⌛ Example Of Vertical Integration

Thursday, July 08, 2021 4:01:58 AM

Example Of Vertical Integration

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Tesla's Secret Weapon: Vertical Integration

Examples include iron mining companies that own "downstream" activities such as steel factories. Backward integration takes place when businesses at the end of the supply chain take on activities that are "upstream" of its products or services. Netflix, a video streaming company that distributes and creates content, is an example of a company with backward integration.

A balanced integration is one in which a company merges with other businesses to attempt to control both upstream and downstream activities. An example of a company that is vertically integrated is Target, which has its own store brands and manufacturing plants. They create, distribute, and sell their products—eliminating the need for outside entities such as manufacturers, transportation, or other logistical necessities.

Manufacturers can also integrate vertically. Many footwear and apparel companies have a flagship store that sells a wider range of their products than are available from outside retailers. Many also have outlet stores that sell last season's products at a discount. There are five noteworthy benefits of vertical integration that give a company a competitive advantage over non-integrated competitors. A vertically integrated company can avoid supply disruption. By controlling its own supply chain, it is more able to control and deal with any supply problems itself. A company benefits by avoiding suppliers with market power.

These suppliers are able to dictate terms, pricing, and availability of materials and supplies. When a company can circumvent suppliers such as these, it is able to reduce costs and prevent production slow-downs caused by negotiations or other aspects external to the company. Vertical integration gives a company better economies of scale. Large companies employ economies of scale when they are able to cut costs while ramping up productions—they take advantage of their size.

For example, a company could lower the per-unit cost by buying in bulk or by reassigning employees from failing ventures. Vertically integrated companies eliminate overhead by consolidating management and streamlining processes. This increases supply, lowers fixed and variable costs per unit, and makes a product more attractive to consumers. Companies keep themselves informed on their competition. Retailers know what is selling well. If a company was vertically integrated with a retail store, manufacturing plant, and supply chain, they would be able to create "knock-offs" of the most popular brand-name products.

A knock-off is a copy of a product—a similar product but company-branded with company marketing messages and packaging. Only powerful retailers can do this. Brand-name manufacturers can't afford to sue for copyright infringement, as they would risk losing major distribution through a large retailer. Lower pricing strategies can be used. A company that's vertically integrated can transfer the cost savings they create to the consumer. Examples include Best Buy, Walmart, and most national grocery store brands.

The biggest disadvantage of vertical integration is the expense. Companies must invest a great deal of capital to set up or buy factories. They must then keep the plants running to maintain efficiency and profit margins. Vertical integration reduces a company's flexibility by forcing them to follow trends in the segments they integrated. Suppose a company acquired a retailer for their product and created an outlet store that carried the old merchandise as well.

That retailer's competition began using a new technology which boosted their sales. Let's assume you manufacture handbags and your established sales have been through independently owned gift shops. You are considering vertically integrating by selling direct to consumers on your website. Your plans for going into online sales must take into account potential loss of sales through your present avenues of distribution. Will you lose already established sales to gift shops? Vertical integration can be expensive, and growing the supply chain does not always lead to greater profits. It may require a large investment to set up and maintain manufacturing or distribution centers, and your company may find it difficult to compete with other companies that outsource to countries with cheap labor.

Vertical integration also allows for less flexibility, so it is difficult to reverse. In the end, you may end up losing money on your investment, and too often an acquisition mistake cannot be made profitable by working harder. Vertical integration could potentially hurt a company when new technologies evolve quickly and become available. The company is then forced to reinvest in the new technologies in order to stay competitive, which is costly and may require retraining of employees. If you go into manufacturing, you may not be able to keep costs as low as independent suppliers who sell to many other customers. For example, when an auto manufacturer owns its own tire manufacturing, its production of tires is most likely limited to the needs of the parent firm, whereas a standalone tire company can sell to numerous auto manufacturers, achieving greater economies of scale.

When a union company vertically integrates with a non-union company, labor issues can arise. For example, if a non-union company vertically integrates with a union supplier, there is a chance of the parent company shutting down the supplier and outsourcing the service to reduce costs. This, in fact, has been the trend in the airline industry where outsourcing maintenance to lower cost overseas shops has soared. Through specialization, some companies are so good at what they do they almost remove themselves from the competition. Your company may be excellent at retailing its products, but ill-equipped to manage the manufacturing process. A vertical merger could put the success of the company in jeopardy and may change the culture permanently.

While there are many advantages of vertical integration, all risks must be considered before moving forward. You may find that other strategies, such as buying a business at your own level in the supply chain, are better opportunities with less risk. Create new profit centers Online stores such as Amazon and Chinese e-commerce giant Alibaba, now enable manufacturers to sell directly to customers anywhere, anytime, creating an entirely new center of earnings.

Expand geographically Vertical integration can allow your business to expand geographically by adding distribution centers in new areas or by acquiring a new brand. Maintain quality control If you're a cake maker and manufacture your own cake mixes, you're not at risk of a supplier cutting down or substituting the eggs. Differentiate from competitors Vertical integration may allow a company to set itself apart from its competitors.

Protecting proprietary processes or recipes In some cases, secret recipes are so valuable that they are maintained as true trade secrets and outsourcing their manufacturing would be unthinkable, such as with Coca-Cola.

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