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Vertical
Integration
Chapter 2
McGraw-Hill/Irwin
Operations Strategy
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved.
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Defining Vertical Integration: The Value
Chain


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Defining Vertical Integration: Characteristics
of Upstream/Downstream Activities
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Defining Vertical Integration: Some
Terms
Backward integration: acquisition of upstream
operations, or integration towards the supplier end
of the value chain
Forward integration: acquisition of downstream
operations, or integration towards the customer end
of the value chain
Vertical disintegration: shedding operations, either
upstream or downstream, often by outsourcing
them
Horizontal integration: expanding the scope of
activities presently performed by the firm to
different industries or sectors
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Defining Vertical Integration: Contract
Manufacturer Example
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The Vertical Integration Decision:
Questions to be Answered
How much of the value chain should the
company own? For the owned activities, how
much should be performed in-house and how
much subcontracted?
Under what conditions should the company
change the amount of the value chain it
owns? If it does make a change, in what
direction upstream or downstream should
it make those changes?
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The Vertical Integration Decision:
Considerations
Strategic factors
Core capabilities
Timing of capabilities
development
Market factors
Market reliability
Competition
Control
Economies of scale
Market power
Asset specificity
Dependency risk

Product, service and
technology factors
Intellectual property
Technology
differentiation
Modular or integral
product architecture
Economic factors
Investment costs
Design, production and
delivery costs
Transaction costs
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Market Factors: Valuing Economies of
Scale
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Market Factors: Aggregating Demand
to Reduce Variability
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Market Factors: Asset Specificity and
Transaction Frequency
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Product, Service, Technology Factors:
Technology Access and Integration


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Product, Service, Technology Factors: Part
or Component Access and Integration
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The Vertical Integration Decision:
Summary
Source: Data drawn from Ulrich and Ellison, Beyond Make-Buy: Internalization and Integration of Design and Production, Production and Operations Management, forthcoming. 2005.
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Spectrum of Vertical Integration
Options
Arms length
relationships
Full
ownership
Joint ventures
Strategic alliances
Etc.
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Making Vertical Integration
Decisions
Apply core capabilities screen
Assess industry context and identify
opportunities
Perform a static analysis of the industry
Perform a dynamic analysis of the industry
Identify alternatives
Assess alternatives and select one
Implement