Vertical Integration: The Pendulum Swings Back

An article in today’s WSJ, “Companies More Prone to Go Vertical,” discussed the current trend for some companies such as Oracle, Pepsi, IBM, General Motors, Boeing and Apple, to cite a few,  to return to the practice of vertical integration. Vertical integration can be defined as the degree to which a company owns its upstream suppliers and downstream customers and distribution channels. Some of the main reasons why companies may want to become vertically integrated are to mitigate supplier risk, control distribution channels, increase barriers to entry from competitors.  Boeing, for example, acquired Vought’s Dreamliner operations out of necessity to gain control over troubled suppliers and parts that were having an adverse impact on its Dreamliner program.

While companies don’t seem to returning to the old Henry Ford style of vertical integration, they seem be trying to use it as a method of controlling assets and exerting more control over critical parts of the supply chain. Vertical integration seems to wax and wane over time. Perhaps the global economy with its growing supply risks and increased competition is spawning this new wave.

There are, however, many drawbacks to vertical integration. One is decreased flexibility and potentially higher costs. Once a supplier is captive, there may be more control.  However, there is a cost to increased control, including reduced supplier competition and opportunities to engage with potentially more capable suppliers in the future.  And as business needs evolve, some of the integrated businesses may not evolve, may no longer fit or even be a drag on the bottom line. Vertically integrated companies may find themselves with less attractive overhead and cost structures. And they may be entering industries either upstream or downstream that they have less knowledge of and that may not really mesh with or add value to their real core competencies.

The regulatory environment may determine how far firms are able to go this time with vertical integration. And the competitive environment will ultimately help shape and influence the success of this approach.

Sherry R. Gordon

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