Vertical Integration in Business: 3 Types of Vertical Integration

Vertical integration is a competitive strategy companies use to secure total control over the production process of a product. Any company that buys its own supply of raw materials for a product, along with the tools to make and transport that product in-house, employs vertical integration. This strategy aims to own as many parts of the supply chain as possible and minimize transaction costs typically spent on outsourcing.

There are three ways a company can employ vertical integration.

1. 1. Forward vertical integration: Forward integration is a type of vertical integration in which a company in the supply chain merges with a distribution channel.
2. 2. Backward integration: Backward integration is a type of vertical integration considered an upstream business move. It involves a parent company expanding backward by purchasing and controlling earlier stages of the supply chain. Backward integration allows them to control the raw materials needed to create the final product.
3. 3. Balanced integration: As the name suggests, balanced integration means that the vertical integration strategy contains components of both forward and backward integration strategies.

Coffee giant Starbucks prides itself on its balanced integration strategy. “If you are a consumer products company today, you’re under tremendous profit margin pressure,” says longtime Starbucks CEO Howarld Schultz. “And so you really have to make sure that the hidden costs of the product are something you know a lot about.”

“What I’m talking about is the supply chain aspect of the business,” he explains. “Most people focus so much on the cost of the product to make it, and the retail selling price, and you lose sight of the cost of getting it to market.”

Starbucks uses both forward and backward vertical integration to maximize profits. By maintaining direct relationships with coffee growers and owning their equipment, storage, and roasting facilities, Starbucks can control its entire manufacturing process. They also practice forward integration by providing gas stations and markets with a product line of bottled and canned Starbucks coffee drinks.

Vertical and horizontal integration are business models designed to help companies increase profitability, but they do this differently.

1. 1. Resources purchased: Horizontal integration involves one company buying another company within the same value chain level to increase its market share. In contrast, vertical integration involves purchasing various companies up and down the supply chain for competitive advantage.
2. 2. Competitive strategy: When a vertically integrated company owns all or several parts of the supply chain, they become independent from suppliers. This integration allows the company to increase efficiencies, lower costs, and compete with other companies by offering cheaper or more consistent products. Horizontal integration involves buying competitor companies within the same industry that are similar in size. Buying out the competition not only creates a larger company or conglomerate, but creates economies of scale, increases market power among suppliers and distributors, and opens up new markets for the company.
3. 3. Challenges: A horizontally integrated company has to stitch together similar companies, maintaining cohesion as the company expands. Vertically integrated companies must stitch together several parts of the supply chain, ensuring each disparate piece works as efficiently as the next.

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