Hello everyone, welcome to Business School 101. Vertical integration is a strategy that allows a company to streamline its operations by taking direct ownership of various stages of its production process, rather than relying on external contractors or suppliers. A company may achieve vertical integration by acquiring or establishing its own suppliers, manufacturers, distributors, or retail locations, rather than outsourcing them. In this video, we will discuss the industry value chain, major types of vertical integrations, and the advantages and disadvantages of vertical integrations. 

Part 1: Industry Value Chain. The industry value chain refers to the full range of activities needed to create a product or service. For companies that produce goods, the industry value chain comprises the steps that involve bringing a product from conception to distribution and everything in between, such as producing raw materials, manufacturing functions, and marketing activities. To explain the concept of vertical integration along the different stages of the industry value chain, let us use cell phones as an example. This ubiquitous device is the result of a globally coordinated industry value chain made up of different products and services. 

First stage: the raw materials to make

your cell phones, such as chemicals, ceramics, metals, oil for plastic, and so on, are all commodities. Each of these commodity businesses are different companies, such as DuPont and ExxonMobil. Second stage: intermediate goods and components, such as integrated circuits, displays, touch screens, cameras, and batteries, provided by firms such as Intel, LG, Texas Instruments, and more. Third stage: original equipment manufacturing firms, also called OEMs, such as Foxconn, typically assemble cell phones under contract for consumer electronics and telecommunications companies such as Apple and Samsung. If you look closely at an iPhone, you will notice it says designed by Apple in California, assembled in China. Final stage: to get wireless data and voice service, customers need to pick a service provider such as AT&T, Sprint, T-Mobile, or Verizon. Part two: types of vertical integrations along the industry value chain. There are varying degrees of vertical integrations. Generally, there are two major types of vertical integrations: backward integration and forward integration. First, backward integration: a company that chooses backward integration moves the ownership control of its products to a point earlier in

the value chain or the production process. For example, Amazon.com Inc. started as an online retailer of books that it purchased from established publishers. Over time, Amazon became its own publisher. The company eventually branched out into thousands of branded products. Then, it introduced its own private label, Amazon Basics, to sell directly to consumers. IKEA can be another example of backward integration. IKEA is known as a flat-pack retailer that sells mostly wooden furniture but also other fixtures and fittings. IKEA is also last in the value chain as it directly sells to the final consumer. In 2015, IKEA made a huge step in ensuring complete vertical integration by purchasing a Romanian forest. The company added to this by purchasing forest land in Alabama in 2018. Not only does it now control much of the raw material production, but it also controls the manufacturing process through its subsidiary. By completing these integrations, IKEA controls the production of the wood, the manufacturing process, and the final distribution through its retail units. Second, forward integration. Forward integration is another type of vertical

integration where the company gains control of the business activities that are ahead in the value chain. This is also known as cutting out the middleman. Through forward integration, manufacturers may skip the wholesalers or retailers in the value chain to sell directly to customers. The company extends the next levels of the value chain in an effort to synergize the operations, reduce total expenses, and become closer to the end consumer. Here are two real industry examples of forward integration. First, Apple. Apple had been plagued with a decade of bad retail experiences at the hands of others. In 2001, Apple launched its first Apple retail store to enable its customers to buy Apple products directly from their outlets. Now Apple has many retail stores, which increased customer satisfaction. Second, McDonald's. McDonald's acquired a tech company called Dynamic Yield in 2019. McDonald's plans to improve their digital customer experience touchpoints with this acquisition. The technology allows menus at McDonald's drive-throughs to change based on different factors, including weather, current traffic, and more. This is another example of forward

integration like most corporate strategies. Vertical integration has both advantages and disadvantages. Some of the advantages of vertical integration include the following: one, reliability. Many businesses face problems with their suppliers. This might be late deliveries, poor service, or failing to update and adapt to new trends. At the same time, suppliers may be situated in a location that is unfavorable, meaning deliveries take longer and are more likely to be late. Through vertical integration, firms are able to benefit from a close cooperation between both parties. It controls part of the supply chain, so difficulties can be ironed out. Two, power over suppliers and buyers. Certain players in the market might be difficult to work with but are necessary in order to do business. By vertically integrating, businesses are able to avoid dealing with such companies or at least better dictate terms and prices with them. After all, it owns one of its competitors. Three, flexibility. When two firms at different stages of the supply chain join together, the feedback connection is enhanced. When trends or tastes are changing, this can be proactively fed back to the

integrated suppliers who can then work on an alternative solution. For example, Zara is a Spanish clothing and accessory company that has over a thousand stores worldwide. It owns both the manufacturing and designing of its clothes, which allows it to have a greater say on what customers like and want more of. The retail stores have these statistics, and in turn, those can be translated into actionable trends for lower prices for consumers. Each stage of the supply chain obtains some level of profit through vertical integration. The new firm is able to capture both sets of profits at the same time. It can benefit from several economies of scale, thereby allowing it to charge lower prices in a competitive market. These cost savings are likely to be passed on to the consumer, providing it with a competitive advantage. However, it's important to note that vertical integration also has many disadvantages. 1. High costs. Vertical integration can be very expensive. Not only are there the financial costs, but also the time and effort to purchase as well as integrate the new firm. There are then additional costs such as

moving factories and other facilities so they are closer to the purchasing company. These can potentially prove to be wise investments, but at the same time, they are difficult to reverse. Two management difficulties: owning a manufacturing business is very different from being a retailer. Being a successful retailer does not make for a successful manufacturer. Some of the existing management may be kept on board to help in this regard; however, it can be very difficult for them to work in a new environment by which they have to answer to the parent company. Three loss of focus: integrating a new company is a lot of work. Integrating a company that is at a different stage in the supply chain is even more difficult, particularly due to the lack of experience in that field. For example, running a successful retail business requires a different set of skills than a profitable factory. It is difficult to find a CEO that is good at both. Four reduce flexibility: as previously mentioned, vertical integration can provide some level of flexibility by allowing information to feed backwards into the supply chain. However, if the integrated supplier is

making products a and b. It may then need to make product c instead, yet it may not have the equipment to do so. This requires time and investment to move production to another product. All right, let's do a quick summary. Vertical integration is a strategy that allows a company to streamline its operations by taking direct ownership of various stages of its production processes, rather than relying on external contractors and suppliers. There are two major types of vertical integrations: backward integration and forward integration. Like most corporate strategies, vertical integration has both advantages and disadvantages. Its major advantages include reliability, power over suppliers and buyers, flexibility, and lower prices for consumers. On the other hand, its major limitations include high costs, management difficulties, loss of focus, and reduced flexibility. So, what do you think about vertical integration? Please leave your thoughts in a comment below. If you enjoyed this video, then please be sure to give it a thumbs up and to subscribe to the channel. Thanks for watching, and I will see you next time.

Vertical Integration (With Real World Examples)  | From A Business Professor

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Vertical Integration (With Real World Examples) | From A Business Professor

Vertical Integration (With Real World Examples) | From A Business Professor

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