Vertical Integration of Supply Chain: Pros and Cons

Vertical integration is a supply chain strategy that involves a company taking control of multiple steps in its supply chain -- from raw materials to finished products.

This can involve backward integration (taking control of suppliers) or forward integration (taking control of distributors or retailers).

Vertical integration gives organizations more control over the quality of their products, production costs and also delivery times, allowing them to eliminate their reliance on external suppliers and ensure that each step in the supply chain meets the required quality standards.

The oil and gas industry is an example of vertical integration, with oil companies owning and operating their own refineries and distribution networks to reduce dependence on external suppliers. Besides gaining greater control over the quality and consistency of their products, owning the distribution networks help the companies reduce transportation costs and improve delivery times.

Many fashion companies too have vertically integrated their supply chains by controlling design, manufacturing and retail sales. This has helped them respond quickly to changing fashion trends and reduce lead times for new products.

Another example of vertical integration is the poultry industry, where companies have taken ownership of feed production, chicken farming, and processing plants to ensure consistent quality and supply.

However, vertical integration can also be costly and complex. It requires significant investment in infrastructure and resources along with new capabilities and expertise. It can also limit a company's flexibility and ability to respond to market changes.

What is Vertical Integration and How Does It Work?

Vertical integration refers to a company expanding its operations to cover multiple or all of the stages in the production and distribution of its products. It could involve either acquiring or merging with companies up and down the supply chain. Vertical integration can be achieved through internal business development or through mergers and acquisitions (M&A). While it increases the requirement for resources, the integrated model provides strategic advantages from owning more of the end-to-end process.

Backward Integration

Through this, the company integrates itself with suppliers, bringing the production of certain components or raw materials in-house. This gives the company more control over the quality and availability of these components and potentially reduces costs too.

For example, in the automotive industry, manufacturers integrate backwards by manufacturing their own engines, transmissions, and other critical components to ensure specific quality standards and reduce the risk of supply chain disruptions.

Forward Integration

In this process, the company brings sales and distribution of products or services in-house. This helps it manage customer experience better, providing opportunities to increase revenue and cut distribution costs.

The retail industry has widely adopted forward integration by opening own stores or e-commerce platforms to sell directly to customers.

The Risks of Backward and Forward Integration

Integrating backwards may strain relationships with suppliers while integrating forwards could risk competing with existing customers.

However, vertical integration overall may not always the best strategy for every company. Organizations that rely on a high degree of customization may benefit more from outsourcing to external partners. Also, companies that operate in regulated industries may face challenges in integrating vertically.

Conclusion

Vertical integration can be a useful strategy to gain benefits in terms of quality, cost, and delivery times if it aligns with the overall business strategy. By using data and real-world examples, supply chain professionals can make informed decisions about whether vertical integration is the right approach for their organization.