Vertical Integration vs. Horizontal Integration: Key Differences, Explanation & Examples
When it’s time to grow, businesses often choose mergers and acquisitions as the most efficient way to expand. Such integrations are always related to some challenges: from the process initiation to the integration of two different management systems. The first step in this process is to understand, what is horizontal and vertical integration. The first is acquiring similar companies, and another is about integrating with another-level business from your supply chain. This understanding would allow you to make a correct decision on where to start and what would be the best for you and your business.
In this article, we will cover the difference between the two approaches: horizontal integration vs. vertical integration, touch on a business vertical point and discuss the advantages and challenges of both vertical and horizontal integration.
What does vertically integrated mean? Vertical integration is a strategy of integrating business with other businesses up or down the supply chain. The strategy is effective for greater control over the whole manufacturing process, timing, and all stages of development. Besides this, vertical integration has many advantages for business growth.
Advantages of vertical integration
Most businesses take control over the lower levels of the supply chain as it makes them more confident in everything they do and the result expected. However, there are some deeper reasons why businesses choose this approach:
- Greater control and independence. Once the business is integrated with the lower level in their supply chain, they can manage every aspect, from purchasing the materials to final logistics to the end buyer. This allows for better quality control and fewer delays in production.
- Cost savings. This includes lower logistic costs, decreased production costs, and easier management of all the prices related to manufacturers and logistics. Making the process overall more cost-effective, the strategy leads to long-run profits and more capabilities to attract customers (e.g., by reducing prices).
- Better marketability and market control. As the company now knows more about each step of production, it enables them to use better marketing and more competitive prices. Knowing how everything works lets businesses provide unique experiences to their customers.
Challenges and possible drawbacks of vertical integration
While being highly efficient, the approach has its own drawbacks and challenges that may appear as some obstacles to further growth:
- Many resources are needed. Acquiring other companies or replacing partners with your own manufacturing and logistics entities is not cheap, and it requires time to establish all processes and make them work smoothly.
- A great part of flexibility may be lost. Once the company merges with another company, they become a larger entity requiring more effort to confirm every process and react to all changes required. This may affect general flexibility and outer processes requiring quick decisions and changes.
- Lost focus on their main goals and customer loyalty. As the business starts focusing on many details, the main focus on the customer may be temporarily lost. It’s important to build a new value chain to keep all the processes working.
The businesses that integrated vertically
The most famous vertical integration examples are Apple, Mcdonald's and Amazon.
A good example of vertical integration is Apple, which keeps controlling the whole manufacturing process. Having used to outsource producing some parts before, the company now manufactures basically everything: from chipsets to cases. This allows Apple to offer unique products, hard to counterfeit, keep client loyalty worldwide, and guarantee their products' high quality.
Another business that integrated vertically and won the competition game is Mcdonald's. The company acquired some plants and also created its own manufacturing businesses to ensure the consistency of its products around the globe and better quality.
As it often happens to marketplaces, Amazon has also used vertical integration to grow, as they stopped using third-party partners for major logistics and packaging processes. Instead, they created their own departments that control it all. Moreover, Amazon has created its own electronics and household brands, which are produced under the total control of Amazon.
By contrast with vertical integration, horizontal expansion supposes merging with companies that are in the same industry and at the same stage of the supply chain. These can be competitors, suppliers, or companies that produce similar goods or services. Mostly, businesses choose this approach to increase market share, reduce competition, and achieve economies of scale.
Advantages of horizontal integration
Horizontal integration is a good option for companies if they need to grow without huge budgets. Here are some advantages businesses can get by choosing this approach:
- Increased market power. Most often, companies increase their market power by expanding their operations and merging with competitors. The market share and prices grow, so profitability improves.
- Building economies of scale. By expanding their operations, companies can reduce production costs which leads to offering their products or services at lower prices, making them more competitive in the market.
- Building synergies. When two companies merge together, the businesses share their expertise, resources, and capabilities. This can lead to improved innovation, better decision-making, and improved overall performance.
Challenges and possible drawbacks of horizontal integration
Horizontal integration offers several serious advantages; however, this is a challenging process with possible drawbacks that companies should consider. We list some of the challenges horizontal integration brings.
- Antitrust issues. While competition is reduced, the market becomes more concentrated, which can lead to regulatory scrutiny and potential legal challenges. However, this challenge mainly applies to the big market players and leaders.
- Cultures and integration challenges. When merging, the companies must integrate all their processes, systems, and cultures. Integration of the systems can even be easier if you use the right B2B platform or hire a trusted vendor for help or consultation. At the same time, cultural clashes can lead to resistance to change, reduced productivity, and increased employee turnover.
- Increased complexity and financial risks. The management of all operations becomes twice as hard until you integrate it all into one system. The process might be costly and lead to increased debt, reduced financial flexibility, and reduced profitability.
The businesses that integrated horizontally
The well-known businesses who integrated horizontally are Disney, Facebook and Coca-Cola.
Disney and Pixar merge is a perfect example of horizontal integration. Disney purchased Pixar back in 2006. Since then, the companies have featured a competitive rise as they integrated their capabilities and bundled technologies, gained greater market power, and now provide higher quality.
In 2012, Facebook merged with Instagram horizontally and grew its revenue significantly. This way, Facebook acquired a competitor while growing bigger and getting more capabilities. The merger allowed Facebook to attract more users and grow its positions among other social media.
Another example from the FMCG industry is Coca-Cola which acquired many juice brands around the world. While overcoming antitrust challenges, the company keeps growing as it collects expertise from each of these smaller companies, production assets, and more.
Vertical vs. Horizontal Integration: Key Differences
Now it’s time to consider the difference between vertical and horizontal integration. Vertical integration is all about owning and controlling the supply chain from raw materials to finished products so the company can control it all from the very scratch, guaranteeing higher quality and faster production. In this approach, a company is involved in multiple stages of the production process, such as manufacturing, distribution, and retailing.
Horizontal integration, in turn, refers to expanding operations by merging with similar companies at the same level of the supply chain. The company is still involved in the same supply chain stage but is becoming more powerful.
The difference between the vertical and horizontal integration
The comparison of vertical and horizontal integrations
The differences between vertical and horizontal integration can significantly impact a company's operations and strategy. If you want greater control over their supply chain, consistent quality, and reduced costs, vertical integration will fit the best; however, you must be careful with the future strategy: define the product positioning and target audience carefully, depending on your business goals.
If the business wants to increase its market power, reduce competition, and diversify its product or service offerings, horizontal integration is a perfect choice. While it requires significant investment and can increase a company's exposure to operational and financial risks associated with mergers and acquisitions, cultural clashes, and integration challenges, horizontal integration brings more power and greater capabilities. This means the company should update its strategy and integrate operations for success.
Below, we show how is horizontal integration different from vertical integration.
As the difference between vertical and horizontal is clear, the vertical integration approach seems to be easier and seamless and with fewer risks. However, horizontal integration brings more benefits and capabilities while being hard in terms of integration and the long process of cultures merging. In reality, these are just two different approaches that fit different types of businesses. Choosing between these two options highly depends on your current financial capabilities, target goal, niche, and other details. Further, we will explain the factors to consider when you decide on which strategy to choose.
Factors to Consider When Choosing between Vertical and Horizontal Integration
Once you decide that integration is inevitable and this is your perfect way to grow the business, it’s time to choose which one of two approaches would fit your business best: horizontal vs. vertical integration. Here are the main things to consider before making the final decision:
1. Industry trends
Consider the current and future trends in the industry you belong to. Look at the changes in consumer demand, technological advancements, and emerging competition. Answer these questions:
- Will the processes you plan to acquire still be relevant in the future?
- Do target customers prefer having more diversity or choose deeper quality control?
- Will you comply with these trends after the merger is done?
2. Business goals
Once you know what your integration business aims for, it will be easy to choose your type of integration. For example, if the main goal of the business is to increase its market share and reduce production costs, try horizontal integration. But if you want to gain greater control over the supply chain and ensure greater quality for your customers, vertical integration may be a better option. Whatever business model you choose, the questions to answer are as follows:
- What are the main business goals of the company?
- How will the merger help to reach these goals?
3. Business's resources and capabilities
Consider financial, managerial, and operational resources to determine which type of integration is feasible. For example, if a business has strong capabilities in supply chain management, vertical integration may be more suitable. The following questions can help:
- How much would we need to merge with another company? Is the budget enough?
- Which capabilities are strong enough to reach the target goal more efficiently?
- Will the merger strengthen our capabilities and the budget needed for the achievement of the goal?
4. The regulatory environment and potential risks
Anti-trust laws may restrict horizontal integration if it leads to a significant concentration of market power. Intellectual property and licensing may impact the feasibility of vertical integration. Before starting the merger, consider the regulatory environment and assess which legal or regulatory constraints you can encounter in the process. The useful things to think about:
- Would the merger lead to the overconcentration of the market? How to avoid issues?
- Are there any constraints in the current regulations that would possibly restrict the process? How to resolve them before the merger?
5. Industry structure and fragmentation
Analyze what your industry market looks like: if the industry is full of a few large companies leading the market, choose horizontal integration. However, many industries are fragmented, and competition is shared between many similar companies. In this case, vertical integration can help you reach superiority over your competitors due to a deeper control of all processes and higher quality. Check the following questions to ensure you make a correct choice:
- Do your industry feature just a few big players close in size to your business?
- Do you have many small competitors with the main weaknesses in price and quality?
Vertical integration usually takes longer to implement and may require more ongoing investment, while horizontal integration significance may be bigger: it can offer more immediate benefits. However, choosing a vertical approach, all you do is continuously grow the quality, but your goal and target audience remains the same, so it doesn't affect your surroundings as much as the horizontal changes. So here are the questions to consider:
- How long do you forecast your merger will take?
- How deeply will it affect your customers? How to avoid long-run challenges?
7. Technologies needed
Whatever approach you choose, most possibly your business and the acquired/merged one use different technologies to run the business. This means you will have to merge not only cultures but also all the operational processes. This challenge is easy to overcome if you choose a modern headless solution like Virto to integrate into both companies to be merged. The API-based structure allows connecting any operational software together easily and composing a new easy-to-use platform that significantly eases up possible integration challenges. Once you decide to merge, think about the following:
- Do our companies use the same technology stack for operational management?
- How can we avoid any technical integration issues?
- Which vendor to choose to connect all our different assets and turn them into one database?
Use these questions to realize which approach will fit you the best. Take your time to learn about all the technical and cultural details of your future merger and prepare well to make the process smooth and seamless.
Both approaches (vertical integration vs. horizontal integration) work well and bring many benefits. Along with the benefits, businesses often encounter some challenges to resolve. When choosing the path to go, the most important step is to assess all the possible benefits and challenges and realize if the benefits will cover the challenges.
Merging is always easier when you know what to do or have a trusted partner to support you. While you have to resolve cultural clashes and business details, let an experienced technology partner like Virto help you with the technical part of merging. The fast and easy technological integration will provide faster time-to-value, the seamless building of the new management processes, from internal processes to creating your own marketplace, and an easy start for your upgraded business.
If you don’t know where to start with both vertical integration and horizontal integration or need to assess your future capabilities by merging your technology stack with the acquired company, reach out to our expert team, who will provide a full analysis and offer the easiest way for you to merge seamlessly.