Vertical Integration
What is it?
Vertical integration is when a supply chain of a company is owned by that company. A supply chain usually includes steps such as starting with the raw material, turning it into a product, and then selling the product. When a company uses vertical integration they become in control of all the parts of the supply chain rather than one part. Many companies use vertical integration because it assures that the company has the supplies needed by the firm to produce its products.
Companies use this strategy in order to avoid "the hold-up problem", also known as the commitment problem. The hold-up problem is a situation where two parties may be able tot work most efficiently when cooperating, however they refrain from doing so in order to avoid giving the other party increased bargaining power.
Pros & Cons
Their are plenty of benefits that companies gain when using vertical integration; such as being in control of their materials/supply chain, being able to offer lower prices for their products, and has the ability to become more independent in that they don't need to rely on suppliers. However, this method can create an anti-competitive actions that create free competition in an open marketplace.
Forward/Backward Integration
There are two different ways in which a company can practice vertical integration, depending on what type of company it is. Companies close to the start up of the supply chain, such as mining companies, would use forward integration. Forward Integration is when the company gains control over distributors. On the other hand, companies in the retail and distribution field are more likely to use backward integration in order to gain control of production further back in the supply chain. Backward Integration is when a company gains control over its supplier.
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