NEW YORK, July 20 — Vertical integration, also known as vertical consolidation, describes an arrangement in which a single company owns multiple stages of its own supply chain. Each member of that chain typically produces a different product or service, and their outputs combine to satisfy a common need. The concept stands in contrast to horizontal integration, where a company produces several related items rather than controlling successive steps of production and distribution.
In microeconomics and management theory, vertical integration can be desirable because it secures necessary supplies and markets for a firm’s products. A company that controls its own sources of raw materials, for instance, may be less vulnerable to price swings or disruptions.
Likewise, owning distribution channels can guarantee that products reach customers. Yet the arrangement can become undesirable when it leads to anti-competitive behaviour that impedes free competition in an open marketplace. A monopoly produced through vertical integration is called a vertical monopoly.
The degree of a firm’s distance from final consumers is measured by its vertical position: a firm selling directly to consumers has position 0, a supplier to that firm has position 1, and so on. The Ford River Rouge complex in the 1920s offers a classic historical example.
There, the automaker began making much of its own steel rather than buying from outside suppliers, taking control of a key input. In the media industry, vertical expansion — growth through acquiring companies that produce intermediate goods or help market and distribute products — has been notable. The acquisition of DirecTV by News Corporation was a forward vertical acquisition, allowing News Corp to distribute more of its content via satellite television.
By contrast, the acquisition of NBC by Comcast represents a backward vertical integration example, where a distributor moved into content creation.
Measuring integration
Such expansion can increase sales and market power, but when it tends toward monopolistic control, regulative action may be required to rectify anti-competitive behaviour. The vertical integration of a company is measured using the real net output ratio. The formula holds that zero is less than the real net output ratio, which itself equals added value divided by total production value, and is less than one.
Added value is the difference between turnover and externally purchased services, including profit, gross wages, or other non-wage labour costs. The less a company outsources, the higher the degree of vertical integration, with the ratio approaching one.
Lower vertical integration corresponds to a higher proportion of purchased components and services, reducing value creation and the ratio.
What to watch next
As companies continue to weigh the benefits of secured supply chains against the risks of anti-competitive concentration, regulators in various markets are likely to keep a close eye on deals that increase vertical control. The balance between desirable operational efficiency and undesirable monopoly power will remain a central question for business strategy and competition policy alike.
