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Encyclopedia > Vertical integration

In microeconomics and strategic management, the term vertical integration describes a style of ownership and control. Vertically integrated companies are united through a hierarchy and share a common owner. Usually each member of the hierarchy produces a different product or service, and the products combine to satisfy a common need. It is contrasted with horizontal integration. Vertical integration is one method of avoiding the hold-up problem. Image File history File links Please see the file description page for further information. ... It has been suggested that this article or section be merged into Vertical integration. ... Microeconomics is a branch of economics that studies how individuals, households, and firms make decisions to allocate limited resources [1] , typically in markets where goods or services are being bought and sold. ... This article or section does not cite its references or sources. ... Ownership is the state or fact of exclusive possession or control of property, which may be an object, land/real estate, intellectual property or some other kind of property. ... A hierarchy (in Greek: , it is derived from -hieros, sacred, and -arkho, rule) is a system of ranking and organizing things or people, where each element of the system (except for the top element) is subordinate to a single other element. ... The concept of Needs is often used to refer to things that people must have. ... In microeconomics and strategic management, the term horizontal integration describes a type of ownership and control. ... The hold up problem is a term used in economics to describe a situation where two parties (such as a supplier and a manufacturer) may be able to work most efficiently by cooperating, but refrain from doing so due to concerns that they may give the other party increased bargaining...


One of the earliest, largest and most famous examples of vertical integration was the Carnegie Steel company. The company controlled not only the mills where the steel was manufactured, but also the mines where the iron ore was extracted, the coal mines that supplied the coal, the ships that transported the iron ore and the railroads that transported the coal to the factory, the coke ovens where the coal was coked, etc. Carnegie Steel is the steel corporation originally founded and headed by steel magnate Andrew Carnegie. ... The old steel cable of a colliery winding tower Steel is an alloy whose major component is iron, with carbon content between 0. ... This heap of iron ore pellets will be used in steel production. ... Coal Coal (IPA: ) is a fossil fuel extracted from the ground by coal mining, either underground mining or open-pit mining (surface mining). ... Coke is a solid carbonaceous residue derived from low-ash, low-sulfur bituminous coal. ...


A monopoly produced through vertical integration is called a vertical monopoly, although it might be more appropriate to speak of this as some form of cartel. In economics, a monopoly (from the Latin word monopolium - Greek language monos, one + polein, to sell) is defined as a persistent market situation where there is only one provider of a product or service. ... Vertical monopoly refers to monopoly achieved through vertical integration. ... A cartel is a group of legally independent producers whose goal it is to fix prices, limit supplies and limit competition. ...


Vertical integration is the degree to which a firm owns its upstream suppliers and its downstream buyers.

Contents

Three types

Vertical integration is the degree to which a firm owns its upstream suppliers and its downstream buyers. Contrary to horizontal integration, which is a consolidation of many firms that handle the same part of the production process, vertical integration is typified by one firm engaged in different aspects of production (e.g. growing raw materials, manufacturing, transporting, marketing, and/or retailing).


There are three varieties: backward (upstream) vertical integration, forward (downstream) vertical integration, and balanced (horizontal) vertical integration.

  • In backward vertical integration, the company sets up subsidiaries that produce some of the inputs used in the production of its products. For example, an automobile company may own a tire company, a glass company, and a metal company. Control of these three subsidiaries is intended to create a stable supply of inputs and ensure a consistent quality in their final product. It was the main business approach of Ford and other car companies in the 1920s, who sought to minimize costs by centralizing the production of cars and car parts.
  • In forward vertical integration, the company sets up subsidiaries that distribute or market products to customers or use the products themselves. An example of this is a movie studio that also owns a chain of theaters.
  • In balanced vertical integration, the company sets up subsidiaries that both supply them with inputs and distribute their outputs.

It means, using McDonald's as an example, that they would own the farms where they raise the cows and chickens, the potatoes and the wheat. They would own the plant that processes everything and turns it all into food, the distribution centers for every area, and the fast food retailers. It has been suggested that this article be split into articles entitled Ford Motor Company and Ford (vehicles). ... The 1920s was a decade sometimes referred to as the Jazz Age or the Roaring Twenties, usually applied to America. ... Centralization (or centralisation) is the process by which the activities of an organization, particularly those regarding decision-making, become concentrated within a particular location and/or group. ... Wikibooks has more about this subject: Marketing Distribution is one of the four aspects of marketing. ... Wikibooks has more about this subject: Marketing Marketing is a social and managerial function that attempts to create, expand and maintain a collection of customers. ... McDonalds Corporation (NYSE: MCD) is the worlds largest chain of fast-food restaurants, primarily selling hamburgers, chicken, french fries, milkshakes and soft drinks. ...


Examples

Oil Industry

One of the best examples of vertically integrated companies is the oil industry. Oil companies, both multinational (such as ExxonMobil, Royal Dutch Shell, or BP) and national (e.g. Petronas) often adopt a vertically integrated structure. This means that they are active all the way along the supply chain from locating crude oil deposits, drilling and extracting crude, transporting it around the world, refining it into petroleum products such as gasoline, to distributing the fuel to company-owned retail stations, where it is sold to consumers. Exxon Mobil Corporation or ExxonMobil (NYSE: XOM), headquartered in Irving, Texas, a suburb of Dallas, USA, is the largest publicly traded integrated oil and gas company in the world, formed on November 30, 1999, by the merger of Exxon and Mobil. ... Royal Dutch Shell PLC is a multinational oil company (oil major) of Anglo Dutch origin. ... BP plc (LSE: BP, NYSE: BP, TYO: 5051 ), originally British Petroleum, is a British energy company / multinational oil company (oil major) with headquarters in London which is amongst the largest private sector energy corporations in the world, and one of the six supermajors (vertically integrated private sector oil exploration, natural... PETRONAS, short for Petroliam Nasional Berhad, is Malaysias owned oil and gas company that was founded on August 17, 1974. ... Pumpjack pumping an oil well near Sarnia, Ontario Petroleum (from Greek petra – rock and elaion – oil or Latin oleum – oil ) or crude oil is a thick, dark brown or greenish liquid. ... A refinery is a building and/or the equipment used for refining or processing specific products. ... Gasoline or petrol is a petroleum-derived liquid mixture consisting mostly of hydrocarbons and enhanced with benzene or iso-octane to increase octane ratings, used as fuel in internal combustion engines. ...


Apple Inc.

Apple is one of the few vertically integrated businesses in the IT sector. The company designs the computer hardware, accessories, operating system and much of the software itself. Production, however, has been transferred to specialized suppliers such as Flextronics, which also manufactures computer hardware for other companies. This arrangement is similar to that of most high-tech companies today. Although no longer participating in the actual manufacturing process, Apple has recently established a chain of high-profile upscale retail outlets, establishing a type of forward vertical integration which ensures that it retains some measure of control over its product image and marketing strategy. This article does not cite its references or sources. ...


AT&T prior to 1996 and 1984

Prior to the 1984 Bell System Divestiture, AT&T was structured as 22 Bell Operating Companies, a research division, Bell Labs, the Long Lines division, and their manufacturing division, Western Electric. Bell Labs researched new technologies, such as Touch-Tone Dialing, Dataphone Service, PicturePhone Service, electronic switching, the UNIX operating system, and the transistor. Western Electric manufactured products based on Bell Labs research, and the Bell Operating Companies deployed those products to the field. After 1984 AT&T no longer owned the Bell Operating Companies, however it remained vertically integrated through the Long Lines, Bell Labs, and manufacturing operations. In 1996 AT&T divested itself of Bell Labs and manufacturing because those divisions were losing business because competitors to AT&T's network operations were often hesitant to buy AT&T equipment. The break up of AT&T was initiated in 1974 by the U.S. Department of Justice anti-trust suit against the telephone monopoly. ... Bell System trademark used by AT&T and affiliated companies from 1921 to 1939 The Bell System was a trademark and service mark used by the US telecommunications company American Telephone & Telegraph Company (AT&T) and its affiliated companies to co-brand their extensive circuit-switched telephone network and their... Bell Laboratories (also known as Bell Labs and formerly known as AT&T Bell Laboratories and Bell Telephone Laboratories) was the main research and development arm of the United States Bell System. ... AT&T Long Lines logo, 1969-1983 The AT&T Long Lines microwave relay network provided long-distance transport services to AT&T and its customers from the late 1940s to the early 1980s. ... Western Electric (sometimes abbreviated WE and WECo) was a US electrical engineering company, the manufacturing arm of AT&T from 1881 to 1995 . ... A DTMF telephone keypad Dual-tone multi-frequency (DTMF) signaling is used for telephone signaling over the line in the voice-frequency band to the call switching center. ... A modem (from modulate and demodulate) is a device that modulates an analogue carrier signal to encode digital information, and also demodulates such a carrier signal to decode the transmitted information. ... It has been suggested that Visiophone be merged into this article or section. ... Filiation of Unix and Unix-like systems Unix (officially trademarked as UNIX®) is a computer operating system originally developed in the 1960s and 1970s by a group of AT&T employees at Bell Labs including Ken Thompson, Dennis Ritchie and Douglas McIlroy. ... Assorted transistors A transistor is a semiconductor device that uses a small amount of voltage or electrical current to control a larger change in voltage or current. ...


Problems and Benefits

There are internal and external (e.g. society-wide) gains and losses due to vertical integration. They will differ according to the state of technology in the industries involved, roughly corresponding to the stages of the industry lifecycle. Industry lifecycle is a theory linking the intensity of competition in a particular market with the time since the breakthrough innovation that made that market possible. ...


Static technology

This is the simplest case, where the gains and losses have been studied extensively.


Internal gains:

  • Lower transaction costs
  • Synchronization of supply and demand along the chain of products
  • Lower uncertainty and higher investment
  • Ability to monopolize markets throughout the chain by market foreclosure

Internal losses: In economics and related disciplines, a transaction cost is a cost incurred in making an economic exchange. ... Supply has a number of meanings: In economics, supply is the aggregate amount of any material good that can be called into being at a certain price point; it comprises one half of the equation of supply and demand. ... The supply and demand model describes how prices vary as a result of a balance between product availability at each price (supply) and the desires of those with purchasing power at each price (demand). ... In economics, a monopoly (from the Latin word monopolium - Greek language monos, one + polein, to sell) is defined as a persistent market situation where there is only one provider of a product or service. ...

  • Higher monetary and organizational costs of switching to other suppliers/buyers

Benefits to society:

  • Better opportunities for investment growth through reduced uncertainty

Losses to society:

Socialism is a social and economic system (or the political philosophy advocating such a system) in which the economic means of production are owned and controlled collectively by the people. ... John Kenneth Galbraith John Kenneth Galbraith (October 15, 1908–April 29, 2006) was an influential Canadian-American economist. ...

Dynamic technology

Some argue that vertical integration will eventually hurt a company because when new technologies are available, the company is forced to reinvest in its infrastructures in order to keep up with competition. Some say that today, when technologies evolve very quickly, this can cause a company to invest into new technologies, only to reinvest in even newer technologies later, thus costing a company financially. However, a benefit of vertical integration is that all the components that are in a company product will work harmoniously, which will lower downtime and repair costs.


See also

To meet Wikipedias quality standards, this article or section may require cleanup. ... Exclusive dealing refers to when a retailer or wholesaler is ‘tied’ to purchase from a supplier on the understanding that no other distributor will be appointed or receive supplies in a given area. ... This article or section does not cite its references or sources. ... Zaibatsu , lit. ... Chaebol are South Koreas business conglomerates. ... In microeconomics and strategic management, the term horizontal integration describes a type of ownership and control. ... The economic calculation problem is a criticism of socialist economics. ... A planned economy is an economic system in which economic decisions are made by centralized planners, who determine what sorts of goods and services to produce, and how they are to be priced and allocated. ... It has been suggested that The Firm be merged into this article or section. ... Vertical Disintegration refers to a specific organizational form of industrial production. ...

Lists

This is a list of articles on general management and strategic management topics. ... This is a list of over 200 articles on marketing topics. ... This aims to be a complete list of the articles on economics. ...

References

Martin K. Perry. "Vertical Integration: Determinants and Effects". Chapter 4 in: Handbook of Industrial Organization. North Holland, 1988.


  Results from FactBites:
 
Vertical integration - Wikipedia, the free encyclopedia (1001 words)
Vertically integrated companies are united through a hierarchy and share a common owner.
Vertical integration is one method of avoiding the hold-up problem.
vertical integration is called a vertical monopoly, although it might be more appropriate to speak of this as some form of cartel.
Vertical - Wikipedia, the free encyclopedia (221 words)
An object is in a vertical position when it is aligned in an "up-down" direction, roughly speaking perpendicular to the horizon or horizontal.
In science, a vertical direction is aligned with the direction of the force of gravity, as materialized with a plumb line.
In networking the vertical is typically the portion of network cabling that runs between floors, and is usually considered the backbone.
  More results at FactBites »

 
 

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