Vertical Integration

Question 1

What is Vertical Integration (“VI”)?

Answer 1

The internalisation of economically and technologically distinct processes in a Firm’s supply chain (“SC”).

Porter, Competitive Strategy —P. 363.

Question 2

What are the Four Types of Vertical Integration?

Answer 2

• Forward Integration (“FI”): Acquisition of downstream processes.
• Backward Integration (“BI”): Acquisition of upstream processes.
• Tapered Integration (“TI”): Partial acquisition of a distinct process, supplemented by outsourcing.
• Quasi-Integration (“QI”): Partial control over a distinct process using bonding mechanisms, e.g. long-term contracts, joint ventures, equity stakes, etc.

Porter, Competitive Strategy —P. 363.

FI and BI constitute Full Integration, TI and QI constitute Partial Integration.

Question 3

What are the Benefits of Vertical Integration?

Answer 3

• Increased efficiency.
• Increased pricing power.
• Increased quality control.
• Increased Differentiation.
• Increased access to new markets.
• Increased strategic independence.
• Increased Entry and Mobility Barriers.
• Increased Scale and Scope Economies.
• Increased technological advancement.
• Increased secrecy of proprietary knowledge.
• Increased SC access, stability and coordination.
• Increased access to market information.
• Increased control over critical inputs and outputs.
• Increased resilience against market imperfections.
• Increased resilience against upstream-downstream Firms’ bargaining power.

Porter, Competitive Strategy —P. 364-372.

Economic and strategic considerations must be balanced against each other when evaluating a prospective VI, as a strategic advantages may outweight economic costs in the long run.

Question 4

What are the Costs of Vertical Integration?

Answer 4

• Increased Exit Barriers.
• Increased operating leverage.
• Increased exposure to sector- and market-specific risks.
• Increased costs from surmounting Entry and Mobility Barriers.
• Increased costs from subsidising a strategically important but economically weak unit.
• Increased costs from coordinating and maintaining balance between units.
• Increased costs and decreased efficiency from dulled competitiveness in units.
• Increased costs and decreased efficiency from differing managerial requirements between units.
• Decreased ability to change upstream-downstream partners.
• Decreased ability to freeride off of upstream-downstream Firms’ commercial and technological expertise.

Porter, Competitive Strategy —P. 372-379.

Question 5

Why would a Firm select Partial Integration over Full Integration?

Answer 5

It requires less commitment and can blend the costs and benefits of VI in more strategically and economically advantageous ways than Full Integration.

Porter, Competitive Strategy —P. 383

Question 6

What are Common Pitfalls when considering Vertical Integration?

Answer 6

• Assuming integration will bolster a sick business and failing to recognise how the sickness could spread.
• Assuming it is always cheaper to internalise costs and failing to recognise the hidden costs of integration.
• Assuming managerial experience or a strong market position in one process will automatically translate to another.

Porter, Competitive Strategy —P. 387-388.