Vertical Integration – How companies leverage this arrangement to curb supply chain issues
The term “vertical integration” may not be used in everyday vernacular, but it is a part of our everyday lives. From your clothes to your electronics there has been multiple purchases that have been involved in vertical integration. While this practice had grown over the years it can be a risky and expensive one for a company to undergo.
In simple terms
Vertical integration is the practice of a company or an organization purchasing resources it needs to not just produce or manufacture their product but also to get their product in their customers hands with as little cost to them as possible.
Maybe the easiest way to understand this function is through a real-life example. Something everyone is familiar with is Amazon. Whether you use it or don’t, you have likely heard about the exponential growth and reach of this company. In no small part is this due to vertical integration.
What was once an online bookstore, turned online product purchasing, turned warehousing, turned delivery has now grown into even more than that. When Amazon began suffering from warehousing, they started to build their own warehouses. This is an example vertical integration. Next would be when they became primarily reliant on their own mode of transportation that included trucks, vans and more recently inter modal and airplanes. This has streamlined their delivery operations on such a large scale making it difficult for anyone to compete.
The vertical integration of Amazon doesn’t stop there. They have spent the last decade purchasing their own manufacturers to create home goods, clothing, electronics and more (this is called horizontal integration which is widening your customer base by tapping into different industries entirely). Amazon and its companies have done well as they are able to offer their products against their competitors at a lower cost. This, of course is one of the largest, scaled example of vertical integration but vertical integration can also look much smaller and simpler.
Though, lesser known than Amazon (depending on who you are) the clothing brand and store, Zara, has become a strategic seller in their market.
“Zara is a Spanish clothing and accessory company that has over one thousand stores worldwide. Not only does it own its own retail stores and distribution, but the vast majority of its clothes are sourced inhouse. Zara is vertically integrated with both the manufacturers and designs of its goods.
Whilst other stores rely on independent designers and manufacturers, they are left at their mercy. By contrast, Zara is able to adapt to new trends much quicker than its competitors. It has also led to improved efficiency in stock management – something that is crucially important in fashion design.”
Behind the scenes
As useful as vertical integration can be and as much as it could positively impact an organization if done the right way, it isn’t for everyone and will depend on what stage a company may be in.
The biggest hurdle any organization looking to vertically integrate their business will encounter is the expense. It is a large commitment, people-wise and financially to begin the process of vertical integration. Though it may pay off over time, a company must be prepared to shell out continuous funds to support this arrangement.
Whether it is backward integration (a pie company purchasing an orchard to ensure apple supply) or forward integration (said pie company then purchases small shops to sell pies in), the costs incurred to do either will weigh heavy for some time. This will also limit the company’s budget significantly while making the arrangement.
Another secondary hurdle will be combining cultures. If you are mainly a manufacturer that wishes to open a store front, you’ll then need a retail team that knows the business. The two branches of the company will have to often be in communication and on the same page with each other which can lead to a lot of trial and error until each side finds their groove.
But the good news is that hurdles can be overcome with strategy and planning. Investing not just the funds but the appropriate time and effort into vertical integration can benefit organizations in the long run. With the recent volatile supply chain, companies are looking at vertical integration solutions more than ever to safeguard themselves from future issues.
Fun Fact: The first recorded practice of vertical integration was Carnegie Steel. Andrew Carnegie coordinated the purchase of the iron mills to produce the raw product, the coal mines to always have fuel and even the railroads to transport the steel. By owning the sources, in a sense, he mitigated supply shortages, delays, and was able to offer quicker solutions within the operations.