Vertical integration involves the merger of organizations within different stages of the production process within an industry, extending into the distribution of goods. There are several reasons for following this strategy, including the following:
- The acquirer can secure essential raw materials that may be in short supply
- The acquirer can gather more information about the ultimate customer by acquiring distributors
- The acquirer can obtain all of the profits being generated along the supply chain
- The acquirer can keep its acquired businesses away from competitors, thereby creating a limited form of monopoly
When a company acquires one of its suppliers, the transaction is called backward integration, while the acquisition of a customer is called forward integration. For example, a backcountry skiing operation that buys a helicopter rental organization to give lifts to its skiers is an example of backward integration. By doing so, the skiing operation gains access to the helicopters needed for its operations. Alternatively, a clothing manufacturer that buys a women's clothing retail chain is an example of forward integration. By doing so, the manufacturer gains an assured customer and learns more about the retail chain's customers.
A potential problem with vertical integration is that acquired suppliers now have an assured customer, and so have less incentive to engage in cost cutting and product development, which can eventually reduce the overall competitiveness of the combined company.