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What is Vertical Integration?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 27 September 2014
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A vertical integration is the union of two companies who come together in order to create a value chain that allows all parties to enjoy the benefits of business while sharing the costs and risks. A number of factors can be the motivation for entering into a vertical integration, such as costs of produced goods and services or the market differentiation associated with each partner. Choosing to enter into a working agreement of this type call allow both parties to enjoy a quicker service delivery with the distribution of a product, and thus increase the profit margin by generating additional sales.

There are several areas in which a vertical integration may be to the mutual benefit of both companies. One such area is the securing of raw materials for the production of the goods and services offered by each company. Together the two companies may enter into a joint effort of exploration and purchase of these materials. By conducting this task of search and recovery together, costs are kept to a minimum. This will result in a lower overall cost per produced unit, which means more profit at the point of sale for the supplier and possibly a discounted cost per unit for the buyer.

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Another area in which a vertical integration may be mutually advantageous is in the distribution process for the end products. Both companies may be able to work together on securing retail outlets that will carry the goods produced by both entities. This can also allow the partners to save money on distribution costs such as transportation, as well as help both entities to break into retail markets that may have been closed to one or both companies in the past.

At its core, the vertical integration can be an excellent means of managing a higher level of profitability for both the supplier and the customer. By working together, it is possible for the supplier to incur less cost in the production process, and pass on part of the savings to the customer. At the same time, the customer works with the supplier to open up additional retail markets to the mutual benefit of both.

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anon326038
Post 6

When in History did these types of Integrations take place?

burcidi
Post 5

We just covered this subject in Econ class. I compared my class notes and the article is spot on. It was also a nice review for me.

One thing that my Professor mentioned is that vertical integration is contractual. So if the two companies have made a contract that they will integrate for a period of ten years, if the contract is not renewed after ten years, it's over.

So it's definitely not permanent, companies integrate, disintegrate and reintegrate again all the time.

SteamLouis
Post 4

@anon28996, @alisha-- I think this answers both of your questions.

The way I understand it, two companies will vertically integrate because any other way of working together is just too costly or undesirable.

For example, let's say a soda company outsources the production of bottles to another company. Not only will this increase the cost of bottles, because the soda company is having another company do it, but it also doesn't get any say in how that company runs even though it has a huge impact on the soda company's production, costs and profits.

The soda company will then want to vertically integrate with the other company. This way the other company still makes money, the soda company saves money and has a say in the management of the other.

Do you see why it's desirable and which type of companies would want to do this? It's for greater profits and more managerial power and usually done by companies who have to outsource some of their activities.

discographer
Post 3

I don't know if I understand this right, but wouldn't it be better for the two companies to work in different steps of the production rather than the same exact one?

For example, if exploration and buying of raw materials is cheaper for one company to do rather than the other, they could integrate and have one be responsible for exploration and another for distribution for example. They would both benefit from profits.

Why is vertical integration better than this? Why would we want the companies to engage in the same exact step in production?

anon31705
Post 2

Thank you, wiseGEEK, you have saved my life! I am doing my final on a law exam, it's take home. I am finishing up my Masters in Jurisprudence, specializing in Health Law, and I must have been absent the day the professor discussed vertical integration. Thanks

anon28996
Post 1

What types of companies are more likely to become vertical integrated?

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