As companies look for ways to streamline their operations and processes, the supply chain presents a significant area of opportunity.
Even the shortest supply chains have a number of moving parts and, therefore, a number of ways to increase efficiency. One strategy to streamline supply chains is through vertical integration.
Vertical integration is when a company takes more control over the different stages of its supply chain, from the purchase of raw materials to the delivery of the final product.
While vertical integration may seem like a natural step forward for most companies, it can be a challenge to successfully implement. This article will cover the process of transitioning into a vertically integrated supply chain and how to determine whether it’s the right strategy for your business.
How does vertical integration work?
Vertical integration is when a company assumes ownership over several or all parts of its supply chain. For example, a retailer could acquire a fulfillment service and handle its own customer delivery operations, which is referred to as forward integration.
In contrast, a manufacturer could merge together with its raw material suppliers and manage its end-to-end production process, also known as backward integration.
Companies can further opt to expand into both forward and backward integrations, which is called balanced integration, or bring their entire supply chain in-house.
Vertical vs. horizontal integration
Vertical integrations and horizontal integrations are two ways to structure a company’s supply chain. While both involve acquiring or merging with other companies, a vertical integration is only with other stages along the same supply chain.
Companies will vertically integrate with components either before or after their role in the supply chain.
Horizontal integration, on the other hand, is when a company merges with another entity at the same point of the supply chain. This is usually a company selling the same products, complementary lines, or another similar offering.
This type of horizontal integration is intended to expand the company’s offerings and eliminate competition in the market.
Benefits of vertical integration
The primary benefit of vertical integration is gaining control and preventing disruption along the supply chain. With all the operational challenges in recent years, bringing more components in-house offers increased visibility and communication.
Companies are able to manage all stages of production, making them less vulnerable to issues, such as supply shortages and shipment delays, and more equipped to adapt to any unexpected mishaps or market shifts.
By streamlining the path from raw materials to manufacturing to final order delivery, vertical integration results in a self-sufficient setup and faster time to market.
With more oversight across its operations, companies are able to reap cost savings and produce higher quality products and services. It becomes easier to balance supply with demand, which creates a competitive advantage and increases customer value in the long run.
5 Examples of successful vertical integrations
With the benefits to be gained from vertical integration, there are several notable examples of companies have successfully implemented the strategy.
Amazon
From its origins as an online marketplace for books, Amazon is now referred to as “The Everything Store,” with home goods, groceries, office supplies, and many other products available on its e-commerce site.
Alongside product expansion, Amazon also brought the majority of its operations in-house. To start, the company vertically integrated its warehousing, distribution, fulfillment, and customer service functions.
It then built out supporting infrastructure by launching its web hosting and cloud computing divisions — services that are not only critical to its operations but ones that it also provides to other companies as part of Amazon’s expanding business portfolio.
Ikea
Ikea, known for affordable flat-pack furniture and other home goods, had its start in mail-order and furniture retail.
In time, through a backward vertical integration with Swedwood — now renamed Ikea Industry — the company expanded operations with a manufacturing and distribution arm.
To gain even more ownership of its value chain, Ikea began a strategy and sustainability initiative in 2014 to purchase forests across the globe. The company currently owns more than 600,000 acres of forestland in Estonia, Latvia, Lithuania, Romania, and the US to help sustain its products — many of which contain elements of wood.
McDonald’s
McDonald’s would not be one of the largest fast-food chains in the world, selling at its pocket-friendly prices, without vertical integration. The company currently controls almost every component of its supply chain.
While most restaurants purchase bulk supplies from wholesalers, McDonalds grows its own vegetables and potatoes, processes its own meat, and mixes its own seasonings to ensure uniform taste and quality.
Beyond its popular menu items, McDonald’s is also known for its strength in real estate. The company owns 45% of the land and 70% of the buildings for all its locations across the globe.
Luxottica
Luxottica is an Italian eyewear brand that set its sights on building a vertically-integrated company early on.
Starting as a small producer of optical components and semi-finished products, Luxottica soon began making ready-to-wear frames that it could distribute directly to retailers. By the 1980s, the company began its gradual global expansion by acquiring independent distributors and entering licensing agreements with popular luxury brands like Giorgio Armani, Bulgari, Chanel, and Prada.
Luxottica doubled down on its acquisition strategy with other brands that offered physical retail locations, including Oakley, Sunglass Hut, Cole National, and others.
Today, Luxottica enjoys a full scale of global operations, from product development and manufacturing to logistics and retail.
ExxonMobil
Gas and oil companies are known to use horizontal and vertical integration strategies, with ExxonMobil being a particularly prominent example in the industry.
ExxonMobil is an integrated oil company that operates in all parts of the oil and gas supply chain. In addition to producing a variety of petroleum products, including gasoline, jet fuel, and synthetic petrochemicals, The company also manages its refineries and logistics to transport its products.
ExxonMobil is a fully integrated company that manages an upstream division, which handles all extraction and production, as well as its downstream division, to refine, retail, and market its final products.
When should a business consider vertical integration?
With so many examples of vertical integration across industries, it seems that the business strategy works for many operations. However, it’s important to first determine whether cutting out the middleman and controlling your entire manufacturing process can deliver the expected benefits.
For example, companies in industries with few suppliers can swiftly gain market power by acquiring a scarce supply chain component. Similarly, large companies planning to expand geographically can benefit from a form of vertical integration that acquires manufacturers or distribution centers in new areas.
Backward integration is also recommended for premium or luxury companies where there is a need to protect proprietary processes or when more oversight is needed for higher-quality goods.
Companies that cater to a cost-conscious customer base may also be able to gain new markets by integrating more of their production and operating with lower production costs. Products with low profit margins are easier to maintain if a company has greater control of its distribution and delivery. Acquiring retail channels is another good option for companies to go direct-to-customer without paying commissions or stocking fees.
Ultimately, the ideal company setup for vertical integration is one that has a clear line of sight across its business and supply chain. QuickBooks Enterprise offers a variety of tools to manage order fulfillment from start to finish and can easily scale with your business as it grows.
When is it a bad idea to vertically integrate?
Vertical integration is a risky and resource-intensive business model that’s difficult to reverse. In fact, many companies may lose money in the expansion process and even put their core business at risk by focusing on other areas of the supply chain.
Synergies take significant work to align with existing processes and systems, which can increase organizational complexity and affect a company’s core competencies.
Like running any other business, vertical integration requires large amounts of capital and commitment across all teams. Moreover, as new technologies and trends impact supply chains, companies need to continue investing in their expanded operations.
Unless you operate at the quantity necessary to achieve economies of scale, it might be more cost-effective to continue outsourcing to third parties.
Final thoughts
If your company is exploring growth opportunities, vertical integration presents a logical expansion along your supply chain. It also promises greater operational control and reduced dependencies on external factors.
However, vertical integrations are similar to any other merger or acquisition. They require due diligence, consolidated efforts, and a clear strategic plan on how the integration will roll out.
Companies with software that provides supply chain visibility are best equipped to analyze the potential for vertical integration and can more easily adapt to any shifts in operations.
