Vertical integration strategy is a way through which companies try to hold their upstream suppliers and downstream buyers. There are three types of vertical integration and vertical Integration strategies are the combination of those strategies that are applied in the organization to acquire control over suppliers, competitors & distributors. Following are the three main types of vertical integration strategy, which are also collectively known as vertical integration strategies.
- Forward Integration Strategy
- Backward Integration Strategy
- Horizontal Integration Strategy
Vertical Integration Strategies are very useful for the organization. Following points show the benefits associated with the vertical integration strategies.
- The organization acquires the control over its competitors by the application of vertical integration strategies.
- The organization takes control of the activities of its suppliers through implementation of vertical integration strategies
- The organization gets control of functioning of its distributors with the implementation of vertical integration strategies.
Types of Vertical Integration Strategy
Forward Integration Strategy:
This is first type of the vertical integration strategy. In this vertical integration strategy the transactions between the organization & its customers are included. The organizations sells its products to intermediaries like distributors, retailers etc because it is not possible for it to sell its products directly to the final customers. When organization gets much control over or even ownership of its retailers or distributors then it applies forward integration strategy. The control can be gained over the distributor, supplier & competitor.
There are certain circumstances under which the implementation of forward integration strategy becomes much beneficial. For this purpose there are certain rules under which the organization should employ this strategy in order to get maximum advantage. Following are the six guidelines that are helpful for the organizations in the decision of implementing this vertical integration strategy.
- When the existing distributors of the organization are not reliable & are much expensive. They do not have the potential to fulfill the demands of the organization.
- When there is scarcity of the potential & qualified distributors.
- When there are competing organizations in the industry that is expected to rapidly grow.
- When the Business Organization has sufficient capital along with the human resource. In such situation the organization has the capacity to manage any new setup of distribution.
- In certain situations, there are much more advantages associated with the stable production by the organization. In such cases the forward integration is the best option for the organization.
- Sometimes the current distributors charge high profit margins for their services which lower the profit portion of the organization. So in such conditions the organization needs to formulate & implement sound forward integration strategy.
When there is a problematic situation in which the distributor of the organization is much expensive so in that case the organization should consider the forward integration strategy. The organization should formulate & implement this strategy in an effective manner by maintain the quality of product the same good as by the distributor in past. In the other case when the distributor is not much reliable for the organization to effectively deliver the products to the final customers at the given time frame. Moreover the requirements of the organization are not fulfilled by such distributor, than it is beneficial for the organization to apply forward integration strategy & gains control over that inefficient distributor. Sometimes there is no adequate availability of quality distributor to the organization which shows the scarcity of potential distributors in the market. The quality goods cannot be properly distributed to the final customers. In such case the organization should consider the forward integration strategy. For example an organization of computers also possesses other strategic business unit mobile phones, than it is quite needful for the organization to take into account forward integration strategy so that both the units work smoothly & effectively.
In certain situations the organization possesses enough amount of capital. Moreover there is also sufficient portion of human capital available to the organization. In such situation, it is much better option for the organization to employ its spare capital along with the available human resource in order to get maximum return.
The stable supply is necessary for the stable production in the organization. Also, when high markup is charged by the distributor then it is beneficial for the organization to takes the control of distribution operations & saves the costs of higher mark up charges. When organization acquires control, there comes stability in the production along with the consistent profitability.
- When the current distributors are not efficient enough to distribute good reliably & charges high costs for performing distribution functions for the organization. Moreover the requirements of the organization are also remains unfulfilled then forward integration becomes essential.
- When the quality distributors are not found in the market than better option for organization is to be involved in forward integration.
- When the industry of the organization shows growth & competition, then better alternative for the organization is to utilize forward integration strategy & by doing so the organization makes itself diversified against the faltering of the industry.
- When the organization possesses the needful human resources & capital to perform its functions than it is better option to be involved in forward integration.
- When the profitability of stable production is quite high, then the organization implement forward integration strategy so that it can predict the future demand of its output because its production is stable.
- When high profit margins are charged by the distributors & retailers than it is better option for the organization to distribute its products directly so that the extra costs could be saved & hence profitability is enhanced.
Backward Integration Strategy:
Backward integration strategy is the second utmost important type of vertical integration strategy. When the organization needs to acquire the control over the functioning of its suppliers, backward integration strategy is considered by the organization. Suppliers provide required input materials to both distributors & retailers. The distributors & retailers adopt this vertical integration strategy in order to get control of the operation & functioning of their suppliers. The application of backward integration strategy is quite useful when the suppliers are not reliable enough to provide required material on consistent basis. Also when the suppliers charge too much amount for their services & cannot properly fulfill the needs of the organization, then this vertical integration strategy is the only option for the organization to get control over the functioning of its suppliers & eliminate all the problems that come in the way of smooth running of the business.
Below are the guidelines that will assist you to apply this vertical integration strategy properly. There are certain conditions that become problematic for the organization for proper obtaining of required material & smooth running of the business. In such cases it is better option for the organization to adopt the strategy of backward integration in which it controls the operations of its suppliers & maintains consistent production & distribution functions. There are guidelines that are supportive for the organizations to adopt the strategy of backward integration. Following are six guidelines in this regard to apply this vertical integration strategy.
- The situation in which the current suppliers are not effective enough to provide the required materials to the organization. Also high amounts are charged by these suppliers which make them too expensive for the organization to tackle. The suppliers are not reliable & do not provide inputs in consistent manner.
- The condition where there are smaller number of suppliers in the market. The smaller number of suppliers is not proper enough to cover the entire market. The competitors in this case are also larger in number which makes the proper availability of required material from suppliers more difficult.
- The industry in which the organization is operating grows in a rapid manner which disturbs the smooth functioning of the input acquisition by the organization
- There is sufficient amount of capital available to the organization. The availability of human resource is also enough to the organization & so the organization posses the capacity to start any new business.
- When there are more benefits associated with the stable prices of the products which can be achieved though reduction in the costs of inputs.
- In certain situations the suppliers of the organization keeps high profit margins for their services & operations which ultimately affects the profits of the organization.
The organization has needs of different kinds of raw materials, components, parts & assemblies which are not properly delivered by its suppliers. Moreover the suppliers are not much reliable for making transactions & dealings with the organization. The suppliers are much expensive for the organization to obtain raw materials & inputs. In such condition it is quite beneficial for the organization to consider the backward integration strategy. The small number of suppliers along with the large number of competitors also forces an organization to apply backward integration strategy & gets control over the activities of its suppliers.
The industry growing rapidly also forces organization to diversify itself so that it can remain stable in the faltering of the industry. So the organization accomplishes this target through application of backward integration. The organization possessing sufficient human well as capital resource has the potential to start & manage any new project. So, it quite beneficial for the organization to involved in the backward integration by supplying the required inputs & raw material itself.
In certain cases there are high advantages of stable prices which become opportunity for the organization to be availed by lowering cost of acquisition of raw material from the suppliers. The organization accomplishes this through backward integration which in turn maintains the prices of its goods as stable one. In some situations the suppliers charges much higher profit margin from the organizations. In such case it is better for the organization to be involved in this type of vertical integration strategy. Finally when the organization strongly demands quick acquisition of raw materials, then backward integration is quite useful.
Horizontal Integration Strategy:
The third and last type of vertical integration strategy is horizontal integration strategy. Acquiring control over the operations & functioning of the competitors of the organizations is referred to horizontal integration strategy. In recent years, horizontal integration strategy is frequently used as growth strategy by the organization in their strategic management. Through increasing number of acquisitions, mergers & takeovers the organization not only increases its resources but also obtains large economies of scale. The effectiveness of the organization is also enhanced through horizontal integration strategy.
In horizontal integration there is increased control over the functioning & operations of the competing organizations through purchasing & hostile takeover. This provides new opportunities to organization to be availed. The organization gets control over the other organization that works in the same industry.
Below are the guidelines for this type of vertical integration strategy. This strategy is effective in certain conditions. Following are the four guidelines in this regard.
- When the federal government of the country cannot challenge the monopolistic characteristics of the organization.
- The industry in which the organization is competing grows.
- There are several competitive advantages attached with economies of scale.
- When there is need for particular resource or expertise then faltering is made by the organization.
In all the above situations & conditions, there is strong need for the organization to adopt this type of vertical integration strategy, which gives many benefits & advantages to the organization.
Hello everyone! This is Richard Daniels, a full-time passionate researcher & blogger. He holds a Ph.D. degree in Economics. He loves to write about economics, e-commerce, and business-related topics for students to assist them in their studies. That's the sole purpose of Business Study Notes.
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