Horizontal and vertical integration both concern where to draw the boundary of the firm – which activities does the company want to expand into and do itself.
Horizontal integration – more often referred to as diversification – involves expanding into other businesses. It involves expanding into new products or services – increasing the portfolio of products that your company offers.
Some reasons why firms may consider horizontal integration – or diversification – include:
- Sharing resources – reduction of costs: Potentially there are resources that you can share across the different areas so that the costs involved with operating across areas are lower than they would be if the businesses were entirely separate.
- Creation of new markets: Potentially the capabilities of the firm will allow for the creation of a new market (potentially a blue ocean, free of competition).
- Charge higher prices: Potentially the firm’s brand or other strengths will allow it to charge a higher price in the new market than other companies.
Vertical integration relates to operating in different areas of the value chain – either going backwards and undertaking activities traditionally undertaken by separate suppliers, or going forward and undertaking activities traditionally undertaken by downstream firms.
Backwards vertical integration
Backward vertical integration involves integrating activities that would traditionally have been completed by your suppliers. This is sometimes referred to as going ‘upstream’. Rather than outsourcing these activities to others, you bring them in-house, completing them within the firm.
Some reasons why firms may look to backward integrate include:
- Avoiding the power of supplier: Avoid the possibility of a supplier looking to exert their power to increase prices.
- Control: Getting greater control over the production process.
- Secrecy: Not wanting the technologies or process improvements that you are developing to leak out to other firms.
Forward vertical integration
Forward vertical integration is going closer to your customers – downstream from activities typically undertaken within your firm. For example, you may expand forward to compete directly with your original customers – potentially building final products with components that you used to manufacture. Or it may involve setting up a retail channel to sell your products – integrating the task that would previously have been made by dedicated retailers.
Some reasons why firms may look to forward integrate include:
- Move into a higher profit margin segment: Assemblers of electronic products (such as HTC) have moved into the design and retail of such electronics.
- Maintain control of the brand: Firms have expanded into retail to have a better control over the customer experience.