Vertical integration - Definition and Overview

In microeconomics and strategic management, vertical integration is a theory describing 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, and the products combine to satisfy a common need. It is contrasted with horizontal integration.

A monopoly produced through vertical integration is called a vertical monopoly.

Three types

There are three varieties of this : backward vertical integration, forward vertical integration, and balanced 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.
• 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.

An example

Some in the music recording industry believe vertical integration is the best way to survive in the modern, post-Napster environment. The idea would be to vertically integrate the record label with the radio station of its genre in local markets. This would allow the label to more cheaply produce music (because many of the elements which make the production expensive are due to unnecessarily high standards of production required by the radio stations, and the system of payola). It should also ensure that the record company better understands the wants of the radio listeners. The hope would be that anything the record label would play on their radio station, provided the listening habits and distribution system of music has not changed, would very likely be a hit.

See also

• Strategic management
• Zaibatsu (the Japanese approach to vertical integration)

Lists

• List of management topics
• List of marketing topics
• List of economics topics