What's Vertical Integration and its Effect on a Company's Growth

If you're a student of business management, you must have come across the term 'Management Control'. Vertical integration is a type of management control and the following article attempts to dig out the details of this style of management control.
Before getting to the details of vertical integration, let's start with unraveling management control. Control is a function of management, as put down by Henri Fayol. According to Fayolism, there are six primary functions of management - Planning, Organizing, Directing, Coordinating, Controlling and Forecasting. The management control function pertains to all those activities carried out by a business to foresee the future course of action in order to set standards for business operations, both external as well as internal, and make sure that there is no deviation from such standards. It is a continuous management process and is an integral part of each hierarchical level of an organization. This process looks into the future and works in close conjunction with the planning function of business management.

To quote Henry Fayol, "Control of an undertaking consists of seeing that everything is being carried out in accordance with the plan which has been adopted, the orders which have been given, and the principles which have been laid down. Its object is to point out mistakes in order that they may be rectified and prevented from recurring." Coming back to vertical integration, let's take a detailed look at this style of management control to get a complete understanding of this concept.

What is Vertical Industrial Integration?

Vertical industrial integration is a very prominent structure of industrial integration and is mostly seen in the form of supply chains where the finished goods of one firm becomes the raw material for the next firm in the chain. This form of industrial integration is different from horizontal integration, the latter being undergone for market dominion purposes. This goes on till the very last stage where the final product is ready for release in the end consumer market. Most of the time, these vertically integrated firms are owned by a common enterprise which unites and coördinates the activities of such a supply chain. Most of the time, when each step of the manufacture of a compound product is performed by a different firm functioning under a separate owner, coordinating the activities may become a big issue, leading to hold up problems which take place due to concerns of each of these separate firm owners that such co operational integration may bestow increased bargaining power upon the other parties, which may eat into their own profit share.

Type of Vertical Integration Strategy

This type of industrial integration may exist in any of the following three forms:-
  • Forward Integration where a firm manufacturing functional raw materials for another firm's production process controls such subsequent product/ process firms. Forward vertical integration may also be seen in the form of a manufacturing firm which controls and co√∂rdinates the activities of its distributors and retailers.
  • Backward Integration where a firm is in control of other firms that produce materials needed for its own manufacturing or processing activities. For instance, a PC assembling firm may be in control of other firms producing monitors, keyboards, motherboards and CPU.
  • Balanced Vertical Integration where a single firm holds ownership and control over all components or firms of a manufacturing process from procurement of materials to the final goods reaching the end customer - right from the different firms involved in direct manufacturing and assembly to the distributors, suppliers and retailers.
Examples of Vertical Integration

Most heavy industry players, such as Iron and Steel companies, are perfect examples of vertical integration. Carnegie Steel company is a prominent example as it controlled the steel mills as well as the iron ore mines, coal mines, the shipping firms that were responsible for transporting the ore and the railroads that were used to convey coal to the steel factory. Another good example of a vertically integrated industrial structure is the oil industry where almost all players are actively involved in controlling the activities throughout the supply chain - right from detecting crude oil sources to drilling, extraction, transporting to refineries, refining and distribution to company owned retailers who sell the end product (petrol, gasoline, etc.) to the retail consumers.

Vertical integration often opens doors for vertical expansion of firms where a powerful business entity that is part of a vertical supply chain may acquire firms manufacturing intermediate products and services. Such acquisition ensures regular and secure supplies from one firm to the next without facing supply chain management interruptions brought about by time and open market factors. This lowers costs and increases profits by eliminating wasteful competitions and unnecessary supplier biddings. However, vertical integration is often responsible for producing vertical monopolies and cartels.