Professional Documents
Culture Documents
INDUSTRIAL ECONOMICS
SUBMITTED BY-
Paulami Sen (3261)
Palash Acharya (3270)
Aruja Srivastava (3272)
Shashi Rajput (3251)
SUBMITTED TO-
Ms. Shrabana Mukherjee
● ACKNOWLEDGEMENT
● EXECUTIVE SUMMARY
● METHODOLOGY
● INTRODUCTION
● ANALYSIS:
1. COMPARISON BETWEEN VERTICAL AND HORIZONTAL
INTEGRATION
2. VERTICAL EXPANSION
3. TYPES OF VERTICAL INTEGRATION
4. CRITERIA FOR INTEGRATION DECISIONS
5. VERTICAL MARKET FAILURE
6. SUCCESSFUL VERTICALLY INTEGRATED COMPANIES
7. UNSUCCESSFUL VERTICALLY INTEGRATED COMPANIES
8. ADVANTAGES AND DISADVANTAGES OF VERTICAL
INTEGRATION
9. BENEFITS AND LOSSES OF VERTICAL INTEGRATION TO
THE SOCIETY
10. WHEN AND WHEN NOT TO VERTICALLY INTEGRATE
● CONCLUSION
● REFERENCE
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ACKNOWLEDGEMENT
Inspiration, motivation and presentation have always played a key role of any
venture.
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EXECUTIVE SUMMARY
This report basically covers the topic ‘Vertical Integration’ and analysis it from the
point of several integration parameters.
Firstly, the Introduction to the topic is covered where we see that vertical integration
is a strategy where companies try to get advantage by moving upstream in a means
to control production in a way that cuts down their cost and other business
parameters or downstream to ensure that they can enter the market and control their
supply or both. Gustavo Swift was the first company which adopted vertical
integration in the traditional world.
In order to understand vertical integration, we need to know the difference
between vertical integration and horizontal integration to understand it at large. Both
vertical and horizontal integration are business strategies that various firms use to
synthesize their position among competitors in the market. Horizontal integration is a
firm’s accession of a similar or competitive business- it may acquire or run a merger.
For better understanding vertical and horizontal integration, a distinction between the
two has been given in the analysis section. A topic related to vertical expansion has
also been covered which says that Vertical expansion occurs when a company
moves to perform a service or produce a good in different parts of a supply chain
including the concept of vertical monopoly has also been explained deliberately in
the analysis section of the report.
Further, the types of vertical integration is covered which includes the three
namely; forward, backward and balanced integration has been explained deliberately
with examples. For better understand integration, a criteria has been given by which
different firms take up vertical integration in an economy which includes set up cost,
transaction cost, transaction risk and coordination effectiveness. Also, a detailed
paragraph about why a vertical market fails has also been explained in the report
along with its features which includes small number of buyer and seller, transaction
frequency, etc is given.
Further, examples of successful and unsuccessful companies which vertically
integrated is provided and has been explained in detail along with few diagrams -
includes Apple Inc.,Starbucks, Alcoa and Standard Oil. The advantages and
disadvantages of Vertical Integration which includes smooth supply chain
(successful) and barrier to new market entry (unsuccessful), etc has been explained.
Also, information regarding vertical integration’s benefits and losses to the
society has been provided. It basically highlights how vertical integration brings
about changes in the society which can be either positive or negative in nature. It
also gives us a brief information about when and when not companies should
vertically integrate. This report becomes a overall guide to vertical integration.
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METHODOLOGY
Research Question;
·1. Describe your knowledge of vertical integration;
2. Select a case study where vertical integration has been successful and narrate
the model
3. Select a case study where the firm has failed to successfully integrate vertically
and narrate the reasons of failure;
Participants:
There were total of 4 participants involved in this group project namely Aruja
Srivastava, Palash Acharya, Paulami Sen and Shashi Rajput.
Research Conduction:
The research work was equally distributed between the team members. All of the
study and research Conduction was done with the help of internet and articles. In the
beginning all of the participants first went through the topic and its meaning and then
accordingly the topics were distributed for the research work. All the participants
went through a qualitative research and the case studies related to it. After the
completion of the research and study by everyone all the data and research work
was compiled, analyzed and arranged in the particular format to make the
presentation and the report.
Conclusion:
The methodology helped every member of the team to learn how to do a deep
research work and how to analyse the data as per our own understandings.
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INTRODUCTION
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he needed to sell first and offered smaller cuts, which seemed to induce shoppers to
buy more.
When he started shipping live cattle from Chicago to various other markets, he
realised that it was a inefficient way as the cattle had to be fed, some died in transit
and the cost was too high. So instead he thought, that butchering cattle and shipping
dressed beef was a far more profitable idea. He hired an engineer to perfect a
refrigeration car that used circulating free air cooled by ice and established his
meatpacking business in Chicago. This idea became very successful for his
business and soon he was starting to earn around 500 million dollars of profit.
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ANALYSIS
In order to understand Vertical Integration better, one should also understand what
horizontal integration is and compare it with Vertical Integration.
Horizontal Integration- The merging of two or more companies, which are working in
the same line of business and their production level is also same, then this is known
as Horizontal integration. The product can be complementary product, by-product or
any other similar product. It can also be competitive product or entering into the
product’s repairs, services and maintenance section.
Horizontal integration can reduce competition between firms in market, because if
the producers of the product get combined they can create a monopoly. However, it
can also create an oligopoly if there are independent manufacturers in market.
It is a common tactic used by most of the companies to increase its size and achieve
economies of scale due to improved production level. This helps companies to get
new customers and market. Because of this, the company can also diversify its
products and services.
One of the biggest examples of horizontal integration is the acquiring of Instagram by
Facebook.
THE COMPARISON
1. Horizontal Integration occurs between two or more firms where product and
production level are the same. Vertical Integration is an integration of two
firms that operates in different stages of manufacturing process of the same
product.
·
orizontal Integration is adopted mainly to increase the size of the business
2. H
and scale of the production, whereas Vertical Integration is mainly adopted for
strengthening and smoothing its production-distribution process
3. Horizontal Integration helps companies gain synergy, but not self-sufficiency but
Vertical Integration helps the company gain synergy along with self-sufficiency.
4. Horizontal Integration helps the firms to acquire control over the market, while
Vertical Integration helps company to gain control over the whole industry.
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2. VERTICAL EXPANSION
In order to understand it better let’s take an example of Milk supplier. A milk supplier
collects milk from a farm, processes it and sells it to the distributors. So, in order to
expand his market, he can either vertically expand backward or forward. So if he
buys a milk farm or starts his own milk farm, he has vertically expanded backward
and if he owns a shop from where he sells his processed milk then he has vertically
expanded forward.
Vertical expansion can be also considered undesirable because its actions can
become anti-competitive and hinder free competition in an open marketplace. If it
leads to monopolistic control of a product or service, then regulative action may be
required to rectify anti-competitive behaviour. In United States, protecting the public
from communications monopolies that can be built in this way is one of the missions
of the Federal Communications Commission.
1 Forward Integration
2 Backward Integration
3 Balanced Integration
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● Forward Vertical Integration
1. When the company takes control over its distribution sector, to which
company sell its product it is called as forward vertical integration
2. This strategy is implemented when the company wants to achieve higher
economies of scale and larger market share.
3. Forward integration strategy became very popular with increasing internet
appearance.
4. Many manufacturing companies have built their online store and started
selling their products directly to consumers by passing retailers.
5. For Example- A mobile company opening its own mobile retail chain.
1. When the company takes control over its suppliers and manufacturers then
it’s turn to be backward integration.
2. It is also known as Upstream Vertical integration.
3. Backward integration strategy is most beneficial when firm’s current
suppliers are unreliable, expensive or cannot supply the required inputs.
4. For example- When an automobile company own a tyre company.
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4. CRITERIA FOR INTEGRATION DECISION:
● Set Up Cost-
While integration, the company firstly takes into account the set up cost like capital,
system development and training. So the main focus of the firm lies on capital
development like equipment, acquisition, machineries and highly trained people
which increases the efficiency of the company.
● Transaction Cost-
Secondly, it takes into account the transaction cost which includes information,
collection and processing, legal cost and purchasing cost. It is a cost incurred on
collecting information about the market and cost incurred on making legal agreement
and purchasing cost like buying different types of raw material.
● Transaction Risks-
Thirdly, it takes into account the transaction risk which include possibility of
unreasonable price fluctuation, supply or outlet foreclosure etc. If the company is
ready to take transaction risk it means that the company is aware of the unreasonable
change in prices, technological changes and new product coming in the market and
also change in supply of the product in the market.
● Coordination Effectiveness-
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Lastly, they look for coordination effectiveness like capacity utilization, delivery
performance and quality. So basically in coordination effectiveness, company looks
forward about the quality of product, customer services like delivery performance and
after delivery services.
A vertical market usually fails when transaction within it are too risky and the
contracts designed to overcome these risks are too costly.
The features of a failed vertical market are –
● Small number of buyer and seller- Problem arises when the market has one
buyer and one seller called bilateral monopoly or only a few buyers and few
sellers called Bilateral Oligopoly.
● High assets specificity, durability and intensity-
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(2) Technical Specificity- It occurs when one on both parties to a
transaction invest in equipment that can only be used by one or both
parties to a transaction and that has low value in alternative uses.
(3) Human capital Specificity- It occurs when employees develop skills
that are specific to a particular buyer or customer relationship.
ii) Durability – it increases the time horizon over which the risk and cost are
relevant.
iii) Intensity – When component is specific to a particular make and model
when the amount of research and development investment in the
component is high i.e. asset intensity. It is risky for component supplier
and auto assemble to be independent.
● Transaction Frequency- High transaction frequency is another factor that will
promote vertical market failure when it is accompanied by bilateral oligopolies
and high assets specificity.
A company choses vertical integration to ensure full control over the supply of the
raw materials to manufacture and sell its products. It may also in its process employ
vertical integration to take over the reins of distribution of its products which it infact
takes care of through its own retail stores like Apple Inc.
● APPLE INC:
Firstly, a very successful vertically integrated company and ‘hard to compete’ kind of
company is Apple, that is widely known and used by us today and which is said to be
the most successful company that has employed the strategy of vertical integration
for 35 successful years, for its market to grow to the level that it assumes today.
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1. Apple is a company which owns a hardware company, a software company, a
services company and also a retail company so we can easily see that apple
owns four diverse types of companies under one banner and these companies
involve both production and distribution plans which makes it an effective
vertically integrated market.
2. In today’s world most of the tech companies can manage only one or two of these
disciplines but only apple has all four entities working together side by side
effectively. Thus Apple as we say is vertically integrated. It controls all the major
critical portions to make and sell products
3. It builds great hardware like iPhones and iMacs, owns the core software
experience, optimizes its software like iOS and the MacOS, equips it with web
services of its own like the iTunes and iCloud and also controls its selling
experience through its own retail stores. This is why we can say that Apple is by
far one of the most successful model of vertical integration.
4. If we compare other PCs, smartphones, etc, the vendors make the hardware, put
someone else’s software on it, add third party services and sell through some
other stores. Apple supports its products on the ground which is consistent with
its brand values as it does not trust other retailers to take care of its products and
values.
”People who are really serious about software make their own hardware” (Alan Kay)
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● STARBUCKS:
Starbucks is also a very popular company that has successfully integrated vertically.
The key points are:
1. Starbucks is considered as a very extreme kind of vertical integration model
because, it buys and roasts its own coffee and sells it through company owned
stores as it does not trust industry suppliers to provide the quality its coffee drinks
business requires. (Today there are more than 27,000 company owned outlets in
the world)
2. Starbucks assumes backward vertical integration by making purchase
agreements with coffee growers, it owns its own bean roasting plants, it owns
warehousing and distribution facilities and also owns coffee bean farms in Costa
Rica and China. As we can see it easily reduces its costs of buying raw materials
and thus maximizes its production and profits.
3. It also sells its company owned food, drink, coffee beans, appliances and
accessories to reduce its cost.
*Netflix is a also very successful model of vertical integration as it produces its own
series and airs them through their own application exclusively. It is backward
integrating into programming so that the cost per hour of viewing can be reduced
significantly and effectively by producing a series such as Sacred Games instead of
the licensing of all its contents.
● ALCOA:
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2. Alcoa failed as a model of vertical integration because of its market failure and
also because the upstream business offered no material market power to the
downstream business
3. As a result, its vertical integration plan failed due to lack of planning between the
upstream and downstream business automatically leading to the failure of its
market.
*Limited demand, an increase in Chinese exports and flooding Western supply have
created a confluence of surplus in the aluminium market and Alcoa stocks sank
leading to the failure of the firm.(2015)
● STANDARD OIL:
Standard oil was first established in 1870 in Ohio, US and later spread into
Western Europe, Asia, etc. It was once a very successful vertical integration
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model as it employed a variety of impressive strategies and tactics in order to
undermine its competitors.
1. In order to achieve their goals, they undercut prices, bought oil barrel
components, rebated railroads, corporate espionage and violence and also
brought about technological innovation to maximize profits and it was very
successful too until it became a monopoly. By 1978, it controlled 90% of all oil
refined in the US.
2. It soon became a monopoly as there was no oil company as huge as Standard
which was now into expanding to all stages of oil and gas production and as it
made entry barriers for new companies, competition fell.
3. Also The Standard Oil Trust was formed which was soon criticized entering into a
law suit and thus the Standard Oil was broken down into 33 separate companies
of oil production and supply (like Exxon, Chevron, etc) ending the reign of
Standard oil as a model of vertical integration.
● Advantages-
1. Companies that are vertically integrated can reduce their transaction costs which
is beneficial to both the producer and consumer
2. Companies do not need to worry about ridges in its supply chain. They can easily
control their own supply.
3. Companies can make their distribution and after sales service more efficient
4. They can make profits in both upstream business i.e, production and downstream
business i.e, distribution
5. They have the independence to create strategies of their own without any
external indulgence
● Disadvantages-
1. It requires a huge amount of money since they might have to buy new facilities,
hire large number of new employees if a company is to start vertical integration.
2. The motivation to start well off at the beginning of the supply chain is very weak
thus sometimes ending up in losses.
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3. It creates barriers to market entry since the vertically integrated companies have
the ability to limit competition and establishes a strong position in the market.
4. It results in decreased flexibility in the upstream and downstream business.
Every kind of economic activity leads to some or the other changes in the society, it
could negative or positive for the society. Vertical integration has a considerable
impact on the economy and also on the society.
● Here are few of the benefits caused to the society due to vertical
integration:
2. Local companies are better positioned against the big and competitive foreign
companies in the market competition. Since vertical integration provides with a
platform for the companies to expand and grow in the economy it gets the right and
opportunity to stand neck to neck with the other foreign companies which used to
take over their market. Due to it the society faces the benefit of financial and
economic growth as a whole and it helps in increasing more job opportunities for
many people.
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3. Manipulation of prices. This phenomenon is caused again due to the
monopolisation and market power of the company caused by vertical integration. We
as their customers face the problems of manipulation of prices since we don’t get it
to participate in the pricing of goods since we are left with no choices.
4. Loss of tax revenue. vertical integration owns all the stages of production and
due to which they are not required to pay any kind of taxes like ‘service charges’ or
‘rent’ to anyone which is a economical loss for the society.
Throughout the study we have understood the term vertical integration, its types,
pros and cons, and also a few case studies about it. But a question always arises
that when and when not an industry should vertically integrate. Companies and
industries before jumping upon the strategy of the vertical integration should know in
depth that when and when not there is a need to integrate vertically.
1. When the company is young. A newly established industry has the energy and
capital in the beginning to expand, also their goal should be to grow and expand
vertically from the beginning itself. Forward integration would help the company
to grow its market and capture more consumers.
2. When the strategy would help them to create or exploit the market power by
raising the barriers to enter price discrimination and practice of monopoly. As we
have studied before, vertical integration leads to monopoly of the industry in the
market since it becomes more powerful by capturing more market and practicing
its own production and manufacturing.
3. When the market is declining and the independents are pulling out of adjacent
stages. So, when the company is facing the loss and economically declining,
companies sometimes integrate as in to fill in the gaps caused by the
independents that are pulling away. As an industry or market declines, weaker
independents exit, leaving many players vulnerable to exploitation by increasingly
saturated suppliers or consumers.
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● WHEN NOT TO VERTICALLY INTEGRATE:
Sometimes the strategy is required for the betterment and expansion but a lot of
times the companies err on the side of excessive integration. This mostly happens
due to two reasons: A. Decisions to integrate are mostly based on spurious reasons
and B Managers fail to undertake the fact that rich array of quasi-integration
strategies can be superior to full integration in both benefits and cost.
1. Spurious reasons: most common reasons given are ensuring supply or outlets.
Industries argue that owning captive supply outlets and sources reduces the
possibility of market foreclosure or unfair prices and hence insulates industry
from short run supply and demand imbalances. Economists and researchers
believe that when there is an efficient market, it is not required to own the supply
or outlets.
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CONCLUSION
Vertical integration can be said to be a strategy which can have a huge impact on
the business performance of the industry. It is a strategy which involves big
commitments of resources which utilised wisely can make but if not can break the
fortunes of even the biggest corporate and industries.
Few companies believe that vertical integration can be crucial to survive while others
blame excessive integration for causing corporate failure. It is a huge risk since it
requires a lot of capital and resources and hence a lot of companies cannot opt for it.
It could be a life saver for a few while can drown some of the industries forever. It is
very hard to come up again in the market after a failed vertical integration since this
strategy is very hard to reverse and requires loads of capital and raw materials and
skilled workers.
One of the main or major objective of the vertical integration is to eliminate or at least
reduce the buying and selling cost incurred when separate companies own the two
stages of production.
When vertically integrated, companies are best equipped to innovate because they
participate in many of the production and distribution activities of the product.
At the end, vertical integration entails both benefits and risks and it’s reasonable to
expect the payoff of a strategy of increased integration to vary according to the
market and competitive conditions in which a business operates.
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REFERENCE
● https://www.google.co.in/amp/s/sloanreview.mit.edu/article/when-and-when-n
ot-to-vertically-integrate/amp
● https://en.m.wikipedia.org/wiki/Vertical_integration
● http://techland.time.com/2011/07/01/why-competing-with-apple-is-so-difficult/
● https://www.forbes.com/sites/kenfavaro/2015/10/09/with-alcoas-split-a-faux-st
rategy-bites-the-dust/
●
https://www.mbacrystalball.com/blog/strategy/vertical-horizontal-integration-str
ategy/
● https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/
our-insights/when-and-when-not-to-vertically-integrate
● https://keydifferences.com/difference-between-horizontal-and-vertical-integrati
on.html
● https://study.com/academy/lesson/vertical-expansion-in-business-definition-ex
amples.html&ved=2ahUKEwizg4PBypzdAhXMWisKHW87D_kQFjAPegQIAxA
B&usg=AOvVaw2gxPg619HfLlgnPHI-u4iU&cshid=1535900391301
● https://www.britannica.com/biography/Gustavus-Swift&ved=2ahUKEwjNj7aOy
5zdAhVHYo8KHe6QD_cQFjAMegQIBhAB&usg=AOvVaw3NKc5lwKAT9-MTu
u3r1cuW
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