm can potentially save on some of the selling, price shopping, negotiating, and transactions costs of market transactions.

Strategic Benefits of Integral Integration

Economies of Integration
Economies of Stable Relationships - Both upstream and downstream stages, knowing that their purchasing and selling relationship is stable, may be able to develop more efficient, specialized procedures for dealing with each other that would not be feasible with an independent supplier or customer-where both the buyer and the seller in the transaction face the competitive risk of being dropped or squeezed by the other party Characters of Vertical Integration Economies Economies of integration are at the core of the analysis of vertical integration, not only because they matter in and of themselves, but also because they contribute to the significance of some other issues in integration to be discussed

Strategic Benefits of Integral Integration

Tap Into Technology

- Vertical integration can provide close familiarity with technology in upstream or downstream businesses that is crucial to the success of the base business, a form of economy of information so important as to deserve separate treatment.

Strategic Benefits of Integral Integration

Assure Supply and/or Demand

- Vertical integration assures the firm that it will receive available supplies in tight periods or that it will have an outlet for its products in periods of low overall demand

Strategic Benefits of Integral Integration

Offset Bargaining Power and Input Cost Distortions

- If a firm is dealing with suppliers or customers who exert significant bargaining power and reap returns on investment in excess of the opportunity cost of capital, it pays for the firm to integrate even if there are no other savings from integration

Strategic Benefits of Integral Integration

Enhanced Ability to Differentiate

- Vertical integration can improve the ability of the firm to differentiate itself from others by offering a wider slice of value added under the control of management

Strategic Benefits of Integral Integration

Elevate Entry and Mobility Barriers

- If vertical integration achieves any of these benefits, it can raise mobility barriers. The benefits give the integrated firm some competitive advantage over the unintegrated firm, in the form of higher prices, lower costs, or lower risk

Strategic Benefits of Integral Integration

Enter a Higher-Return Business

- A firm may sometimes increase its overall return on investment by vertically integrating

Strategic Benefits of Integral Integration

Defend Against Foreclosure

- Even if there are no positive benefits of integration, it may be necessary to defend against foreclosure of access to suppliers or customers if competitors are integrated

Strategic Costs of Integration

Cost of Overcoming Mobility Barriers

-Vertical integration obviously requires the firm to overcome the mobility barriers such as economies of scale and capital requirements to compete in the upstream or downstream business

Strategic Costs of Integration

Increased Operating Leverage

- Vertical integration increases the proportion of a firm's costs that are fixed. If the firm was purchasing an input on the spot market, for example, all the costs of that input would be variable

Strategic Costs of Integration

Reduced Flexibility to Change Partners

- Vertical integration raises the costs of changeover to another supplier or customer relative to contracting with independent entities.

Strategic Costs of Integration

Higher Overall Exit Barriers

- Integration that further increases the specialization of assets, strategic interrelationships, or emotional ties to a business may raise overall exit barriers

Strategic Costs of Integration

Capital Investment Requirements

- Vertical integration consumes capital resources, which have an opportunity cost within the firm, whereas dealing with an independent entity uses investment capital of outsiders

Strategic Costs of Integration

Foreclosure of Access to Supplier or Consumer Research and/or Know-How

- By integrating, the firm may cut itself off from the flow of technology from its suppliers or customers

Strategic Costs of Integration

Maintaining Balance
- The productive capacities of the upstream and downstream units in the firm must be held in balance or potential problems arise

Strategic Costs of Integration

Dulled Incentives
- Vertical integration means that buying and selling will occur through a captive relationship

Strategic Costs of Integration

Differing Managerial Requirements

- Businesses can be different in structure, technology and management despite having a vertical relationship

~FIN ~