Vertical integration is a strategy where a firm owns or runs several stages of production, including taking raw materials and turning them into finished products. Therefore, firms that adopt vertical integration own numerous parts of the supply chain. Forward integration is when a firm owns an upstream supply chain such as an oil-drilling firm running a refinery plant. On the other hand, a firm that adopts backward integration runs a section of the operations that are downstream production while at the same time pursuing their own marketing campaigns. This means that a firm that deals in cotton will find it necessary to establish a fabric manufacturing section and a sales promotion section.
Quantified Commerce is a fully-vertically-integrated firm, founded by Agam Berry, and has full control of their supply chain, which has reduced cost and helped them achieve market control.
Here are some of the reasons why Quantified Commerce believes vertical integration is the way to success:
Scalability and profitability.
Large businesses are more able to adopt vertical integration than small competitors are since large firms are able to achieve higher levels of efficiency at all stages of their operations. Whether you pursue backward or forward integration, you are more likely to achieve greater competitiveness because of your ability to diversify. Diversification of operations tends to spread risks and optimize operations to levels that are extremely sustainable. A business that boasts of a large market share is able to achieve efficient scale compared to businesses that operate in a single market. Therefore, large market share firms have a higher chance of gaining greater benefits from continued vertical integration.
Improved coordination and reduced cost.
Vertical integration is capable of reducing cost through improving production. In addition, this strategy allows for better coordination thus adopters of this strategy are able to coordinate their operations better. Clearly, an in-house supplier is in a better position to schedule production processes more efficiently compared to an external distribution service.
Increased Technological Capabilities.
Experts claim that companies that are vertically integrated are well prepared to adopt innovations. This is because they are better equipped to engage in production activities that generate change. This argument relies on the belief that essential requirements for successful implementation are effective coordination of both technical and marketing aspects of a business.
Reduced Transaction Costs.
The primary objective of increased adoption of vertical integration in businesses is to minimize the selling and buying costs where a firm has two or more stages of production. The physical cost of handling distribution of final goods and raw materials to the production point accounts for over 30 percent. Therefore, if your company has the capabilities of reducing these costs, chances are you are going to record better profits. For example, a company that manufactures integrated circuits together with finished items will operate with fewer sales personnel. In addition, such companies will be able to incur less cost in product promotion and market research.
Is It Profitable or Isn’t It?
Because vertical comes with both benefits and downsides, it is expected that the payoff due to this strategy will vary according to different circumstances in which the business operates. Numerous research studies have been conducted to establish the significance of vertical integration. Here are some of the benefits of this strategy.
Challenges of Vertical Integration.
Higher entry barriers – surveys have indicated that a business that is vertically integrated requires more financial and managerial resources in order to compete favorably. Therefore, businesses that need to adopt this strategy need to have sufficient resources. This means that while vertical integration is undoubtedly an incredible strategy, only established companies have the capacity to leverage its benefits of this strategy.
How Businesses Can Resolve the problem of Disproportionate Return on Investment (ROI).
Clearly, you need to understand that with higher vertical integration, businesses will experience heightened investment needs. Some businesses that adopt this strategy tend to hurt their returns on investment (ROI). This is because such businesses are unable to cope with higher resource needs. Therefore, the best solution to this challenge is to increase your investment base through processes and operations that add value to production processes. One sure way of adding value is through improving the technical skills in areas that matter to your business, including design, customer service and standardization of operations.