Most companies have to experiment with a wide array of strategies and activities to fulfill their logistics and supply chain needs.
For some, the end goal might be to create a lean and streamlined supply chain operation, and for others, it may be to decrease costs and get more control over their product and process quality.
Vertical and horizontal integration are two strategies that can optimise different parts of your business and get you closer to achieving those goals.
While both strategies can change how you manage your supply chain, vertical integration stands out by helping you regain control over quality and streamline your operations.
Let’s start by understanding the vertical integration definition in the supply chain and delve deeper into its benefits and the degrees to which you can implement the strategy.
Understanding Vertical Integration in Supply Chain
Even in the largest companies, it is common practice to have processes that are not completely under the management’s control. Some processes are delegated to agencies or experienced service providers, especially when a new skill set is involved. But in some cases, this is not an option, and the best way forward is to take complete control of all your processes.
Vertical Integration in the supply chain refers to managing and controlling all the steps in a typical supply chain operation. Vertical integration may entail integrating steps in the forward or backward direction or, in some cases, in both directions.
Say you have been manufacturing toys for a popular brand but have decided to open your toy store, going from manufacturer to retailer. Or you have suddenly decided to start sourcing the raw materials for the toys you produce on your own. In either case, the flow may be different, but the applicable principle is vertical integration.
Contrary to how simple it sounds, vertical integration is a highly strategic and expensive undertaking for any company, so it is best to conduct thorough research and ensure that it is the best move for your company before moving forward.
In several cases, the backward or forward integration of supply chain and shipping processes can result from a merger or acquisition of another company with yours.
4 Types of Vertical Integration
Now that we have a clear understanding of vertical integration's meaning in supply chain operations, let us look at the common types of vertical integration you must consider:
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Forward Integration
Forward vertical integration of your supply chain involves converting all the downstream or latter activities of the process, such as sales or distribution, in-house.
In most cases, forward integration for a manufacturer involves adding activities like sales or distribution to its current operational range.
Example: Walt Disney launched the OTT platform Disney+ to showcase its huge library of titles, thus gaining control of the medium that delivers content produced by the company to the viewers.
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Backward Integration
When a company decides to switch to an in-house approach for all its upstream or earlier activities within the supply chain, it is referred to as backward integration.
Backward vertical integration is one of the best solutions for gaining more control over the product and process quality.
Example: McDonald's owns and manages all the production facilities providing agricultural products. As a result, the fast food chain has more control over the quality of vegetables and ingredients used in its recipes.
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Balanced Integration
When a company wants to implement balanced integration, it is likely to integrate its upstream and downstream processes into a single, streamlined operation.
When a company handles the middle activities in a supply chain and logistics operation, it may eventually want to take control of the upstream and downstream activities.
When executed well, your supply chain can benefit from balanced integration much more, even though it is tricky to pull off.
Example: Samsung exemplifies balanced integration, wherein the company has taken control of the sales and distribution with its official stores and backward integration by setting up its facility for producing some hardware for its phones.
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Disintermediation
When you want to gain more control of your supply chain by removing the intermediaries from the process, you will consider implementing disintermediation.
While most companies take this step to reduce supply chain costs and increase efficiencies, some do it to shorten the overall process and get closer to the customer.
Example: While many computer manufacturers still rely on dealerships, companies like Dell and HP have decided to start selling their products directly to consumers through their website and retail stores rather than general retailers and distributors.
6 Key Advantages of Vertical Integration
Implementing a vertical integration strategy in your company gives you comprehensive control over multiple stages of your supply chain processes and even helps you streamline product delivery operations.
With this in mind, let us look at a few major advantages of vertical integration you should consider:
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Increase Efficiency
Vertically integrated companies gain control of multiple stages of their supply chain and eliminate the need to rely too much on external distributors and suppliers.
With the reduced dependency on stakeholders, companies can lower supply chain costs and boost the efficiency of the production process by optimising each stage.
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Maximise Control Over the Supply Chain
Being a vertically integrated company means having more control over each stage of your supply chain — right from production to retail.
With the help of increased control, you can enable seamless coordination and integrate all the interrelated processes and stages by establishing a more centralised management approach.
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Reduce Risk and Liability
Supply chain disruptions are inevitable — largely because most bottlenecks are often unpredictable. However, you can manage the effects of price volatility and mitigate the risks posed by these disruptions and any other external uncertainties.
Companies can maintain the flow of products and materials in and out of the supply chain by establishing more ownership and better management through vertical integration vs horizontal integration.
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Boost Innovation
Whether it comes to boosting innovation in processes or products, companies that have implemented vertical integration examples are in a better position to lead drastic changes.
When companies have better control over their products and services, they can drive advancements and focus on letting their innovations push their company performance forward, thus helping them stay ahead of the competitors.
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Improve Quality Control
One of the biggest reasons that drives companies to invest in their downstream activities and push them to implement backward integration in their supply chain is quality control.
You can adhere to the strictest quality protocols when you have complete control over the process and even meet the specifications and expectations of your customers from start to finish.
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Increase Market Power
Enhancing the market power and position of a company involves getting more control over its supply chain, though the entire process can be quite complex.
By reducing excessive reliance on the suppliers and distributors, vertically integrated companies can stay ahead of market fluctuations and negotiate terms and conditions that are more favourable to them.
4 Degrees of Vertical Integration in Supply Chain
While there are plenty of rewards to gain from vertical integration, you must consider the numerous risks associated with the strategy. Here are the various degrees of vertical integration you should know about when you want to implement the strategy for your company:
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Full Vertical Integration
Full vertical integration can be tricky to implement, but it is often the solution companies go for when they want to fully commit to the strategy.
Companies going for a full vertical integration will invest heavily in building or acquiring all the assets, skillsets and resources required to integrate an entire step in the process or take complete control of the entire supply chain process — right from arranging for the raw materials to delivery of the finished goods.
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Quasi Vertical Integration
Most companies want the benefits associated with vertical integration but do not want to go through the complex and risky process of implementing it.
So they may often opt for the more contained and less risky option of a quasi vertical integration strategy, which generally entails strategic alliances, joint ventures, or even acquiring minority stakes in upstream or downstream companies.
As a result, you will incur lower costs upfront and have more flexibility than you would if you were building a fully integrated supply chain process for your company.
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Spot Contracts
Companies that don’t have a clearer picture of their production or supply chain requirements in the long run may opt for spot contracts.
These are contracts created to fulfill the next major step in the production and supply chain process rather than being integrated into it. Spot contracts are targeted at immediate needs and don’t contribute to long-term goals and strategies.
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Long-Term Contracts
Unlike spot contracts, long-term contracts are used to give you more control over your upstream or downstream activities and have a much longer duration.
This approach can help you reduce unpredictability, control costs and help establish a more stable supply chain operation.
Concluding Remarks
You can enhance your supply chain visibility and performance by implementing a successful vertical integration strategy for your business. However, before you can proceed with it, it is a good idea to consider the pros, cons and types of vertical integration so that you know to what degree the vertical integration strategy should be. Consider the stakeholders and resources associated with your supply chain process before working on your vertical integration strategy.
Contact us to discuss your requirements and have experienced 3PL partners help you implement and navigate the perfect supply chain operation.