All companies want to grow their operations to expand their businesses. Various methods can help them achieve this goal. Usually, companies can grow organically, which can be significantly beneficial in understanding a market and its customers. Sometimes, however, companies may also use other methods for expansion. These methods involve growing through acquiring or merging with other companies.
Expansions are a part of a company’s market strategy. When a company wants to penetrate a new market, it will contemplate this strategy. In most circumstances, companies will expand to a new market or through a new product. However, they may also choose to do both at the same time. This process falls under a diversification market strategy. One of the techniques used under this strategy is vertical integration.
What is Vertical Integration?
A supply chain is a system of entities, activities, and resources involved in supplying a product to consumers. In other words, it includes all parties that help deliver a finished good to the end-user. A company that manufactures goods or renders services may lie in the middle of its supply chain. On top of it, it will usually have its suppliers. Beneath it will lie its distributors. Similarly, on the side, the supply chain consists of similar businesses.
Vertical integration is a strategy through which companies extend their operations within the supply chain. As the name suggests, this process occurs on a vertical scale. Therefore, it does not concern a company’s competitors or other similar entities. Instead, it leads to an expansion into the supplier or distributor category within a supply chain.
With vertical integration, companies take over their suppliers or distributors. This process causes the company to expand its operations by controlling a larger scale within its chain. Therefore, vertical integration results in in-house processes which required outsourcing in the past. Through this process, companies can govern more of the overall supply chain and gain a competitive advantage.
The opposite of vertical integration is horizontal integration. This process usually involves taking over a competitor’s business or similar entities within the supply chain. However, vertical integration does not concern those parties. Instead, it looks at entities that are crucial in completing the delivery of goods to consumers. Through this process, companies can secure supplies and the market needed to sell their products.
Overall, vertical integration can be highly substantial to growth and expansion. This process involves expanding into a new market with a new product. However, it helps companies support their current operations by targeting the supply chain vertically. Within this process, companies can use two strategies. These include forward and backward integration.
What is Forward Integration?
Forward integration is a type of vertical integration in which a company takes over its distributors. Therefore, it involves a form of downstream vertical integration. Through this process, companies own and control business activities that follow their operations. For example, it may include the distribution or supply of its products to its consumers.
With forward integration, companies get more control over the distribution of their products and services. Usually, this process involves acquiring or merging with its customers. This way, companies can reach the consumer faster by cutting overtaking the distribution process. Forward integration expands a company’s operations downstream while also maintaining its initial business.
In some cases, companies may share distributors with the market or their competitors. Through forward integration, they can control those channels to receive better services. Similarly, it may involve cutting the competitors from the process and making it exclusive. This way, companies can receive the same services while achieving a competitive advantage.
Similarly, forward integration may also involve overtaking the marketing and sales channels. Apart from distributors, it may also include promoters or other entities that provide similar services. However, this process does not involve eliminating those channels. Instead, companies still use those services but perform them in-house rather than outsourcing them.
Overall, forward integration is a form of downstream vertical integration in which companies take over their distributors. This process leads to more control over how their goods get delivered to the consumers. In essence, forward integration involves acquiring or merging with distributors. However, it does not require eliminating those channels.
How does Forward Integration work?
Forward integration works similarly to backward integration. However, it involves targeting distributors rather than suppliers. This process starts with identifying a distributor that a company can acquire. The identification will include estimating how much integrating with that distributor will cost, among other things. If companies have the resources to do so, they can overtake the distributor to control its business.
Forward integration allows companies to take over a portion of their supply chain. This chain includes entities, resources, information and technologies that help manufacture and deliver goods to consumers. As mentioned, the suppliers fall above the company in the supply chain. In contrast, distributors come under the company. Once the goods reach the consumers, the supply chain ends.
Forward integration seeks to use vertical integration to provide more control over the delivery process. Through this, companies can improve their efficiency while also shortening the distribution chain. This way, companies can dictate how quickly consumers receive their goods and services. In some instances, it may also involve taking over the marketing process for those goods and services.
Most companies may control the quality of their goods and services by choosing suppliers. In some cases, however, they may not govern the distribution and marketing process. Therefore, forward integration becomes crucial. Through this process, companies can get more control over those processes. However, they may need to incur some expenses to achieve that.
What are the advantages of Forward Integration?
Forward integration comes with several advantages. These advantages relate to the increased control that companies have over their marketing and sales processes. On top of these, forward integration may also benefit from being a part of the vertical integration process. Overall, the specific advantages of forward integration include the following.
Reduced costs
Forward integration reduces the costs related to the marketing and sales process. Usually, these costs may include transportation expenses that companies incur on delivering goods to distributors. On top of these, it may consist of the margins paid to those distributors for their services. Apart from these, forward integration can also decrease the costs related to the overall distribution process.
Control distribution
The primary objective of the forward integration process is to control the distribution process. In some cases, companies must do this from necessity. For example, companies may overtake their distributors to receive better services. Similarly, it may involve not sharing the same distribution channels with competitors. Overall, it gives companies more independence in the process.
Competitive advantage
Forward integration can be significantly crucial in achieving a competitive advantage. When a company control a higher part of its distribution process, it can provide better services to its consumers. Similarly, this process reduces its overall costs, as mentioned above. Therefore, it helps in achieving a competitive advantage over competitors. On top of that, it also creates barriers to entry for new entrants.
What are the disadvantages of Forward Integration?
Forward integration may come with various disadvantages despite its many benefits. These disadvantages relate to the steps involved in achieving this integration. On top of that, it may also get some drawbacks from being a form of vertical integration. Overall, the disadvantages of forward integration include the following.
Capital requirement
Forward integration comes with the primary disadvantage of requiring significant capital. When companies implement this strategy, they must expand operations. Usually, they do so through mergers and acquisitions. Both of these processes involve high costs, including investment in other companies. Therefore, this process may not be an option for smaller companies.
Eliminates competition
Eliminating competition may not be a significant disadvantage directly. However, it may have several side effects which can significantly hinder the business. Firstly, it leads to the higher market dominance of one company. This process can lead to monopolistic behaviour in the market. Similarly, it can lead to a lower quality product and reduced efficiency due to lack of competition.
Challenging to manage
The whole process of forward integration can be significantly challenging to manage. Usually, this process involves a merger and acquisition process. Any inefficiencies within this process can lead to issues. On top of that, a company may fail to realize synergies between the involved parties. This failure may come from the management process of forward integration.
Conclusion
Vertical integration involves taking a part of the supply chain, not including competitors and similar entities. Within this process, forward integration consists of a company obtaining control over its distribution channels. This process can help reduce the time it takes for products and services to reach customers. Apart from that, forward integration can have various advantages and disadvantages, as listed above.
