Integration refers to combining activities related to the present activities of a firm, on the basis of the value chain. Recall that a value chain is a set of interrelated activities an organization performs right from the procurement of basic raw materials to the marketing of finished products to the ultimate consumers.
Integration as an expansion strategy results in a widening of the scope of the business definition of a firm. Integration may take two forms:
(a) Vertical integration
(b) Horizontal integration
Vertical Integration:
Vertical integration means that a company is producing its own inputs (backward or upstream integration) or is disposing of its own outputs (forward or downstream integration). In other words, any new activity an organization undertakes for the purpose of either supplying inputs or serving its customers for outputs. Vertical integration is a strategy which expands or restricts the business definition primarily in terms of functions performed. For example, a steel company supplies its iron ore needs from company owned iron ore mines is an example of backward integration. A two- wheeler manufacturer that sells its scooters through company-owned distribution outlets illustrates forward integration. Thus forward integration involves movement into distribution and backward integration involves movement into intermediate manufacturing and raw-material production. Usually, when firms integrate vertically, they move backward or forward decisively resulting in a full integration. ‘ A backward integration is associated with strategies affecting the supply of a firm’s inputs’ while ‘a forward integration refers to moves altering the nature of the distribution of the firm’s output. A company achieves full integration when it produces all of a particular inputs needed for its processes or when it disposes of all of its output through its own operations. But when a firm does not integrate fully, it may opt for partial vertical integration. Two such partial vertical integration strategies are known as ‘taper integration’ and ‘quasi- integration’. Taper integration occurs when a company buys from independent suppliers in addition to company owned suppliers or when it disposes of its output through independent outlets in addition to company- owned outlets. When firms purchase most of their requirements from other firms in which they have an ownership stake, they follow ‘quasi’ integration strategies. Ancillary industrial units and outsourcing through sub-contracting are examples of ‘quasi’ integration. A company pursuing vertical integration is normally motivated by a desire to strengthen the competitive position of its core business. There are four main arguments for pursuing a vertical integration strategy.
(1) Enables the company to build barriers to new entry
(2) facilitates investments in efficiency- enhancing specialized assets,
(3) protects product- quality, and
(4) results in improved scheduling. The vertical integration creates a number of advantages for the firm.
(1) Creates barriers to entry: A company can build barriers to new entry into its industry by vertically integrating back to gain control over the source of critical inputs or vertically integrating forward to gain control over distribution channels. Effective vertical integration restricts competition in the company’s industry and enable the company to charge a higher price and make greater profits than it could otherwise make’.
Integration as an expansion strategy results in a widening of the scope of the business definition of a firm. Integration may take two forms:
(a) Vertical integration
(b) Horizontal integration
Vertical Integration:
Vertical integration means that a company is producing its own inputs (backward or upstream integration) or is disposing of its own outputs (forward or downstream integration). In other words, any new activity an organization undertakes for the purpose of either supplying inputs or serving its customers for outputs. Vertical integration is a strategy which expands or restricts the business definition primarily in terms of functions performed. For example, a steel company supplies its iron ore needs from company owned iron ore mines is an example of backward integration. A two- wheeler manufacturer that sells its scooters through company-owned distribution outlets illustrates forward integration. Thus forward integration involves movement into distribution and backward integration involves movement into intermediate manufacturing and raw-material production. Usually, when firms integrate vertically, they move backward or forward decisively resulting in a full integration. ‘ A backward integration is associated with strategies affecting the supply of a firm’s inputs’ while ‘a forward integration refers to moves altering the nature of the distribution of the firm’s output. A company achieves full integration when it produces all of a particular inputs needed for its processes or when it disposes of all of its output through its own operations. But when a firm does not integrate fully, it may opt for partial vertical integration. Two such partial vertical integration strategies are known as ‘taper integration’ and ‘quasi- integration’. Taper integration occurs when a company buys from independent suppliers in addition to company owned suppliers or when it disposes of its output through independent outlets in addition to company- owned outlets. When firms purchase most of their requirements from other firms in which they have an ownership stake, they follow ‘quasi’ integration strategies. Ancillary industrial units and outsourcing through sub-contracting are examples of ‘quasi’ integration. A company pursuing vertical integration is normally motivated by a desire to strengthen the competitive position of its core business. There are four main arguments for pursuing a vertical integration strategy.
(1) Enables the company to build barriers to new entry
(2) facilitates investments in efficiency- enhancing specialized assets,
(3) protects product- quality, and
(4) results in improved scheduling. The vertical integration creates a number of advantages for the firm.
(1) Creates barriers to entry: A company can build barriers to new entry into its industry by vertically integrating back to gain control over the source of critical inputs or vertically integrating forward to gain control over distribution channels. Effective vertical integration restricts competition in the company’s industry and enable the company to charge a higher price and make greater profits than it could otherwise make’.
(2) Facilitates Investments in Specialized Assets: Vertical integration facilitates investments in specialized assets. A specialized asset is designed to perform a specific task and whose value is significantly reduced in its next best use. Companies invest in specialized assets because these assets allow them to lower the costs of value creation and/or to better differentiate their product offering from that of the competitors, thereby facilitating premium pricing.
(3) Protect Quality of Product: Vertical integration facilitates a company to become a differentiated player in its core business and thus protect the quality of its product.
(4) Improve Scheduling: Planning, coordination, and scheduling of adjacent processes in vertically integrated businesses give rise to strategic advantages. This enables a company to respond better to sudden changes in demand situations, or establish its product into the market place faster.
(5) Vertical integration provides better control of suppliers or distributors and possible cost savings.
Vertical Integration also shares a couple of disadvantages.1. Cost Disadvantages :Vertical integration is often undertaken to take advantage of production cost, but it can increase costs if a company commits itself to procuring inputs from company-owned suppliers when low- cost external sources of supply are available. For example GM makes 68 percent of the components for its vehicles in-house that has caused GM to be the highest-cost producer among the world’s major car companies. Compared to the independent suppliers, the company owned supplier might have high operating costs because they know that they can always sell their output to other parts of the company. They do not have to compete for orders and that reduces the incentive to minimize operating costs. They tend to pass the increased costs on other parts of the company in the form of higher transfer costs.
2. Technological Change: Another disadvantage of vertical integration is with fast changing technology. Vertical integration may create the hazard of tying a company to an obsolescent technology.
3. Demand Uncertainty: In unpredictable or volatile demand conditions, vertical integration can be become risky. When demand conditions to a certain extent are stable, higher degree of vertical integration might be managed with better scheduling and coordination of production flows among different activities. When demand conditions are unstable, it would be difficult to achieve close coordination among vertically integrated activities. The resulting inefficiencies can raise bureaucratic costs significantly. If demand conditions are not predictable, taper integration might be less risky than full integration.
(3) Protect Quality of Product: Vertical integration facilitates a company to become a differentiated player in its core business and thus protect the quality of its product.
(4) Improve Scheduling: Planning, coordination, and scheduling of adjacent processes in vertically integrated businesses give rise to strategic advantages. This enables a company to respond better to sudden changes in demand situations, or establish its product into the market place faster.
(5) Vertical integration provides better control of suppliers or distributors and possible cost savings.
Vertical Integration also shares a couple of disadvantages.1. Cost Disadvantages :Vertical integration is often undertaken to take advantage of production cost, but it can increase costs if a company commits itself to procuring inputs from company-owned suppliers when low- cost external sources of supply are available. For example GM makes 68 percent of the components for its vehicles in-house that has caused GM to be the highest-cost producer among the world’s major car companies. Compared to the independent suppliers, the company owned supplier might have high operating costs because they know that they can always sell their output to other parts of the company. They do not have to compete for orders and that reduces the incentive to minimize operating costs. They tend to pass the increased costs on other parts of the company in the form of higher transfer costs.
2. Technological Change: Another disadvantage of vertical integration is with fast changing technology. Vertical integration may create the hazard of tying a company to an obsolescent technology.
3. Demand Uncertainty: In unpredictable or volatile demand conditions, vertical integration can be become risky. When demand conditions to a certain extent are stable, higher degree of vertical integration might be managed with better scheduling and coordination of production flows among different activities. When demand conditions are unstable, it would be difficult to achieve close coordination among vertically integrated activities. The resulting inefficiencies can raise bureaucratic costs significantly. If demand conditions are not predictable, taper integration might be less risky than full integration.
4. Vertical integration could result in the addition of new markets for products, and the firm may compete with established distributors or suppliers
Horizontal Integration: An organization is said to follow a strategy of horizontal integration when it takes up the same types of products, markets or functions. For example, a leather shoe company takes over its rival leather shoe company; it is horizontal integration or merger. Horizontal integration strategy is generally followed for the purpose to expand geographically by buying a competitor’s business, to increase the market share or to take advantage of the economies of scale. The principal attraction of a horizontal integration strategy is that the acquiring firm greatly expands its operations, thereby achieving greater market share, improving economies of scale, and increasing efficiency of capital usage with only moderately increased risk, since the success of the expansion is principally dependent on proven abilities. Horizontal integration, like concentration strategies, carry a risk as the firm makes its commitment to adjacent businesses all set to cater the same set of customer groups and customer needs. The firm faces a grave risk if the product of the integrated firm fails or get obsolete. Because of such reasons, many firms diversify to reduce their risk. Diversification strategies are discussed in the next section.
Horizontal Integration: An organization is said to follow a strategy of horizontal integration when it takes up the same types of products, markets or functions. For example, a leather shoe company takes over its rival leather shoe company; it is horizontal integration or merger. Horizontal integration strategy is generally followed for the purpose to expand geographically by buying a competitor’s business, to increase the market share or to take advantage of the economies of scale. The principal attraction of a horizontal integration strategy is that the acquiring firm greatly expands its operations, thereby achieving greater market share, improving economies of scale, and increasing efficiency of capital usage with only moderately increased risk, since the success of the expansion is principally dependent on proven abilities. Horizontal integration, like concentration strategies, carry a risk as the firm makes its commitment to adjacent businesses all set to cater the same set of customer groups and customer needs. The firm faces a grave risk if the product of the integrated firm fails or get obsolete. Because of such reasons, many firms diversify to reduce their risk. Diversification strategies are discussed in the next section.
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