Vertical Integration Vs. Horizontal Integration: What’s The Difference?

Both vertical integration and horizontal integration are types of business consolidation strategies. While the terms sound abstract, they’re actually descriptive of the process, which means that once they’re explained to you, it isn’t difficult to remember which is which.

Companies can take one of two tracks (or both of them, if they have enough capital) to consolidate their business, decrease competition, and increase their market power.

The first is horizontal integration. This is one that everyone’s familiar with, though the better-known term would be monopolization or a monopoly. Of course, it doesn’t need to be a true monopoly for it to be considered horizontal integration – for instance, T-Mobile purchasing Sprint was horizontal integration, but they still compete against Verizon and AT&T.

Vertical integration, on the other hand, would be if T-Mobile had bought Samsung’s cell phone division. That gives them ownership of a cell phone manufacturer, which they can then sell to customers.

It could also work if they bought a company that constructs cell towers or makes the components for those towers. Vertical integration, then, is buying up businesses up and down the supply chain so that one umbrella company has control over all of them.

Key Takeaways:

What Is Vertical Integration?

Vertical integration is taking over companies up and down the supply chain. For instance, if a software company buys a computer manufacturer (such as Microsoft buying Lenovo), that’s vertical integration.

If they want to continue it, they could then buy the companies that make computer chips (such as Intel) and a mining company for rare earth metals and other necessary materials.

A good example of it is Amazon starting its own delivery service. While they didn’t purchase a company, it’s still vertical integration in that they take another company out of the delivery part of it. This would also work if the company had, say, purchased FedEx.

There are two types of vertical integration. The first is backward integration, which is when one company buys another company that makes a necessary component for whatever the acquiring company makes. For instance, a bicycle company buying a company that makes bicycle tires.

The second is forward integration, which is the opposite. It’s when a company decides to purchase a business that is in its post-production process. For instance, if that same bicycle company purchased a bicycle retailer.

Vertical integration has several different advantages; however, as with most things, they are tempered by disadvantages.

Pros:

• Cost reduction. As each individual part of the production process no longer has to make a profit, it allows for cost reduction. It also gives the company a larger market share and more power to negotiate prices.

• Strict control over quality. Quality control can now extend up and down the chain with the same standards.

• Allows for control of production volume. If you know how much raw materials you can get and how many goods you intend to produce, you can calculate resources quite precisely. It also means you won’t be squeezed by your supplier not selling you what you need or a retailer deciding to choose a competitor’s product.

• Can increase sales. You can start selling from your supply side to other companies, or, if you have control of the retail side, you can have more control over sales goals and strategies.

• Has a connection to the supply side and the customer-facing side (if you’re fully vertically integrated). This can allow you to be on the lookout for potential squeezes in terms of supply and to be closer to the customer base and what they want.

Cons:

• Increases risk. This type of integration has a bit of the putting all your eggs in one basket effect. It’s fantastic if everything goes well, but if there are issues with supply or with selling, then it can be difficult to pivot to deal with the shortfall.

• Coordination and organization are complex and expensive. The logistics of a fully vertically integrated company are staggering. Supply, production, transportation, manufacturing, and sales all have to be taken into consideration.

  Each of these arms has to be able to communicate with one another and work together, which isn’t easy or simple.

What Is Horizontal Integration?

Horizontal integration is when a company buys a direct competitor. For instance, if Harley-Davidson were to buy Triumph Motorcycles. That would give them an even bigger market share in motorcycle manufacturing and sales.

The best-known monopoly is likely Rockefeller’s Standard Oil. That was an example of full horizontal integration, achieved both through purchases and driving other companies out of business (which wouldn’t count as integrating).

As with vertical integration, horizontal integration has pluses and minuses.

Pros:

• Bigger market share. A larger share of the market allows for more negotiating power. For instance, while Disney isn’t a monopoly, it has such a large share of the market that it can set the rules for movie theater companies, as the loss of Disney movies would shred their revenue.

• Economies of scale. Buying in bulk ends up being less expensive overall. The more you manufacture, the larger the economy of scale, which reduces the cost per item.

• Higher revenue. The lowered costs and larger customer base allow for a greater revenue stream.

• Reduces competition. Having less competition means that your customer base is larger, your market share is larger, and this gives you more control over pricing and distribution.

Cons:

• Antitrust laws lead to government scrutiny. Due to abuse by former monopolies, there are government regulations to limit horizontal mergers. That means that buying a competitor can lead to intense scrutiny, and the purchase can even be stopped if it’s found to be in violation.

• Reduces customer choice. While this isn’t bad for the company, consumers can suffer from limited choice. The fewer choices they have, the more the company can set standards such as quality control and price, which can force consumers to buy overpriced, inferior products.

• The company becomes larger and less agile. The bigger the company is, the harder it is for them to adapt or move quickly. A large conglomerate can sometimes become stagnant due to the lack of innovation and the inability to react to change in a timely manner.

Author

Di Doherty

Di has been a writer for more than half her life. Most of her writing so far has been fiction, and she’s gotten short stories published in online magazines Kzine and Silver Blade, as well as a flash fiction piece in the Bookends review. Di graduated from Mary Baldwin College (now University) with a degree in Psychology and Sociology.