Vertical integration in the supply chain benefits an organization by allowing greater control over the goods needed to create their finished product.
Benefits of vertical integration in the supply chain include:
Organizations that are not vertically integrated must price their products to match the supply chain costs. Vertical integration allows reduction of costs by cutting out middlemen and allows an organization to monitor costs with greater transparency. Cost savings obtained often allow companies to lower the prices of their products, directly benefiting consumers. At the same time, as profit margins increase, the result of these cost savings in raw materials can also translate into geographical expansion and equipment renovation.
New Economies of Scale
Vertical integration leads directly to the reduction of the fixed cost-per-unit or “economies of scale.” For instance, by producing raw materials instead of purchasing them, an organization may reduce the cost per unit by spreading the price through a larger quantity of products. In addition, removing lower-tier suppliers through vertical integration reduces the marked-up prices paid in raw material obtention.
Protection for Proprietary Processes
Some organizations are known for their unique processes or distinct characteristics of their products. You may have seen knock-off consumer goods such as counterfeit designer handbags or have heard of industrial espionage in the news. Many organizations maintain a competitive advantage through specific or undisclosed characteristics of their products. Companies with these characteristics often hesitate to leave manufacturing or raw material supply to third parties. This leads to them developing vertical integration strategies that allow them to keep every stage of their manufacturing process in-house.
Increased Market Share
By vertically integrating, an organization can leverage specific niche markets that different demographics might need. Offering a value proposition that’s better than their competitors and is suited to a specific market leads to a larger market share obtention.
In addition, if a company has a retail distribution network, it can gain insights into its customers with less effort. Therefore, it can discontinue products with low demand, increase the production of the most consumed ones, and obtain accurate and first-hand information for future planning.
Vertical integration may also mean owning the means of goods distribution. This may allow an organization to conduct market research and figure out which of its competitors’ products are performing well. After researching, it’s cheaper for a vertically integrated organization to produce a similar product that competes in the same market as the one performing positively. In addition, due to the nature of the relationship between vertical integration and company size (larger organizations are more prone and capable of vertically integrating), competitors don’t often react to this market strategy.
Gaining Independence From Suppliers
Acquiring raw material suppliers allows your organization to gain independence from their needs and requirements. In addition, this acquisition results in more stability since any unforeseen events that affect your suppliers and that consequently might stop or delay that stage of your supply chain are avoided. Furthermore, shipping timing and characteristics are established by your company, increasing productivity and efficiency. In times of peak demand, having control over the obtention of raw materials is an almost unmatched competitive advantage.
Supply Chain Risk Reduction
Each one of the stakeholders involved in the supply chain has its risks, which directly affect your supply chain’s operations. For instance, vendors might face financial hardships, suppliers can find themselves with a shortage of raw materials, and distributors may suffer delays and even harm your products due to obsolete transportation methodologies and equipment. Vertical integration mitigates those risks by allowing you to gain control of your operations from the helm and forecast shortages or economic adversities, renovate equipment, and ship your products more efficiently.