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Vertical integration

In theory vertical integration is all about capturing the margin. It can be forward integration when a manufactures distributes and sells its own products, like Apple does through its own stores, and it can be backward integration as Apple also did by manufacturing their own components and operating systems. Which is a particular case of both forward and backward integration, usually integration is one way or another.

Not many know that Steve Jobs was also one of the board members of Disney after Pixar was acquired, and he said that “You should forward integrate only if you are creating an experience that helps raise willingness to pay”. You must do something different that enables you to retail your product in a way that others cannot.

But what is the rationale for vertical integration? One reason might be to address a holdup problem? You will not be a victim of suppliers and customers if you own your entire production and distribution chain. Difficult but certainly doable, and this will help you take advantage of synergy at different points in the supply chain.

Through vertical integration you also gain access to a crucial input not available before and avoid the foreclosing of access to resources if you can control the production of your components for example. Very important, this is a great way to offset the bargaining power of suppliers or buyers, elevate barriers to entry and protect your products and enhance differentiation of products, bu also to acquire important information from the market.

While this is great, some warning signs are the possibility of dulled incentives for high performers, some potential for conflict of interest, reduced flexibility that comes with size, higher internal costs and some internal conflicts, but also the higher costs associated with managing a different business.

While vertical integration is in decline as a practice in the world of business Zara’s example is one that proves that it still works if you don’t pursue vertical integration to capture the margin, you are able to add value by owning different parts of the supply chain, you understand the costs and benefits of the strategy alternative and know when to choose a middle path.