Q 643. What is Vertical Integration? Provide some examples where it has been successfully done. Also, how does it impact the Business Excellence strategy of both the companies (the one acquiring and the one getting acquired)?

 

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Methodology	Vertical Integration
Concept:	Vertical integration approach is taken by companies to integrate one or two production processes or steps into their own business, instead of relying on external suppliers for those particular requirements. A business can achieve this by acquiring or taking direct control for some of their own suppliers, distributors, or retail locations rather than outsourcing them as external service providers, also it can be done by merging two or more companies which are serving different function in same supply chain.
Types:	Mainly there are two types of vertical integration, one is Forward Integration, when a company takes ownership of downstream process or further along the supply chain like sales or distribution of finished goods. And another is Backward integration, it is when a company acquires an upstream process which is prior to it along the supply chain, for example a fast-food restaurant takes control to some of the agricultural production that supplies ingredients for cooking foods.
Purpose / Advantages	1. To have greater control on supply chain thus fewer disruptions and lower lead time 2. Company can identify possible disruptions in advance also can have more visibility 3. To lower the manufacturing costs by optimizing operations in all verticals based on need 4. Direct control on processes ensured better quality control in each stage as per requirement 5. Lower transportation costs, less turnaround times if the entire process is managed in-house.
Example	In my earlier organization of paper and paperboards manufacturing, brown Kraft paper core pipe was one of the major raw materials, there were few suppliers for core pipes, one local & two from other states. We were facing issues like size variation, moisture content and also on higher lead time for core pipes. Hence it was decided to develop the local supplier with training and guidance in terms of variation reduction, later company acquired that core pipe cutting facility, also upgraded the machines, and deputed 2 resources. Which has lead to eliminate size variation issue also stock out scenarios. This was one backward integration. It was also planned to relocate that facility inside the main plant to reduce the fixed cost further also making logistics and transportation simpler & more cost effective.
Impact on Business Excellence strategy	A successful vertical integration means company the one acquiring, must manage multiple challenges, some of them for which company resources may not be expert as it was not in original core competencies. Also, it increases business complexity as some new processes gets added in existing operations. To deal with these challenges, business excellence strategy must be aligned to get the full potential benefit and the new process must be thoroughly investigated to integrate those operations with existing processes and ongoing systems, it will also help to get upstream or downstream profits. On the other hand, the business, one getting acquired, may raise good capital if the assets were not getting utilized fully or not making profitable business. Also, the business will get more exposure with the modern tools and techniques used in parent organization, and expertise to make the processes more effective like improving quality considering actual customer requirement.

Vertical Integration is when a company expands its operation within its organization. By merging various processes - from production of goods, materials acquisition up to the selling of the goods and services to the customers. This can reduce cost and increase the product or service quality though this has advantages - It can avoid supply disruption; company can lower the cost by buying bulk which mean low pricing strategies can be an advantage and there is potential risk to consider - invest in a large capital to set up the stages of the production and cost on maintenance since they have to maintain efficiency. Unforeseen labor issues as it could face a greater risk of the acquired firm also becoming a unionized unit or vice versa.

Example:

Mcdonalds has integrated every process of their supply chain by partnering with their suppliers- process their own meat and grows its own potatoes.

Netflix has gone through vertical integration to increase engagement in the entertainment development earlier.

Apple designs and manufactures its own products and sell them in Apple store.

Overall, vertical integration has a significant impact a business excellence strategy by gaining greater control on its stages of processes. It can streamline the operations that will ensure quality control as well as reducing cost.

Vertical Integration:

Its a business strategy in which a company takes ownership of two or more stages in the production or distribution of its products.It is where two businesses at different stages of the supply chain join together.For instance, a business that depends on another for its supplies sometimes that supplies may find unreliable which effects business.In turn it may vertically integrate with its suppliers.There are stages in vertical integration-materials,vendors,manufacturing and distribution.If at all a manufacturing company finds anything unreliable in the above four stages it can take the control of the companies related to any of the stage.

EXAMPLES OF VERTICAL INTEGRATION:

1.AMAZON:

Amazon acts as both sellers and buyers.It has vertically integrated much of its business.It offers its own products and services and its own distribution channel as well.So in effect it has 3 stages of supply chain.It sources the products, markets and sells them on its website and then delivers them.

2.NETFLIX:

A popular OTT platform Netflix decided to vertically integrate and enter the production business in 2013.It provides platform for producing films,T.V,documentaries and other content.It acquired the production houses to produce own content and release in the platform.

Vertical integration impact on acquiring company:

1.No reliance on suppliers

2.lowers the price 

3.Potential access to monopolize suppliers

Vertical integration impact on acquired company:

1.acquired company can gain access to additional resources such as capital,technology,enhancement of facilities which helps to fuel its growth and development.

Unlike horizontal integration which happens when two companies from the same industry combine by way of acquisition or merger, vertical integration happens when a company acquires another firm which operates below or above the company in the supply chain. 

 

Vertical integration can be further broken down into forward vertical integration and backward vertical integration.

Forward vertical integration occurs when a company acquires the distribution center/consumer company to which it sells its products or services. Backward vertical integration occurs when a company expands into an activity that is earlier in the supply chain than the one the company is involved in. As an example of backward vertical integration, the company might acquire the supplier of its raw materials.

 

While forward vertical integration helps a company to increase its bottom line & move closer to the end customer, backward vertical integration will enable the company to lower its costs, ensure quality control and also maintain the certainty of supply.

 

Reliance industries is an example of vertical integration. While it has exploration units that seek new sources of oil, it also has subsidiary companies for oil extraction and refining it. Its transport division transports the refined oil to the retailer companies who then sell it to end customers. Another example of vertical integration is Apple which  owns the entire supply chain from chipsets to the finished product. This has helped Apple maintain its independence and control the rate at which it produces its products for the end customer.

 

In terms of business excellence strategy, most often than not, the company which acquires the firm either by way of forward or backward vertical integration will try to implement its business excellence strategy in the firm that has been acquired. While there is always room for the company acquiring the firm to benefit from the firm's best practices, it will in all likelihood try to impose its business excellence strategy/principles on the acquired firm/s.

 

Thanks.

 

Regards,

Lalit R

 

 

Vertical Integration is a strategy that allows an organization to streamline it's operations by taking control over one or multiple stages of production or distribution of its finished goods rather than relying on external suppliers or contractors.

 

The stages related to Vertical Integration are Materials, Suppliers,  Manufacturing and Distribution.

 

D-Mart is one of the best example of Vertical Integration where it survived the competition from e-commerce platforms by running their outlets in own space, increasing profit margins by creating in house brands like Premia, Homes etc.,

 

Apple is another example of vertical integration where it owns the manufacture of A-series chips unlike Android which depends on Snapdragon or Qualcomm to provide chipsets.

Advantages:

• No need to depends on suppliers
• Lower production cost
• Competing with most popular brands by producing identical products

 

Disadvantages:

• Initial investment is higher and risk of failure is high
• May fail in estimating the demand, production cost and selling price

 

A Company usually depends on two key contributors as part of their Supply Chain. A Supplier/Vendor who is a Person or another company who provides goods or services for manufacturing of the products. Similarly, A Distributor who is a Person or an organization or a business who purchases goods or services from the industry and supplies them to the Customers.

 

Let us take a Smart Phone Company for an example. To manufacture a Smart Phone, the Smart Phone company requires different parts like Display, Camera & it components, Processors, Memory chips etc., Where the Smart Phone company only owns the process of assembling the parts to produce a Smart phone, they always rely on their suppliers for producing the parts they need. Each supplier will be owned by a different entity. Similarly, to distribute the Smart Phones the Smart phone company relies on the Distributors who procure the Smart Phones and sell it to the Customers.

As you can see in the example, the Smart Phone company relies on the Suppliers and Distributors as major part of their supply chain and hence may face multiple challenges like, Dependency on Suppliers, No direct Quality control, Higher costs due to intermediates, etc., which may lead to disruption of the Company’s Operations and also the affects the integrity of their brand

 

Vertical Integration Strategy helps a Company to overcome these challenges by taking direct ownership of these Key parts of their supply chain which are the Suppliers and the Distributors. In vertical integration, a Company can also directly manufacture the goods required for producing their product (Backward Integration) and also Sells them directly to their Customers (Forward Integration). Taking the Smart Phone company for Example, the Smart phone company will own the manufacturing of the goods required for producing a Smart Phone and the same time they directly sell the Smart phones to their Customers.

This helps the company in Saving costs, having direct Quality control on End to End process, Increases market power, etc.,

 

Few other examples of Vertical integration are:

 

• Amazon owning and operating its own logistics (Amazon Logistics) – Forward integration
• Starbucks acquiring Coffee farms and roasting facilities – Backward integration
• Netflix started producing its own shows (Original content TV shows & Movies) – Forward integration
• IKEA owning Swedwood, a furniture company – Backward integration

 

Similarly, there is also Horizontal integration in which an industry acquires merges it competitors (A company in the same industry) to grow their business. A simple example is: Facebook acquiring WhatsApp and Instagram…

Vertical Integration

It’s a business strategy where the organizations would be keen to integrate the business functions which were dependent on suppliers to

1.       Improve the quality

2.       Optimize cost

3.       Gain control of the market power and market share

4.       Expand its reach to the end customers/ consumers

Vertical Integration is of the following types

Backward Integration: In this strategy, Company A integrates the upstream processes in the supply chain function, this helps them to gain more control over the inventory, and procurement of raw materials all the way to the manufacturing of the raw materials.

1.       Reliance Industries is a classic example of Backward Integration as they were originally in the textile industry from which they entered precursor chemicals, plastics, petrochemicals, petroleum refining and finally oil and gas exploration and production.

2.       UK Supermarket chain Tesco took over the Booker Group which was the UK’s leading Food Wholesaler. This gave Tesco additional access to become a major supplier to competing small retailers, serving 125,000 independent convenience stores as well as 468,000 restaurants and pubs

Forward Integration: In this strategy, Company A integrates the downstream processes in the supply chain. This will give them an extended reach to take control of the distribution, sales and post-sales services of their product/ service.

1.       Telecom giant Airtel is to acquire ~97% stake in the Beetel Teletech a company that manufactures landlines and cordless phones

2.       Dell successfully manages the sales and distribution of their products without support from any partners as it gives full control over owning the services to its customers and consumers

Balanced Integration: In this strategy, the company decides to pick up both the upstream and downstream activities in the supply chain. This enables it to be in a strong position to source raw materials, design, develop, manufacture and manage the post-sales

1.       Apple is a classic example of balanced integration as it has tight control over sourcing the raw materials, manufacturing chips, opening its retail stores and managing post-sales service

2.       D Mart is another successful organization that had successfully implemented the balanced integration as it helped them to gain a significant market share in the hypermarket chain

Impact on Business Excellence Strategy

The business excellence strategy will have to be realigned to consider vertical integration. The company that performs the Vertical Integration will have an upper hand in defining, formulating, implementing and governing the business excellence roadmap for the combined organization. Below are the key priorities in such instances

1.       Define and achieve economies of scale, expand foot print

2.       Relook at the Cost structure as some of the fixed costs will now be variable costs, greater scope for implementing cost avoidance/ saving projects

3.       Cross-skilling of resources and redeployment of resources

4.       Consolidation of Tools, inventories and platform

Improve Employee and Customer Satisfaction levels

Some interesting examples of vertical integration, both forward and backward. Hence, it is recommended to read all answers.

 

Harishankar has provided the best answer to this question.