Which of the following best describes backward integration

Introduction and definition

Vertical integration and horizontal integration are business strategies that companies use to consolidate their position among competitors.

Índice Show

• Vertical Integration in Strategic Management
• Types of vertical integration strategies
• When is vertical integration attractive for a business?
• Advantages of vertical integration
• Disadvantages of vertical integration
• Horizontal Integration in Strategic Management
• When is horizontal integration attractive for a business?
• Advantages of horizontal integration
• Disadvantages of horizontal integration strategy
• Major Topics in Business Strategy

What is vertical integration?

Vertical integration is a competitive strategy by which a company takes complete control over one or more stages in the production or distribution of a product. It is covered in business courses such as the MBA and MiM degrees.

A company opts for vertical integration to ensure full control over the supply of the raw materials to manufacture its products. It may also employ vertical integration to take over the reins of distribution of its products.

A classic example is that of the Carnegie Steel Company, which not only bought iron mines to ensure the supply of the raw material but also took over railroads to strengthen the distribution of the final product. The strategy helped Carnegie produce cheaper steel, and empowered it in the marketplace.
 

What is horizontal integration?

Horizontal integration is another competitive strategy that companies use. An academic definition is that horizontal integration is the acquisition of business activities that are at the same level of the value chain in similar or different industries.

In simpler terms, horizontal integration is the acquisition of a related business: a fast-food restaurant chain merging with a similar business in another country to gain a foothold in foreign markets.
 

Vertical Integration in Strategic Management

Types of vertical integration strategies

As we have seen, vertical integration integrates a company with the units supplying raw materials to it (backward integration), or with the distribution channels that carry its products to the end-consumers (forward integration).

For example, a supermarket may acquire control of farms to ensure supply of fresh vegetables (backward integration) or may buy vehicles to smoothen the distribution of its products (forward integration).

A car manufacturer may acquire tyre and electrical-component factories (backward integration) or open its own showrooms to sell its vehicle models or provide after-sales service (forward integration).

There is a third type of vertical integration, called balanced integration, which is a judicious mix of backward and forward integration strategies.

When is vertical integration attractive for a business?

Several factors affect the decision-making that goes into backward and forward integration. A company may go in for these strategies in the following scenarios:

• The current suppliers of the company’s raw materials or components, or the distributors of its end products, are unreliable
• The prices of raw materials are unstable or the distributors charge high fees
• The suppliers or distributors earn big margins
• The company has the resources to manage the new business that is currently being taken care of by the suppliers or distributors
• The industry is expected to grow significantly

Advantages of vertical integration

What are the benefits of vertical integration? Let us take the example of a car manufacturer implementing this strategy. This company can

• smoothen its supply chain (by ensuring ready supply of tyres and electrical components in the exact specifications that it requires)
• make its distribution and after-sales service more efficient (by opening its own showrooms)
• absorb for itself upstream and downstream profits (profits that would have gone to the tyre and electrical companies and showrooms owned by others)
• increase entry barriers for new entrants (by being able to reduce costs through its own suppliers and distributors)
• invest in specific functions such as tyre-making and develop its core competencies

Disadvantages of vertical integration

But what is the downside? What are the drawbacks of vertical integration? Let us see the main disadvantages.

• The quality of goods supplied earlier by external sources may fall because of a lack of competition.
• Flexibility to increase or decrease production of raw materials or components may be lost as the company may need to sustain a level of production in pursuit of economies of scale.
• It may be difficult for the company to sustain core competencies as it focuses on the integration of the new units.

However, there are alternatives to vertical integration, such as purchases from the market (of tyres, for example) and short- and long-term contracts (for showrooms and with service stations, for example).
 

Horizontal Integration in Strategic Management

Horizontal integration, as we have seen, is a company’s acquisition of a similar or a competitive business—it may acquire, but it may also merge with or takeover, another company to strengthen itself—to grow in size or capacity, to achieve economies of scale or product uniqueness, to reduce competition and risks, to increase markets, or to enter new markets.

Quick examples of horizontal expansion are Standard Oil’s acquisition of about 40 other refineries and the acquisition of Arcelor by Mittal Steel and that of Compaq by HP.

When is horizontal integration attractive for a business?

A company can think of acquisitions and mergers for horizontal integration in the following situations:

• When the industry is growing
• When rivals lack the expertise that the company has already achieved
• When economies of scale can be achieved
• When the company can manage the operations of the bigger organisation efficiently, after the integration

Advantages of horizontal integration

The advantages of horizontal integration are economies of scale, increased differentiation (more features that distinguish it from its competitors), increased market power, and the ability to capture new markets.

• Economies of scale: The bigger, horizontally integrated company can achieve a higher production than the companies merged, at a lower cost.
• Increased differentiation: The company will be able to offer more product features to customers.
• Increased market power: The new company, because of the merger of companies, will become a bigger customer for its old suppliers. It will command a bigger end-product market and will have greater power over distributors.
• Ability to enter new markets: If the merger is with an organisation abroad, the new company will have an additional foreign market.

Disadvantages of horizontal integration strategy

As touched upon earlier, the management of a company should be able to handle the bigger organisation efficiently if the advantages of horizontal integration are to be realised.

The legal ramifications will have to be studied as there are strict anti-monopoly laws in many countries: if the merged entity threatens to oust competitors from the market, these laws will be used against it.

Standard Oil, which was seen as a powerful conglomerate brooking no competition, was split up into over 30 competing companies in an anti-trust case.

As a company grows bigger with horizontal integration, it might become too rigid, and its procedures and practices may become unfriendly to change. This could prove dangerous to it.

Moreover, synergies between companies that may have been predicted may prove elusive or non-existent (for example, the failed horizontal integration of hardware and software companies merged in the expectation of “synergies” between their products).

The decision whether to employ vertical or horizontal integration has a long-term influence on the business strategy of a company.

Each company will have to choose the option more suitable to it, based on its unique place in the market and its customer value propositions. A deep analysis of its strengths and resources will help it make the right choice.
 

Major Topics in Business Strategy

– Introduction to Strategic Management
— Core Competencies
— SWOT Analysis
— PEST Analysis
— Porter’s Five Forces Analysis
— GE McKinsey Matrix
— BCG Growth Share Matrix
— MECE Framework
— Business Strategy Simulation Games
— Management Consulting

Back to the top: MBA Syllabus

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Horizontal integration and vertical integration are competitive strategies that companies use to consolidate their positions and set themselves apart from their competitors. Both are corporate growth strategies that involve the acquisition of other businesses. While they can help companies expand, there are important differences between these two strategies. Horizontal integration occurs when a business grows by purchasing related businesses—namely, its competitors. Vertical integration, on the other hand, occurs when a business takes control of one or more stages in production or distribution, thereby owning all of the parts of the industrial process.

• A horizontal acquisition is a business strategy where one company takes over another that operates at the same level in an industry. 
• Vertical integration involves the acquisition of business operations within the same production vertical.
• Horizontal integrations help companies expand in size, diversify product offerings, reduce competition, and expand into new markets.
• Vertical integrations can help boost profit and allow companies more immediate access to consumers.
• Companies that seek to strengthen their positions in the market and enhance their production or distribution stage use horizontal integration.

Horizontal integration is a growth strategy that many companies use to boost their position within their industries and to get an edge on their competition. They do this by taking over another company that operates at the same level of the value chain. This means both companies offer similar (if not the same) goods and services, and deal with the same customer base.

The primary goal of horizontal integration is to grow through the acquisition of one or more competitors that function within the same industry. Other goals include:

If a department store wants to enter a new market, merging with a similar company in another country can help it to start operating overseas. Doing so would allow the company to generate more revenue and reach a wider market. Ideally, the newly-formed company would make more money as a single unit compared to when they operated independently.

Horizontal integration allows companies to cut down on their costs by sharing technology, marketing efforts, research and development (R&D), production, and distribution.

Horizontal integration usually works best when two companies have synergistic cultures. The process may fail if there are problems when the two cultures merge.

Vertical integration is a corporate strategy that involves growth through streamlining operations. This occurs when one company acquires a producer, vendor, supplier, distributor, or other related company within the same industry. Companies that choose to integrate vertically do so to strengthen their supply chains, reduce their production costs, capture upstream or downstream profits, or access new distribution channels.

Not only does vertical integration increase profits from the newly acquired operations by selling its products directly to consumers, but it also guarantees efficiencies in the production process and cuts down on delays in delivery and transportation.

Companies can integrate vertically by moving backward or forward:

• Backward integration occurs when a company decides to buy another business that makes an input product for the acquiring company's product. For example, a car manufacturer pursues backward integration when it acquires a tire manufacturer.
• Forward integration occurs when a company decides to take control of the post-production process. So, that car manufacturer may acquire an automotive dealership through forward integration by acquiring a business ahead of its own supply chain. This gets the manufacturer closer to the consumer and gives the company more revenue.
  

Companies may achieve vertical integration through internal expansion, an acquisition, or a merger.

While there can be many benefits to horizontal integration, the most obvious benefit is an increased market share for the company. When two companies combine, they also combine their products, technology, and the services that they provide to the market. And when one company multiplies its products, it can also increase its consumer foothold.

Here are some of the other benefits associated with horizontal integration:

• A larger customer base
• Greater revenue
• Cutting out the competition
• More synergy between two companies (including marketing resources)
• Reducing production costs

Even though a horizontal integration may make sense from a business standpoint, there are downsides to horizontal integration for the market, especially when they succeed. This kind of strategy faces a high level of scrutiny from government agencies, which is why antitrust laws are in place.

Additionally:

• Merging two companies that operate within the same supply chain can cut down on competition and reduce the choices available to consumers.
• It may lead to a monopoly where one company plays a dominant force that controls the availability, prices, and supply of products and services.
• The new, larger company may take advantage of consumers by raising prices and narrowing product options.
• Reduced flexibility, increased bureaucracy, and a greater need for transparency
• The chance of failure if there isn't synergistic energy between the two companies.

Pros

• Increased market share

• Larger consumer base

• Increased revenue

• Reduced competition

• Synergistic efforts

• Economies of scales

• Reduced production costs

Cons

• High level of scrutiny from government agencies

• Creation of a monopoly

• Higher prices for consumers

• Less options for consumers

• Reduced flexibility for the new, larger company

• Deterioration of company value

Vertical integration helps a company:

• Reduce costs across different parts of its production process
• Creates tighter quality control and guarantees a better flow and control of information across the supply chain
• Increase sales
• Improve profits
• Reduce or eliminate the leverage that suppliers have over the company (backward integration)

The drawbacks of vertical integration include:

• A concentration of resources in one approach
• Increased risk when market environments are uncertain
• High costs to coordinate the strategy, including the potential of additional debt

Pros

• Increase sales

• Reduce costs across various parts of production

• Ensure tighter quality control

• Better flow and control of information across the supply chain

• Better control over production volume

Cons

• Concentrates resources and prospects in one approach

• Increased risk during uncertain times

• High organizational and coordination costs

• Marriott and Starwood Hotels: Marriott International (MAR) acquired Starwood in 2016, creating the world's largest hotel company in the hopes of diversifying its portfolio of properties. While Marriott had a strong presence in the luxury, convention, and resort segments, Starwood's international presence was very strong. The merger offered greater choice for consumers, more opportunities for employees, and added value for shareholders. Both companies had approximately 5,500 hotels and 1.1 million rooms worldwide after the merger was completed.
• Anheuser-Busch InBev and SABMiller: Finalized in October 2016 with a valuation of $100 billion, the new company now trades under the name Newbelco. Each company had to agree to sell off many of their popular beer brands, including Peroni, Grolsch, and the Czech Republic’s Pilsner Urquell, in order to comply with antitrust laws before the merger was approved. One of the goals was to increase Anheuser-Busch InBev's market share in developing regions of the world, such as China, South America, and Africa, where SABMiller already had established access to those markets.
• Walt Disney Company and 21st Century Fox: Disney's (DIS) acquisition of 21st Century Fox was finalized in March 2019. The goal was to increase Disney's content and entertainment options, expand internationally, and grow its direct-to-consumer offerings, including ESPN+, Disney+, and the two company's combined ownership stake in Hulu. The deal also included Twentieth Century Fox, Fox Searchlight Pictures, Fox 2000 Pictures, Fox Family and Fox Animation, Twentieth Century Fox Television, FX Productions and Fox21, FX Networks, National Geographic Partners, Fox Networks Group International, Star India, and Fox’s interests in Hulu, Tata Sky and Endemol Shine Group.
  

• Google and Motorola: Alphabet's Google (GOOG) acquired Motorola Mobility in 2012. Motorola created the first cell phone and invested in Android technology that was valuable for Google.
• Ikea and Forests in Romania: The Swedish furniture giant bought an 83,000 acre woodland in northeastern Romania in 2015. It was the first effort the company made at managing its own forest operations. IKEA purchased the forest in order to manage wood sustainably at affordable prices.
• Netflix Produces Its Own Content: Netflix (NFLX) is one of the most significant examples of vertical integration in the entertainment industry. Prior to starting its own content studio, Netflix was at the end of the supply chain because it distributed films and television shows created by other creators. But company leaders realized they could generate more revenue by creating original content. In 2013, the company expanded its original content offerings.

Horizontal integration is an expansion strategy adopted by a company that involves the acquisition of another company in the same business line. Vertical integration refers to an expansion strategy where one company takes control over one or more stages in the production or distribution of a product. Both of these strategies are undertaken by a company in order to consolidate its position among competitors.

Horizontal integration is one of the most common types of mergers. As a result of horizontal integration, competitors in the same market combine their operations and assets. An example of horizontal integration would be if two consulting firms merge. One of the firms offers software development services in the defense industry; the other firm also provides software development but in the oil and gas industry.

Companies that seek to strengthen their positions in the market and enhance their production or distribution stage use horizontal integration.

Horizontal integration can greatly benefit companies. It is important because it can grow the company in size, increase product differentiation, achieve economies of scale, reduce competition, or help the company access new markets.

Horizontal integration and vertical integration are two different growth strategies that can help companies expand their operations. Although the ultimate goals may be the same, there are important differences between the two strategies. Horizontal integration involves acquiring or merging with competitors while vertical integration occurs when a firm expands into another production stage like acquiring a supplier or distributor. As such, vertical integration is the process of acquiring business operations within the same production vertical. A company that opts for vertical integration, though, takes complete control over one or more stages in the production or distribution of a product.