What Is Vertical Integration?

Vertical integration is a business strategy used to expand a firm by gaining ownership of the firm's previous supplier or distributor. Many firms use vertical integration as a way to reduce cost and increase efficiency, which results in increased competitiveness. Firms engage in two types of vertical integration.

• Forward integration
• Backward integration

Forward integration is a method of vertical integration in which a firm will gain ownership of its distributors. Backward integration is a method of vertical integration in which a firm will gain ownership of its supplier. Firms may utilize a forward or backward integration strategy or they may use a combination of both known as a balanced integration strategy.

How a Vertical Integration Strategy Is Used

Implementing a vertical integration strategy, whether backward or forward, allows a firm to have greater control over its process. For instance, for the past twenty years, Bob's family has owned a pig farm. The pig farm makes just enough that it supports his family. Bob wanted to increase his profits and his ability to compete against other farmers in the market. Bob read an article about vertical integration and decided to implement a forward integration strategy in order to increase his profits.

Bob thinks that he has the best pigs around, and if he started a BBQ restaurant, featuring his pigs, he could increase his profits. He owns the farm where the pigs are raised, so he has greater control over things like cost and quality. Bob's restaurant did so well that profits soared, and he decided to utilize a backward integration strategy as well and buys the feed store that supplied him with food for his pigs.

Advantages of Vertical Integration

Introducing a vertical integration strategy can have many advantages for a company, such as:

• Increased competitiveness
• Greater process control
• Increased market share
• Increased supply chain coordination
• Decreased cost

Many companies use this strategy because it may decrease cost by eliminating price markups associated with buying a product from a third party. Starbucks, for instance, is not just a coffee house. They also grow their own coffee beans. Starbucks coffee can also be found packaged and sold in your local grocery store.

Vertically integrated companies are also better able to control quality and coordinate the delivery of raw materials or other supplies. Having this level of control allows companies to increase their supply chain efficiency.