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Economics

Study Notes

Advantage and Drawbacks of Vertical Integration

Level:
AS, A Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Vertical integration is the merger of two firms at a different stage of the same industry or process of production or same final product.

Forward and backward vertical integration:

  • Forward vertical: An integration of a business that is closer to final consumers e.g. a manufacturer buying a retailer. An example is wholesaler grocery firm Booker buying the Budgens and Londis retail grocery chains.
  • Backward vertical: Business integration that is closer to the raw materials in the supply chain e.g. a manufacturer buying a component supplier. Ikea bought Romanian and Baltic forests to improve control of their key raw materials. Apple bought Star Wars motion-capture company Faceshift and Amazon acquired the chip maker Dialog in 2018. The food delivery business Ocado has bought a stake in vertical farming specialist Jones Food Company to help support the building of more farms.

Advantages of vertical integration

Some of the main advantages of vertical integration are:

  1. Control of the supply chain – this helps to reduce unit costs and improve the quality of inputs into the production (supply) process.
  2. Improved access to key raw materials perhaps at the expense of rivals who must then pay more for them.
  3. Better control over retail distribution + adding new channels to sales platforms to build business revenues.
  4. Removing suppliers and taking market intelligence away from competitors which then helps to make a market less contestable (I.e. it increases a firm’s market power).

Disadvantages of vertical integration

  1. Vertical mergers will have fewer economies of scale because production is at different stages of supply.
  2. Mergers can often create new problems of communication and coordination within the bigger more disparate firm. It can lead to diseconomies of scale where the new bigger firm is more inefficient.

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