THE VERTICAL INTEGRATION
Vertical integration means the entry of a company in activities related to the cycle of
exploitation of a product or service, becoming your own provider (backwards or upstream) or client (forward or downstream).
It is one case of diversification, since you can find aspects of diversification-related aspects
The integration vertical exists in any company, as all company made part of its product acquiring the others through suppliers and/or sells their products.
From the strategic point of view it is the appropriate level of integration that a company and its degree of integration is the set of decisions that affect the different dimensions of this phenomenon.
The measurement of the level of integration, criteria:
- Added value of a company in relation to its volume of sales. More integrated much greater value added.
- Vertical ratio, proportion of bº attributable to activities related to the production cycle of the main product. Positive confirmation if it exceeds 70%.
- Number of phases of the full production cycle that made the company.
- Volume of internal transfers that occur between the various phases of the production cycle. Backward integration measures the level of self-sufficiency.
- Degree of ownership and control over integrated assets.
-Reasons or advantages of vertical integration:
- mechanisms of reduction of costs:
- Economies of scope, better utilization of resources that can be shared, spreading fixed costs.
- Reduction of intermediate stocks, by simplifying the production process through the Elimination of the intermediate processes.
- Elimination of the costs of transaction, hiring of suppliers or clients.
- Assume the margin associated with the activity of suppliers or customers.
- Mechanisms to improve the strategic position:
- Easy access to supplies of factors or outlet for their products. Important if high power of suppliers or customers.
- Reinforcement of a strategy of product differentiation. For example through quality and image.
- Protection of an advanced technology, without depending on the provider.
- Power of control over market factors or finished products. The greater integration, the greater this power.
- Manipulation of prices “prices squeeze”. Reduce the margin of a non-integrated competitor below the acceptable level.
- The creation of barriers to entry, hard-to-overcome by non-integrated companies.
-Hazards or drawbacks of vertical integration:
- Global risk of the company increases, to commit themselves to a greater volume of resources with the full cycle of a given product.
- High barriers of exit of the industry because of the greater volume of active in the industry.
- Lack of flexibility to the changes both in the markets of factors of products.
- Reduced ability to introduce autonomous innovations.
- Outside suppliers or customers replaced is not automatically captures… They can enjoy a VC that the company cannot.
- Differences in the optimal scale of all the productive phases. If you have one size of less than optimal, a disadvantage in costs is incurred.
- Considerable increase of the organizational complexity of the companies integrated. It requires complex systems, so you will have higher costs.
In the assessment of vertical integration there are contradictory aspects, which threaten this strategy. There is a clear between the degree of vertical integration and profitability relationship.
Because of this, there is the possibility of disintegration vertical if the disadvantages prevail over the benefits, by what may be the strategy of cooperation with customers or suppliers.