Supply Chain Management (SCM)is defined as the integration strategies aimed at coordinating functions between suppliers, manufacturers, distributors and retailers to ensure that products and services are produced and distributed in the right quantity, at the right place and at the right time, with the aim of Reduce operating costs, maximize profits and ensure everyone's satisfactionsupply chain. Supply chain integration strategies are network-basedbusiness modelsUsed by organizations for targetingstrategic decisionsand processes across the network from the supplier/manufacturer end to the customer end to achieve thiscompetitive advantages, synergies and efficiency in their processes as well as more control over the input and output of their processes. Network-based business models areorganizational structuresthat allow companies to work as interconnected configurationsvalue chainusually consisting of partnerships, collaborations and optimized cross-organizational activities.
Vertical integration is a coordination strategy in which a company owns its supply chain by incorporating the supply chains of suppliers and/or distributors into its operations strategy or by expanding its operations to undertake activities traditionally performed by suppliers and distributors. This strategy helps companies maintain a high level of control and avoid the "hold up" problem, a situation where a company's contract with another party in its supply chain causes delays and lost profits due to delays and non-performance of the contract leads or imbalance of bargaining power between the two parties. The Ford River Rouge Complex, an automobile factory built by Henry Ford in 1927, is a good example of a vertically integrated supply chain that offers economies of scale and ensures a high level of control in the supply and production process - iron ore and coal from Ford-owned mines came up Ford freighters to produce Ford steel. Ford also owned its forest lands, glass factories, railroad lines, and rubber plantations, which helped ensure efficiency, availability of required components, and control over inputs and outputs.
A vertically integrated supply chain can be implemented to varying degrees, roughly divided into 3 categories:
- Vertical Backward Integration, in which a company owns subsidiaries that manufacture the inputs/components used in production. For example the Ford River Rouge Factory with its own forest and glass manufacturing plants.
- Vertical forward integrationin which a company owns or controls its distribution centers and/or retailers and thereby has direct contact with customers at the end of the value chain. For example airlines taking over the traditional role of travel agents.
- Balanced vertical integrationin which a company implements both backward and forward integration by owning/controlling its supply, manufacturing, marketing, and/or retail centers. Apple is a good example of a company that implements balanced vertical integration by owning its own data centers, manufacturing facilities to make its own chips and other proprietary components, and its own marketing and retail stores, content platforms, and support centers.
As a strategic tool, a vertically integrated supply chain can provide companies with solutions to mitigate or eliminate threats from powerful suppliers, reduce the bargaining power of suppliers, distributors, and customers, and reduce transaction costs. When properly implemented, a vertically integrated supply chain can help companies gain competitive advantage and increased profitsEconomies of scale and scope.
Horizontal integration is an industry-specific SCM strategy that companies use to seek competitive advantage and profitable growthvalue-added activitiesthat focus on a single store or industry, for example McDonald's with its focus on the global fast food business and Walmart with its focus on global discount retail. A horizontally integrated supply chain is a business model in which companies acquire or merge with industry competitors to gain competitive advantages through economies of scale and scope. For example, Boeing merged with McDonnell Douglas to create the largest aerospace company in the world, Pfizer acquired Warner-Lambert to become the largest pharmaceutical company.
This SCM structure offers the benefit of focus and reach, particularly in fast-growing, dynamic industries where organizations must focus significant resources and skills on competing in one area to achieve long-term competitive advantage. Technological advances, changing customer needs, fierce competition, and low barriers to entry are common characteristics of horizontally integrated supply chains. Due to changing customer needs, new competition and the speed of change in such industries, companies often find it difficult to maintain competitive advantages without changing/adapting their business model. For example, with the advent of wireless phone services and similar services like SKYPE, companies like AT&T had to quickly adapt their business model and partner with wireless companies that offered them the ability to offer broadband and wireless services. The merger with Time Warner and Comcast enabled AT&T's competitive positioning and relevance in the changing world of telecommunications.
A successfully implemented horizontal integration strategy can increase a company's profitabilityreduction in costsStructures as a result of:
- economies of scale, especially in sectors with high fixed cost structures;
- Elevatedproduct differentiationbecause of the combined merger or acquisition product lines that allow the company to offer product bundles and innovative new products to customers at different price points;
- Replication of the business modeldue to the ability to leverage the greater product differentiation and lower cost structure achieved through horizontal integration to replicate the business model in, for example, new market segmentsWalmart leverages its low-cost discount retail business modelenter the warehouse and supermarket segments in the US and replicate the model globally by acquiring supermarket chains in multiple countries;
- Reduced industry rivalry, as industry overcapacity is eliminated through the acquisition or merger of competitors, leading to more stable pricing environments and the elimination/reduction of price wars;
- Increased bargaining powerdue to industry consolidation resulting in companies being a much larger buyer and therefore having a degree of leverage or "buyer power" that can be used to lower the price they pay to suppliers. Walmart is a good example of a horizontally integrated supply chain with bargaining power advantage.
Horizontal integration has limitations worth noting and being wary of. Similar to vertical integration, horizontal integration is a complex and difficult strategy to implement. For example, it is difficult to successfully bring together companies with very different corporate cultures and where merger/acquisition is onehostile takeover, this often leads to high staff turnover and the loss of much-needed talent and expertise, resulting in suboptimal benefits or outright failure. There is also a risk of failure or punishment under antitrust laws when companies attempt to use horizontal integration to become a dominant player in the industry, as these laws are designed to ensure fair trade and prevent companies from doing so to use their market power to prevent competition.
Vertical and Horizontal Integration - Key Points to Consider:
Vertically and horizontally integrated supply chains tend to be complex and capital intensive to implement. Both are also similar in the sense that they are business models aimed at optimizing value chain processes and services in order to achieve competitive advantages through economies of scale and scope. However, companies need to consider several factors to determine the right strategy and whether it is a profitable investment, including:
- Does economies of scope exist to make it cheaper for the firm to own or control subsidiaries involved in the supply and production of its inputs and outputs?
- Does the industry need to have a barrier to entry or gain monopoly power by controlling the value chain in order to gain competitive advantage?
- Overall, is it cheaper for the company to assume the role of supplier and distributor than to do business with standard suppliers and distributors?
Companies that aim for vertical integration can also aim for horizontal integration, and many actually do so. However, the underlying principles and the operational implications of implementing both strategies have very clear differentiators.
In vertical integration, the company enters new industries to support its core industry business model, while in horizontal integration, the company competes in a single industry but expands through mergers, acquisitions, and strategic alliances/collaborations. Vertical integration is a more closed/proprietary model compared to horizontal integration which is more open due to the involvement of partners and the need for collaboration/collaboration. The differences in operational impact include:
|Vertical Integration||Horizontale Integration|
|More control through ownership of the value chain.||Less control due to reliance on the collaboration of others.|
|The vertically integrated company has the higher benefit.||The benefits come from the success of everyone in the value chain|
|Efficiency before flexibility||Flexibility instead of maximum efficiency|
|Intense capital needed to create, produce and distribute all components of the end product.||Reduced capital requirements through joint ownership.|
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In vertical integration, the proprietary nature of the investment creates a more closed/not very trusting approach in interacting with partners as the organization will try to protect its trade secrets/intellectual property. With horizontal integration, on the other hand, companies deal more openly and trustingly with partners, as this is essential for the success of their business model. For example, Microsoft and Google have taken a more open approach to collaborating with partners in their value chain, as success is achieved collaboratively and through open-source platforms. Apple, on the other hand, operates a proprietary model that tightly protects its intellectual property through its vertically integrated supply chain.
Vertically and horizontally integrated supply chains are supply chain management strategies employed by companies to leverage synergies in their value chain to generate more profits and competitive advantage. Effective supply chains are critical to the success of organizations operating in global, diverse environments, as well as organizations looking to achieve optimal efficiency and customer satisfaction. An increasingly competitive and interconnected global environment means that successful performance depends on the collective decisions and actions of all members of a supply chain rather than any individual member, and competition is increasingly taking place between supply chains rather than between individual companies. Therefore, companies are challenged to make decisions about appropriate supply chain strategies that achieve their goals based on their capabilities, needs and circumstances. Vertical and horizontal supply chain integration are two such strategies that allow companies to manage their organizations and their relationships with other companies in the same supply chain/value chain.
From a supply chain management perspective, vertical and horizontal integration aim to achieve cost savings, increased profits, greater efficiency and customer satisfaction by improving supply chain processes and performance through value-added investments and activities that benefit all members of the supply chain. For example, achieving cost reductions, improved performance and better target market access as a result of eliminating redundancies/duplications, reducing inventory levels, shorter lead times, greater control over supply and distribution, access to partner networks and lower fixed costs.
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- Understand different types of supply chain risk
- Supplier Relationship Management (SRM) – Importance and Importance
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- What is Lean Supply Chain?