In 2009, HBR Published an article that Forward Vertical Integration is making a strong comeback. The context of the article dates back to 2009, but we are seeing an upward trend in a post-COVID world due to trade disruptions in China and USA and also due to the Russia-Ukraine war. Many top manufacturers have started forward vertical integration due to these uncertainties.
Many large organizations like Apple have started manufacture of their own semiconductor chips. It helps them stabilize the Chip Shortages and gain significant advantages over its competitors who do not have the power to manufacture chips. They can also own the manufacturing company which assembles I Phones for them giving them the much needed flexibility in avoiding supply chain shortages and catering to the exact demand.
forward vertical integration occurs when a company acquires a starts controlling the value chain of the successor value chain
Definition of Forward Vertical Integration
Forward vertical integration is the process of combining different value chains of an organization to create a new one. It is typically undertaken to gain a larger share of a market or to reduce costs or improve customer experience. For example, a company Umbrellas Inc. may manufacture and distribute umbrellas through another company, but decide to buy Rainy Day Inc. to make the umbrellas more affordable and its distribution more efficient. This is a case of forward vertical integration as the company which owns the manufacturing now owns its distribution and sales
Examples of Forward Vertical Integration
A company with forward vertical integration will be able to sell its products at lower prices and higher profit margins than competitors. Moreover, the multiple stages of the supply chain will help it to create a stronger brand image. Oil giants like ExxonMobil, Chevron, ENI, BP, Total, and others are examples of vertically integrated companies.
The main aim of forward integration is to lower costs and improve efficiency within a company. By doing so, companies replace third-party supply channels with their own. This approach reduces costs, improves the efficiency of a company, and increases its proximity to the end consumer. Further, this method ensures that profits are not lost to intermediaries.
Forward vertical integration allows companies to control the distribution chain from the point of production to the point of sale. Nieman and Pretorius describe it as “controlling the whole value chain, from suppliers to customers.” Businesses like Business Partners, LLC have adopted this concept and invested in a comprehensive growth strategy. The company plans to expand its product line and open its own retail location. By doing so, it can increase profits and gain control over its supply chain.
Forward vertical integration is a common practice in the manufacturing sector. Companies that manufacture cars, for example, can buy a car retailer. Another example of a forward vertical integration company is Amazon. This company may also purchase a chain of movie theaters for distribution of its Prime Movies. In this case, the company is moving up the supply chain, from raw materials to retail distribution.
Upstream vertical integration can also involve merging with another company. For example, a large retailer can merge with a smaller company and start selling the products to its customers. The other way around is through mergers and acquisitions. In this way, both sides benefit from the integration strategy. However, it is not recommended in all circumstances, as it is more costly and can result in legal disputes.
Forward integration can be a crucial strategy in achieving a competitive advantage. When companies control a higher proportion of the distribution process, they are able to provide superior service to consumers. It also helps reduce overall costs and creates barriers to entry for new competitors. As with any strategy, forward integration has its advantages and disadvantages.
What are the various Types of forward Vertical Integration?
Forward vertical integration involves a company acquiring another company that is further up the supply chain, such as a retailer. For example, a company that makes bicycle tires might acquire a company that makes bicycles. Similarly, a fast-moving consumer goods company might acquire a business that distributes its products to retailers throughout many regions.
Several companies have implemented this strategy. Apple, for example, has opened its own stores but has also been acquiring other companies in the retail industry. The company is leveraging its market presence to create a new advantage in the retail space. As a result, it is now able to sell a wider range of products and increase profits, while reducing shipping costs.
Another example of forward vertical integration is Amazon’s purchase of Whole Foods. Amazon is already a vertically integrated business, as it publishes books and provides a publishing platform to independent writers. In addition, the company owns distribution channels and delivery systems, making it able to provide products directly to the consumer.
The process of vertical integration can also be reversed. A company can purchase other companies or the entire supply chain of a company. For example, a company that manufactures furniture can buy a company that supplies wood to the manufacturing process. This way, the company can control its own inputs and produce a consistent product. This strategy has been used by major corporations such as Ford to reduce their costs and ensure quality.
While the concept of vertical integration is typically discussed in manufacturing, it can also be used by entertainment firms. For example, a Canadian English language specialty television network, The Sports Network (TSN), is owned by CTV Specialty Television and ESPN Inc. TSN owns a production company so that it can continue to broadcast sports content. By doing this, the company is able to guarantee a steady stream of programs to audiences.
Choosing the right vertical integration strategy is crucial. Considering the structure of the company, the products, and the resources that it produces can help determine which areas are most valuable. This will allow the company to make the right business decisions.
How does it help organizations in megers and acquisitions?
Forward vertical integration can help organizations improve their competitiveness through greater control over industry distribution channels and lower costs. The strategy is also effective in strengthening an organization’s position in industry by establishing barriers to competitors. For example, it is possible for a company to acquire a satellite TV company, which allows it to control the distribution of its own media content. Similarly, an organization can acquire a computer manufacturer, such as Dell, and limit its competition’s access to its distribution channels.
A successful vertical integration strategy can increase a company’s value by enabling it to expand globally. It can also provide it with new technologies and talents, improve product quality and timeliness, and reduce costs. However, the risk of a vertical integration strategy is significant. Therefore, managers must consider several factors before making a decision.
Forward vertical integration helps organizations acquire companies that produce value in the secondary supply chain. For example, a farmer who sold his fruits and vegetables to distributors can now sell his products to a local grocery store, while a retail company can offer after-sales service for its products. By acquiring companies that provide value, a company can become more competitive and have greater market control.
Forward vertical integration can also help organizations streamline operations by allowing companies to take direct ownership of the production process. As a result, it helps organizations save money and increase control over their processes. In some cases, it may require additional upfront capital outlays. However, this strategy can benefit both the company and its customers.
Disadvantages of Forward Vertical Integration?
While forward vertical integration is advantageous for some companies, it also has its drawbacks. For example, it may cause complacency in some companies. A company that owns a large aluminum company may feel complacent that its subsidiary will use its products. Alternatively, some companies make their subsidiaries compete with external suppliers, which undermines their original purpose for purchasing the subsidiary in the first place.
Another disadvantage of forward vertical integration is the increase of overheads and costs. Whenever an organization adds a new organization, its overheads, employee costs and salaries are bound to go up.
By Forward vertical integration, many companies can tread outside their core competencies, which can lose their competitive advantage in the long run owing to lack of focus in its core business
forward vertical integration advantages
A company may opt to engage in forwarding vertical integration to improve its strategic positioning and gain more market share. This strategy involves taking internal steps to reduce the dependence on external suppliers and to ensure proper coordination of the supply chain. This method, however, can result in lower product quality, increased bureaucracy, and less flexibility.
Despite the inherent risks, this strategy can deliver a number of benefits to a company. First, it can help assure the supply of critical materials. In addition to reducing costs, vertical integration can also improve coordination and control of inventory. For example, a retail company may be better able to schedule production if it has a firm commitment from a downstream facility. Furthermore, a company may be able to maximize its profits by reducing its costs and increasing its competitiveness.
Backward vertical integration is often discussed in the context of manufacturing firms, but it is possible for entertainment companies to engage in this strategy as well. An example is The Sports Network (TSN), a Category C specialty channel in Canada that is owned by CTV Specialty Television (CTV), Bell Media, and ESPN Inc. It was launched in 1984 as part of the first group of specialty cable channels in Canada. TSN also owns its production company, which can ensure a steady flow of programs for viewers.
Companies pursuing this strategy often invest in new parts of the value chain. Increasing the number of suppliers can lower prices, but it can also reduce flexibility. As a result, companies may be forced to follow trends in the integrated segments. For example, a competitor may be using new technologies that require extensive manufacturing.
Whether forward vertical integration is necessary depends on the size of the company. Some companies have a small scope and do not compete well against independent suppliers. They may also be faced with a profitability penalty. For example, companies that produce high-end personal care products often enjoy high rates of value added. On the other hand, companies that manufacture computers typically only have a modest in-house manufacturing operation.
Forward vertical integration is a good way to reduce costs. Forward vertical integration allows companies to better control various supply chain stages and can lead to a more efficient vertical chain. In addition, it enables businesses to determine their demand quantity and composition earlier, which can lead to more accurate production levels and reduced costs associated with overages.
Samrat is a Delhi-based MBA from the Indian Institute of Management. He is a Strategy, AI, and Marketing Enthusiast and passionately writes about core and emerging topics in Management studies. Reach out to his LinkedIn for a discussion or follow his Quora Page