Vertical Integration summary by Dianes Garguena

7/29/2019 Vertical Integration summary by Dianes Garguena

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Vertical Integration

Diane Mae GargueaCostumer Service Specialist New AccountsSecurity Bank Corporation


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Vertical integration is the combination of technologically distinct production,distribution, selling, and/or other economicprocesses within the confines of a single firm.

All the functions we now expect acorporation to perform could be performedby a consortium of independent economic

entities, each contracting with a centralcoordinator.


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Horizontal integration- process of merging similar industries,

industries that produce similar products

; include tactics like buying competingcompanies that produce the same goods asyou do

Vertical integration- process of buying out suppliers of thatparticular industry.

Vertical Integration vs Horizontal Integration


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Upstream firm = Selling Firm

Downstream Firm = Buying Firm


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Economies of Integration-Cost savings in joint production, sales, purchasing,control, and other areas

Economies of Combined Operations - By puttingtechnologically distinct operations together, thefirm can sometimes gain efficiencies

Economies of Internal Control and Coordination

- The costs of scheduling, coordinating operations,and responding to emergencies may be lower if the firm is integrated

Strategic Benefits of Integral Integration


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Economies of Integration

Economies of Information - Integrated operationsmay reduce the need for collecting some types of information about the market, or more likely, mayreduce the overall cost of gaining information

Economies of Avoiding the Market - By integrating,the firm can potentially save on some of the selling,price shopping, negotiating, and transactions costs of market transactions.



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Economies of Integration

Economies of Stable Relationships - Both upstream anddownstream stages, knowing that their purchasing and sellingrelationship is stable, may be able to develop more efficient,specialized procedures for dealing with each other that wouldnot be feasible with an independent supplier or customer-whereboth the buyer and the seller in the transaction face thecompetitive risk of being dropped or squeezed by the otherparty

Characters of Vertical Integration Economies Economies of integration are at the core of the analysis of vertical integration,not only because they matter in and of themselves, but alsobecause they contribute to the significance of some other issuesin integration to be discussed



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Tap Into Technology

- Vertical integration can provide close familiarity withtechnology in upstream or downstream businesses thatis crucial to the success of the base business, a form of economy of information so important as to deserveseparate treatment.



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Assure Supply and/or Demand

- Vertical integration assures the firm that it will receiveavailable supplies in tight periods or that it will have anoutlet for its products in periods of low overall demand



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Offset Bargaining Power and Input Cost Distortions

- If a firm is dealing with suppliers or customers who exertsignificant bargaining power and reap returns on investmentin excess of the opportunity cost of capital, it pays for the firmto integrate even if there are no other savings fromintegration



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Enhanced Ability to Differentiate

- Vertical integration can improve the ability of the firmto differentiate itself from others by offering a wider sliceof value added under the control of management



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Elevate Entry and Mobility Barriers

- If vertical integration achieves any of these benefits, itcan raise mobility barriers. The benefits give theintegrated firm some competitive advantage over theunintegrated firm, in the form of higher prices, lowercosts, or lower risk



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Enter a Higher-Return Business

- A firm may sometimes increase its overall return oninvestment by vertically integrating



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Defend Against Foreclosure

- Even if there are no positive benefits of integration, itmay be necessary to defend against foreclosure of accessto suppliers or customers if competitors are integrated



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Cost of Overcoming Mobility Barriers

-Vertical integration obviously requires the firm toovercome the mobility barriers such as economies of scale and capital requirements to compete in theupstream or downstream business

Strategic Costs of Integration


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Increased Operating Leverage

- Vertical integration increases the proportion of afirm's costs that are fixed. If the firm was purchasingan input on the spot market, for example, all the costsof that input would be variable



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Reduced Flexibility to Change Partners

- Vertical integration raises the costs of changeoverto another supplier or customer relative tocontracting with independent entities.



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Higher Overall Exit Barriers

- Integration that further increases thespecialization of assets, strategic interrelationships,or emotional ties to a business may raise overallexit barriers



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Capital Investment Requirements

- Vertical integration consumes capital resources,which have an opportunity cost within the firm,whereas dealing with an independent entity usesinvestment capital of outsiders



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Foreclosure of Access to Supplier or Consumer

Research and/or Know-How- By integrating, the firm may cut itself off from the flowof technology from its suppliers or customers



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Maintaining Balance

- The productive capacities of the upstream anddownstream units in the firm must be held in balance orpotential problems arise



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Dulled Incentives

- Vertical integration means that buying and sellingwill occur through a captive relationship



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Differing Managerial Requirements

- Businesses can be different in structure, technologyand management despite having a verticalrelationship



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~FIN ~

Vertical Integration summary by Dianes Garguena

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