A vertical integration strategy is one in which one company operates at more than one level of the distribution channel. The distribution channel begins with the manufacturer that makes a product. The manufacturer sells the product to a wholesaler. The wholesaler sells to retailers, who ultimately sell to end customers. When a manufacturer sells directly to end customers, it uses forward vertical integration. When a wholesaler or retailer manufacturers, it uses backward vertical integration.
A main advantage sought by companies that get into vertical integration is more control over the value chain. When retailers decide to acquire or develop a manufacturing business, they get more control over the production part of the distribution process. Similarly, when a manufacturer performs distribution or retailing activities, it has more control over the way the product is presented and at what prices it is sold in the market.
Vertical integration also typically offers significantly ability to control costs throughout the distribution process. In the traditional distribution process, every step in product movement involves mark-ups so the reseller can earn profit. By selling directly to end buyers, manufacturers can "eliminate the middle man," removing one or more steps of mark-ups along the way. A single entity managing the distribution process also has more ability to optimize resource utilization and avoid wasted costs. Lower transportation costs are common.
Some companies engage in vertical integration solely to increase advantages over competition and to block competitors from gaining access to scarce resources or important markets. A retailer might buy a manufacturing company, for instance, to gain access to proprietary technology, patents or resources only available in the firm's local area. A manufacturing company may enter distribution or retailing to gain direct access to customer in a highly competitive market before its manufacturing competitors do.
Vertical integration gives companies access to more production inputs, distribution resources and process and retail channels. Each of these offers opportunities for the company to distinguish itself from competitors through effective marketing. A retailer can more quickly adapt to changing customer needs if it owns the manufacturing or production firm that makes its products. A manufacturer could sell through an Internet website and use online advertising techniques to drive traffic and build marketplace credibility.
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