What is Vertical and Horizontal integration?

Many a times, while gazing through the business daily, you come across the words “Vertical integration” or “Horizontal integration”. While some take it as a business gimmick; others do have but only a slight idea of what it is. In any case, as a regular business reader or as an entrepreneur, one needs to be aware about all the aspects of vertical and horizontal integration.

Both of these relate to strategies that are made to grow your business but they differ in approach. And most of the times which one to choose is not a very straight forward decision.

In this post we will try to completely understand Vertical and Horizontal integration and list certain key things that a business should take care of while looking forward to any of these options

What is Vertical Integration?

Out of all the definitions I read online the best one is from Investorwords which says.

Vertical integration is the process in which several steps in the production and/or distribution of a product or service are controlled by a single company or entity, in order to increase that company’s or entity’s power in the marketplace.

Simply said, every single product that you can think of has a big life cycle. While you might recognize the product with the Brand name printed on it, many companies are involved in developing that product. These companies are necessarily not part of the brand you see.

Example of vertical integration: while you are relaxing on the beach sipping chilled cold drink, the brand that you see on the bottle is the producer of the drink but not necessarily the maker of the bottles that carry these drinks. This task of creating bottles is outsourced to someone who can do it better and at a cheaper cost. But once the company achieves significant scale it might plan to produce the bottles itself as it might have its own advantages (discussed below). This is what we call vertical integration. The company tries to get more things under their reign to gain more control over the profits the product / service delivers.

Types of Vertical Integrations:

There are basically 3 classifications of Vertical Integration namely:

1. Backward integration – The example discussed above where in the company tries to own an input product company. Like a car company owning a company which makes tires.
2. Forward integration – Where the business tries to control the post production areas, namely the distribution network. Like a mobile company opening its own Mobile retail chain.
3. Balanced integration – You guessed it right, a mix of the above two. A balanced strategy to take advantages of both the worlds.

What is Horizontal Integration?

Much more common and simpler than vertical integration, Horizontal integration (also known as lateral integration) simply means a strategy to increase your market share by taking over a similar company. This take over / merger / buyout can be done in the same geography or probably in other countries to increase your reach.

Examples of Horizontal Integration are many and available in plenty. Especially in case of the technology industry, where mergers and acquisitions happen in order to increase the reach of an entity.

As per me an apt example of Horizontal Integration will be You Tube, which was taken over my Google primarily because it had a strong and loyal user base. (There was no rocket science in technology used at Youtube which Google couldn’t have done without taking over, but yes to increase the viewers was definitely as complex without the takeover.)

Executing these strategies and key points to remembers

Vertical and Horizontal integration strategy generally can be done by businesses which have established themselves and probably have a stable life as compared to ones which have to address risks on a regular basis. The immediate advantage of implementing them is to

1. Have economies of scale
2. Expand your knowledge and capabilities
3. Increase market (and profits)
4. Own the whole life cycle so that you can change it the way required
5. Reduce competition (by merging with them rather than competing)
6. Provide better services
7. Many more (refer links below)

I believe this much will suffice for you to understand what is vertical integration and horizontal integration? Attached are a few more links that will help you understand the concepts further

Before signing off would recommend reading vertical integration case study from wikipedia which highlights how Reliance Industries worked on backward integration and from textiles they got into polyster and later into petrochemicals. This was a brilliant strategy executed by the them owner Dhirubhai. Must read.

References:

1. http://en.wikipedia.org/wiki/Vertical_integration
2. http://en.wikipedia.org/wiki/Horizontal_integration
3. http://www.quickmba.com/strategy/vertical-integration/
4. http://www.businessdictionary.com/definition/horizontal-integration.html
5. http://www.12manage.com/methods_vertical_integration.html

Can you find companies that can easily benefit by exercising  Vertical or Horizontal integration? What can they do to achieve a better position?

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