What is the difference between vertical and horizontal integration?
A company deciding on which strategic direction it should pursue is very important before starting any initiative. They need to decide if acquiring a company to achieve horizontal and vertical integration will provide them with best growth leverage.
Horizontal integration explained
It is common for companies to grow by taking customers from their competition - this is a form of horizontal integration.
A company can pursue vertical integration when it can increase its profits by obtaining better control of its operations.
Companies can also practice horizontal integration by buying or merging with their competitors. This works well when a company has a successful business model and needs to add more customers to increase their profit at higher economies of scale.
Buying or merging also helps diversify a company’s products or services and reduce competitors in the marketplace. Examples of horizontal integration include when one large hotel chain buys another or a studio company purchasing a small, independent film making company.
Unfortunately, horizontal integration is not always successful. This method of growth works best when the two companies have synergistic cultures and customers. Even when two companies sell a similar product to a similar product, the merger may fail if there are problems merging the two company cultures.
Vertical integration explained
Other businesses choose to expand by acquiring a company that occupies a critical place in their supply chain process, including raw materials sourcing, product manufacturing, transportation, distribution or retailing.
Vertical integration can also be the degree to which a firm owns its upstream suppliers (backward integration) and its downstream buyers (forward integration). Businesses do this to secure the supplies, distribution points or other parts of the transaction necessary to produce or market products or services at a lower or more predictable price. (For example, an auction site purchasing a payment company to capture the revenue stream that comes from the fee of paying online.)
The synergies involved in vertical integration are not always successful. Sometimes the two companies have diverse requirements of how much product or service needs to flow through their part of the supply chain. Vertical integration also means committing to a specific company, technology or process. This can result in a lack of flexibility when market trends change.
Pursuing horizontal and vertical integration in your business
Here are some of the elements a company should consider if they're deciding between horizontal and vertical integration. A business can pursue horizontal integration when it operates in a growing industry, and its competitors lack some of the competencies or financial resources it possesses.
Please remember that the acquiring or merging organisations need the financial resources to manage this process. A company can pursue vertical integration when it can increase its profits by obtaining better control of its operations. Through this growth method, it can reduce its costs across its production cycle, ensure better control, and get more control of information across its supply chain.
Some companies pursue vertical integration when they want their existing suppliers or distributors to have less power over their business.
Both horizontal and vertical integration can be successful. But before pursuing either strategy, a company should know which parts of its operation would produce the most leverage on its profit if drastically improved.