What is Integration Strategies? Types: Horizontal, Vertical Integration

What is Integration Strategies?

Integration Strategy basically means combining various activities related to the present doings of the firms on the grounds of the value chain.

This strategy is practiced when an organization is about to expand i.e., widening the scope of the business.

Horizontal Integration

Horizontal integration means bringing two firms that do not have a ­ supplier-buyer relationship and are typically positioned at a common stage of the value chain.

Some of the advantages of horizontal integration are given below:

• If the business acquires/merges with a foreign company, it makes it easier for the acquiring business to enter into the new market.
  
  
• When a business acquires and merges with another foreign company, the customers’ market of the acquired company also comes along with it during the acquisition. It would help the company to access the bigger for the distribution of its products.
  
  
• Acquisition and merging provide an opportunity for both companies to share their expertise and develop something new. It results in the form of a new differentiating product.
  
  
• When two businesses and companies integrate their experiences and expertise for mass production, it reduces the overall manufacturing cost.

Some of the disadvantages of horizontal integration are:

• The merging companies expect certain benefits from the horizontal integration, but the hardware and software of either of the companies don’t match up. The expected synergies turned out to be nonexistent from the integration.
  
  
• Sometimes, horizontal integration brings a lot of benefits in many ways. But it becomes bigger and loses its management and operational ­ flexibility. The functionality of the company becomes so rigid that it would become very difficult to change it.
  
  
• The acquiring and merging companies should keep in mind the legal issues. If the alliance of two firms becomes a monopoly and it threatens to end the business of competitors permanently, then it would result in serious legal issues.

Vertical Integration

There are many advantages of vertical integration that can help a company increase its competitiveness and profitability in the marketplace, some of which are listed below:

• When companies lower their per-unit fixed cost, they achieve “economies of scale.” One way to do this is to buy supplies in bulk, spreading the cost over a larger quantity of products. Another way to achieve economies of scale is to cut costs by eliminating expensive markups from middlemen, consolidating management and staff, and optimizing operations.
  
  
• Online stores such as Amazon and Chinese e-commerce giant Alibaba, now enable manufacturers to sell directly to customers anywhere, anytime, creating an entirely new center of earnings.
  
  
• Vertical integration can allow businesses to expand geographically by adding distribution centers in new areas or by acquiring a new brand. Generally, geo-graphical expansion works best when expanding within a company’s own segment in the supply-distribution spectrum. For example, Louis Vuitton, the manufacturer of fine leather goods, became a worldwide destination for women after opening their own stores in the fashion capitals of the world.
  
  
• Companies that have more control over the production process are able maintain higher quality standards.
  
  
• With vertical integration, a company may set itself apart from its competitors. For example, a company that manufacturers electronics could establish itself as a retailer, providing an experience for its customers that its competitors cannot.
  
  
• Vertical integration helps in protecting proprietary processes or recipes. In some cases, secret recipes are so valuable that they are maintained as true trade secrets and outsourcing their manufacturing would be unthinkable, such as with Coca-Cola.

Disadvantages of Vertical Integration

Even though there are some very good reasons to vertically integrate, there are two important disadvantages—a loss of flexibility and loss of focus—the two Fs.

Loss of Flexibility

• First, when many activities are managed in the value chain, the flexibility to quickly make changes to the business is lost. This might be important when there are major technological changes or unexpected volatility in the business environment (such as what was experienced in the 2020 COVID-19 pandemic).
  
  
• Research has shown that companies that are more vertically integrated take a bigger hit to performance when there is a technological change or volatility in the business environment This happened to taxi companies during the COVID-19 pandemic of 2020 relative to ride-hailing companies like Uber and Lyft.
  
  
  When the pandemic hit, the demand for rides decreased dramatically as many people quit traveling. While taxi companies like Yellow Cab often own their vehicles and hire their drivers, ride-hailing companies like Uber and Lyft neither own the vehicles nor hire the drivers as employees.
  
  
  Consequently, when demand for rides decreased these companies were not hurt as much as taxi companies because they were less vertically integrated. A similar thing happened to the more vertically integrated makers of CD players and Discman—such as Sony and Panasonic—when MP3 players and smartphones hit the market as an alternative to having portable music. The new technology made their in-house capabilities at producing CD players obsolete.
  
  
• Companies typically have greater flexibility to respond to changes in technology or the environment when they outsource. Having more ­ flexibility— that is, being less vertically integrated—is particularly valuable when new technologies are being developed or if the cost to perform an activity can change quickly. For example, one of the reasons that Nike chooses to outsource the production of its shoes is because it likes the ability to switch suppliers depending on which supplier is lowest cost at the moment.
  
  
• To illustrate, in the late 1990s, the Asian financial crises had a dramatic effect on the currencies and exchange rates of some Asian countries, but not others. Indonesia’s currency, the rupiah, was trading at roughly 4,000 to the dollar before the crises, but a dollar would fetch more than 10,000 rupiahs at the crises’ height. This meant that Nike could buy shoes from Indonesian subcontractors for less than half the prices they were paying before the change in exchange rates.
  
  
• At the same time, China decided to keep its currency stable with the dollar, so Nike’s prices on shoes from Chinese shoe suppliers did not change much. Because Nike did not own any of the manufacturing plants, it had the flexibility to shift production to a low-cost location—which, for a period of time, favored Indonesia over China. As a result of changing wages and exchange rates across countries where shoes are produced, Nike likes the flexibility to source the manufacturing of its new products to the lowest cost producer.

Loss of Focus

• A loss of focus refers to the fact that the greater the number and variety of activities a firm needs to manage, the harder it is to be world class in all of those activities. It is just too difficult for managers to focus on many different activities at once and be world class at all of them.
  
  
  To illustrate, for many years General Motors (GM) made almost 70 percent of its parts internally including spark plugs, batteries, brakes, and a host of other automotive parts. In contrast, Toyota makes only about 25 percent of its parts. Toyota outsources to companies that specialize in various parts— such as spark plugs, batteries, and brakes—and therefore provides the best possible parts at reasonable costs.
  
  
• While GM made its own brakes, Toyota outsourced them to companies such as Akebono and Kayabe Brake that specialized in brakes. General Motors cars have cost more than Toyota’s, in part because it just could not make parts cheaper than Toyota could buy them. Why did General Motors have higher costs for producing automotive components such as spark plugs, batteries, and brakes?
  
  
  The primary reason was a lack of focus—suppliers were able to have lower costs by focusing on a narrow product line and producing those products in large scale for multiple automakers. Akebono Brake made braking systems not only for Toyota but also for Nissan and many other automakers. This allowed Akebono to make products in larger volumes and with greater economies of scale, thereby lowering costs per unit. GM’s lack of focus made it difficult for its internal brake divisions to compete with these focused suppliers.
  
  
• Moreover, even though GM could buy cheaper brakes from outside suppliers such as Akebono and Kayabe, it refused to do so because GM did not want to incur the costs to fire its union workers and close its plants. Both a lack of focus and flexibility hurt GM’s overall performance. General Motors finally realized that too much vertical integration was a liability, and it eventually created an automotive components division it spun off as a separate company that would have to compete on its own.
  
  
  Now GM has more flexibility to buy from other suppliers and buys from its former in-house suppliers only if they offer the best product at the lowest price. One more dimension is worth mentioning. When firms are vertically specialized, they stay in business only when they can make profits to cover their cost of capital. If they cannot make enough profits, they go out of business.
  
  
• However, when an activity is conducted within a firm, it can often stay in business even if it is not performing well and making profits—just like some of GM’s automotive parts divisions. This is possible because it gets subsidized by other parts of a company’s business that are profitable. Sometimes you lose the discipline of the marketplace and a focus on making profits when you conduct an activity internally. Keeping employees motivated to perform is critical if an organization hopes to be world class in any activity.