Vertical integration is a process by which a company’s hierarchy in terms of how its services and products are sourced and manufactured is simplified and unified under just one entity. This means that a company takes control of a part of the flow of production so that it would be easier to control the other variables that may affect the performance of a business entity. When more than one company is involved in the making of a particular product, a situation called a “hold-up” may ensue wherein one company would withhold its products and services to bargain for special considerations or terms from the umbrella organization. Since this stalls the production line, this type of situation renders the entire process inefficient and ineffective for the consummation of business.
For a company that produces clothes for instance, it would be to its advantage if it could control the sources of fabrics. That way, it would be easier for the garments producer to ensure the availability of the raw material as well as the process at which the fabric could be bought. The same could be said if the company were to own the subsidiary stores that would later on sell the finish products of the company. This would allow them to control their margins and push particular products that they want featured or pushed more heavily.
Here’s how you make a plan for vertical integration:
- First, you must decide which type of vertical integration you want to do for your company. There are three major types of vertical integration. One is the backward type of integration wherein you would be absorbing the companies and processes that occur before your original phase in the production process. The example of the clothes manufacturer taking in the fabrics company is parallel to this type. The second is the forward type wherein the companies that are involved after your original phase are included. The example of getting the shops that sell your products also fall within this category. The last is the balanced one wherein your company takes the reins from before and after your original phase.
- Do a SWOT analysis on your company and the other entities that you wish to absorb. SWOT stands for strengths, weaknesses, opportunities and threats. This would allow you to zero in on the potential problems and solutions for your prospect. You may hire a management consultant for this or you can do this yourself. Just have an adviser ready so you’ll have another opinion on the matter.
- Use the data from the SWOT analysis to decide whether or not the move is worth it. Sometimes, you will end losing more by doing a vertical integration with a weak and inefficient company. If you’re sold with the idea to integrate, use the data to schedule which companies you want to integrate first and at what rates. Don’t try to integrate all at the same time because this will be very difficult from an administrative standpoint.
Vertical integration is a process that must be studied fully before you take the reins and drive ahead. Take all your options into consideration and see if it truly makes your company better and stronger.