VERTICAL

INTEGRATION AND
VERTICAL
RESTRAINTS
B U S I N E S S I N D U S T R I A L E C O N O MI C S ( MA N E 6 1 2 )
MA RY G R AC E P. E D E J E R
 VERTICAL INTEGRATION

•Vertical integration (VI) is a strategy used by companies to gain

control over other industry’s value chain.

• It is a strategy whereby a company owns or controls its suppliers,

distributors, or retail locations in order to increase the firm’s power
in the marketplace, reduce transaction costs and secure supplies or
distribution channels.
EXAMPLES
Netflix is a prime example of vertical integration.
• The company started as a DVD rental business before
moving into online streaming of films and movies licensed
from major studios.
•Then, Netflix executives realized they could improve their
margins by producing their own original content. Today,
Netflix uses its distribution model to promote its original
content alongside programming licensed from studios.
 Forward Integration
• when a company expands by purchasing and controlling the direct
distribution or supply of its products. 
• occurs when a company decides to take control of the post-production
process

Example: A clothing manufacturer that opens its own retail locations to sell
its products is an example of forward integration. Forward integration helps
companies cut out the middleperson. By removing distributors that would
typically be paid to sell a company's products, overall profitability is
improved.
 Backward Integration
• when a company expands backward on the production path into manufacturing, meaning a
retailer buys the manufacturer of their product.
• when a company decides to buy another company that makes an input product for the
acquiring company's product.

Examples:
1. Amazon, which expanded from an online retailer of books to become a publisher with its
Kindle platform. Amazon also owns warehouses and parts of its distribution channel.
2. A car manufacturer is pursuing backward integration when it acquires a tire
manufacturer.
ADVANTAGES
1. Decreased transportation  costs and reduced delivery turnaround times
2. Reduced supply disruptions from suppliers that might fall into financial
hardship
3. Increased competitiveness by getting products to consumers directly and
quickly
4. Lower costs through economies of scale. By buying large quantities of raw
materials or streamlining the manufacturing process, per-unit costs are
lowered
5. Improved sales and profitability by creating and selling a company-owned
brand
DISADVANTAGES
1. Companies might get too big and mismanage the overall process
2. Outsourcing to suppliers and vendors might be more efficient if
their expertise is superior
3. Costs of vertical integration such as purchasing a supplier can be
significant
4. Increased amounts of debt if borrowing is needed for capital
expenditures
Real-World Examples of Vertical Integration
Technology giant Apple (AAPL), which has retail locations to sell their branded products as well as
manufacturing facilities around the globe.
- In 2012 Apple acquired AuthenTec, which makes the touch ID fingerprint sensor that goes into its
iPhones.
-In 2015, Apple opened a laboratory in Taiwan for developing LCD and OLED screen technologies. It
also paid $18.2 million for a 70,000-square-foor manufacturing facility in North San Jose that same
year. These investments, among others, allow Apple to move along the supply chain in backward
integration, providing flexibility and freedom in its manufacturing.
- However, the company still has suppliers that include Analog Devices (ADI), which provides
touchscreen controllers for iPhones. Also, Jabil Circuit supplies phone casings for Apple from its
manufacturing facilities in China.6
The company has also integrated forward as much as backward. Apart from Best Buy and other
carefully selected retailers, Apple products are almost exclusively sold at company-owned locations.
This allows Apple to tightly control distribution and sale to the end consumer.
 KEY TAKEAWAYS
1. Vertical integration is when a company owns or controls its suppliers, distributors, or
retail locations to control its value or supply chain.
2. Vertical integration benefits companies by allowing them to control the processes,
reduce costs and improve efficiencies.
3. Backward integration is when a company expands backward on the production path
into manufacturing.
4. Forward integration is when companies control the direct distribution or supply of
their products. 
5. Although vertical integration can reduce costs and create a more efficient supply
chain, the capital expenditures involved can be significant.
VERTICAL RESTRAINTS

Vertical restraints are competition restrictions in

agreements between firms or individuals at different
levels of the production and distribution process.