Horizontal integration is the process of acquiring and merging with industry comeptitiors to achieve competitive advantage that arise from a large size & scope operation This strategy makes it possible for an agency to control or own its distributors, suppliers, and retail locations to control the supply chain or its overall value. 6. How to Maximize Your Profit in a Multinational Corporation. The decision to vertically integrate or outsource depends on the nature of the business activities and the industry the business is operating in. New forward or backward vertical integration efforts may require building new facilities, hiring new staff, and understanding new processes that are unfamiliar to the corporation. Methodology and Justification of Sections 4. Vertical integration is merging different types of business that represent different stages of production. By using Investopedia, you accept our. Outsourcing entails giving out noncore, process-intensive or capital-demanding operations to companies that specialize in providing these services. Published, 3 years ago. Stages in the Process of Starting a New Business. ... Products in this industry … For instance, backward vertical integration makes you a supplier of your raw materials, while forward integration grants you greater roles in the production and distribution activities of your industry’s supply chain. ¾ The EU clothing industry was chosen to broader explain what theories missed. Vertical integration allows you to perform additional functions in the chain of production. The biggest disadvantage of vertical integration is the upfront costs. https://strategicmanagementinsight.com/topics/vertical-integration.html This eliminates middle men in your supply chain by expanding your activities in the supply chain. One advantage of outsourcing is that you can trust that the outsourcing company is an expert in the service that it is providing. The benefits of acquiring inputs through competitive markets (when they exist) is stressed. Chapter 19 - Vertical Integration And Outsourcing CHAPTER 19 VERTICAL INTEGRATION AND OUTSOURCING CHAPTER SUMMARY This chapter analyzes the vertical boundaries of the firm. Plus, you will always be tied to the financial well-being of any company that you outsource to. Outsourcing is ideal for industries, such as manufacturing, that require huge work force and capital resources. Vertical integration occurs when two firms at different stages of production merge. Vertical integration is hard to implement. Inditex’s closest comparable competitors had narrower vertical scope than Inditex but outsourced all productions. You cannot tie down outsourcing to any particular industry because it is applicable across different sectors. For example, the high cost of maintaining a workforce and the expensive machinery required in the manufacturing industry means that outsourcing is often applied by manufacturing companies. Strategic Management Insight: Vertical Integration, Time: How Apple Made "Vertical Integration" Hot Again -- Too Hot Maybe. 1. Outsourcing is present under both vertical separation and vertical integration, and the standard conclusions prevail under vertical separation. Vertical integration is merging different types of business that represent different stages of production. You can apply it in any industry depending on the goals you want to achieve. vertical integration or insourcing bringing business processes or activities previously conducted by outside companies in-house -companies that participate in many or all stages of the industry value change from exploration to final sale are highly vertically integrated Another advantage of vertical integration is lowering per-unit costs. Fashion industry excels when the agents have a knowhow of latest trends, and thus outsourcing to specialists, outsourcing is necessary. Vertical integration is a business strategy in which a company acquires or has control over the operations of its suppliers, distributors, or retail stores in order to control its supply chain, reduce costs, and improve efficiency. Learn what the style entails, what the benefits are and follow with us … Vertical integration expands the presence and influence of your business, while outsourcing involves contracting some of your business operations to external service providers. Operating activities are those that pertain to a company's core business activities, such as manufacturing, distributing, marketing and selling a service. For instance, you may choose to incorporate dog training in your dog breeding business. For others, outsourcing is the most viable approach. The company you outsource to may not have the same standards as your company, and they will be driven primarily by making a profit. Vertical integration expands the presence and influence of your business, while outsourcing involves contracting some of your business operations to external service providers. The Role of Operations in Organizational Effectiveness. When making the decision to outsource, a company should always take extra steps to make sure that their data is protected. 1 RomÆn Fossati2 Department of Economics University of Bristol September 2012 Abstract: Empirical evidence shows that vertically integrated producers are more productive, bigger and are matched to better suppliers (with high productivity and size). The capital required to set up or buy factories or acquire retail stores, plus the costs of maintaining those operations after the fact, can be prohibitive for many companies. Similarly, if you are outsourcing certain aspects of production, you can avoid the investment of purchasing expensive equipment. An additional benefit of outsourcing certain services is that you have a new partner in business. ¾ When the business-models of H&M and ZARA are mentioned, we mean the fact that H&M focuses on outsourcing while ZARA focuses on in-house production. Outsourcing makes the most sense in industries where the cost of labor and capital resources are high and is usually the best choice for young … Businesses within the retail industry are rolling out vertical integration supply chain models to keep up with fast fashion. The viability of vertical integration is not limited to any specific industry. If the company is operating in a different time zone, it's possible that your business "partner" will be working while you are sleeping because your business hours are different. Inditex’s unique business model mainly focuses on vertical integration and in-house production, while at the same time outsourcing is becoming a popular trend in clothing industry. There are four stages of the supply chain: A company has vertically integrated when it controls two or more of these stages. Keywords: Vertical integration, Outsourcing, Transaction cost 1. Research on the global fashion industry predicts an increase from ‘$481.2 billion in 2018 to $712.9 billion by 2022’. Traditionally, auto manufacturers outsource seat production due to high labor and design costs; in contrast, Tesla created their own seat assembly line in a “commitment to a vertical integration strategy not seen in the auto industry for decades” [7]. It's advised that companies that decide to outsource also hire a lawyer to review (and possibly amend) the terms of the contract. Outsourcing vs vertical integration James R. Markusen and Yiqing Xie One thing that comes up repeatedly in the international business literature is that multinational firms (with owned foreign subsidiaries) are intensive in what we now broadly refer to as knowledge-based assets or capital. However, a business can provide a contract service to another business without necessarily insourcing that business process. Outsourcing entails giving out different business operations to companies that specialize in providing these services. choices on the change of vertical integration level and the performance implication of such changes. With the huge increase of freelancers and small businesses in the UK it is not surprising that outsourcing is a quickly growing industry. Financing is the process of providing funds for business activities, making purchases, or investing. In business terms, we know that vertical integration refers to the consolidation of all business operations but reducing the need for outsourcing and managing activities in-house. If a company had to train its own staff to perform that same task, there would be a transitional period when the service was not being performed to the expected standard. When it comes to labor costs, outsourcing helps you streamline your work force, as contracting firms remain responsible for the welfare of their own employees. The challenge for small and medium-sized companies is that the initial process of vertical integration requires a significant investment of resources. However, logistics and supply chain management stands out as one industry where you can effectively adopt vertical integration, because vertical integration elevates your operation to different levels of your supply chain. Vertical integration requires companies to get involved in new aspects of the supply chain where they are usually unfamiliar. Vertical integration is typically the preferred strategy for long-term business growth and development. These are completely different economic phenomena. He has been working as a senior accountant for leading multinational firms in Europe and Asia since 2007. Vertical integration is a risky strategy because it is complex and expensive. At the end of the day, this can increase efficiency. You can outsource functions such as payroll, information technology, research and development and customer care services. Inditex’s closest comparable competitors had narrower vertical scope than Inditex but outsourced all productions. A retail company that is vertically-integrated can also identify popular brand-name items and make "knock-off," store-brand items with the same ingredients and manufacturing process, and offer them to consumers at a lower price. Outsourcing and the Fashion Industry. Similarly, the type of employee that is attracted to working at a retail business can be very different than the type of employee that works at a factory. Investopedia uses cookies to provide you with a great user experience. However, it mostly applied in industries that incur huge costs of labor and capital resources. Logical Problems and Sub-questions 3. Chapter 19 - Vertical Integration And Outsourcing CHAPTER 19 VERTICAL INTEGRATION AND OUTSOURCING CHAPTER SUMMARY This chapter analyzes the vertical boundaries of the firm. Horizontal vs. Vertical Integration: An Overview . By being able to acquire highly specialized assets, you will be able to differentiate your business from the rest of your industry, with a highly competitive advantage. Literature Review 4.1 Literature Concerning the Terminology Outsourcing spares you the burden of acquiring costly equipment, machinery or license rights to expensive software products. The benefits of acquiring inputs through competitive markets (when they exist) is stressed. Opponents of outsourcing claim that it results in a loss of domestic jobs. A company that is vertically integrated can avoid suppliers with a lot of market power. Globalization is the spread of products, investment, and technology across national borders and cultures. Businesses within the retail industry are rolling out vertical integration supply chain models to keep up with fast fashion. Outsourcing makes the most sense in industries where the cost of labor and capital resources are high and is usually the best choice for young businesses that cannot afford the high costs associated with implementing vertical integration. Vertical integration and outsourcing are some of the viable approaches for advancing your competitive edge. Vertical disintegration and the outsourcing of production One of the key SCM trends within the mid-market high street sector has been the vertical disintegration and outsourcing of the production function to a global network of independent subcontractors, usually within lower labour cost countries. These cultural differences can lead to conflict and low productivity. The expansion of free trade Example of vertical integration. Vertical integration is a strategy where a firm acquires business operations within the same production vertical, which can be forward or backward in nature. There may be hidden costs that are not immediately apparent if you don't have an accurate understanding of the contract's terms. The most obvious advantage of vertically integrating is that the strategy saves a company money, and those savings can be passed onto the consumer in the form of lower prices. Outsourcing allows companies to focus on streamlining their daily operations and encourages international business and trade. In the model economy, an industrial structure emerges as the result of optimal investment decisions that firms undertake under uncertainty. Proponents of outsourcing argue that it encourages businesses to allocate resources where they are the most cost-efficient. In some cases, it's in the best interest of companies to outsource—and rely on the expertise of others—rather than make the decision to vertically integrate. It begins by defining the vertical chain of production. 1 RomÆn Fossati2 Department of Economics University of Bristol September 2012 Abstract: Empirical evidence shows that vertically integrated producers are more productive, bigger and are matched to better suppliers (with high productivity and size). For example, they may lack the flexibility to follow consumer trends and introduce products to the market that would have to be produced outside of their factories. Thesis and Introduction 1.1 Thesis 1.2 Purpose 1.3 Introduction into the topic 2. It allows you to invest in assets that are highly specialized. Forward integration occurs when you take up roles that are closer to the final consumers in the supply chain. An additional disadvantage of outsourcing is that confidentiality can be compromised when you release certain documents to another company. Threats over quality Quality maintenance is the first need for every fashion sector to excel, and any compromise on quality can bring down the business. As a result, outsourcing is a more favorable option in some situations. For example, many companies in the U.S. have outsourced their customer service centers to lower-cost locations. In business terms, we know that vertical integration refers to the consolidation of all business operations but reducing the need for outsourcing and managing activities in-house. Companies like GAP, Victoria’s Secret, Old Navy, Zara etc are all vertical operations. For example, you may opt to process dog food for your dog breeding business instead of buying processed foods from veterinary suppliers. Zara is a Spanish fashion clothing manufacturer and retailer, formed in the 1970’s It is known that only two weeks are required for Zara to complete the development and shipment of a new product to its stores, which outweighs the average of fashion industry of six months, thanks to the collaborative relationship with customers and suppliers. Companies use outsourcing to reduce labor costs, lower their business expenses, and to focus on the core aspects of the business. This allows you to concentrate on the core aspects of your business, enhance efficiency and cut operational costs. In addition, the outsourcing company will be the one to create a contract for their services. Adoption of efficient operations structures enhances the competitive profile of your business. Vertical integration to be distinguished from horizontal integration Horizontal integration is the addition of other business activities at the same level of the value chain. ZARA’s core competitiveness lies in the model used by it, called Vertical Integration. Learn what the style entails, what the benefits are and follow with us … Over time, most companies save money and increase quality by implementing vertical integration. Zara mainly targets on young and urban female customers and acceptable prices are offered (Christopher 2005 p58) There are always new products in Zara stores… The offers that appear in this table are from partnerships from which Investopedia receives compensation. What Is a Vertically Integrated Business Model? ... but this often resulted in “fashion misses”, while Zara, through its responsive supply chain strategy, is able to produce and deliver styles that capitalize on what the customers are looking for. Vertical Integration vs. Outsourcing “Following the Crowd” Collaboration issues in an SCM context Table of Content 1. Companies decide to outsource to reduce the costs of their operations or to increase their efficiency. The reason for adopting a vertical integration strategy or an outsourcing strategy is to make a business's operations more efficient. CiteSeerX - Document Details (Isaac Councill, Lee Giles, Pradeep Teregowda): Deficiencies in existing theories used to explain outsourcing activities, often stem from the fact that the underlying incentives and constraints are far more complex than what these theories presume. Control over different stages of production becomes a barrier to entry. Tier 1 suppliers appear the most vulnerable to Boeing’s push for vertical integration, as the strategy results in more consolidation in the industry. Paul Cole-Ingait is a professional accountant and financial advisor. ... it could charge high prices to any new firm trying to enter the supermarket industry. What Is Forward Vertical Integration in Business? Hello! Backward vertical integration prevails when you extend the scope of your production activities toward the sources of your raw materials. Another problem companies that attempt vertical integration can encounter is the different skill sets required to run a company that ranges from retail to factory operations. Companies that outsource get to benefit from the differences in labor and production costs in other countries. After decades of focusing on specialization and outsourcing to maximize profits, food and beverage companies are now extending their expertise up and down the supply chain through vertical integration. Vertical integration is a supply chain management style that many businesses decide to use. However, the process of implementing vertical integration is time-consuming and expensive in practice. Also, the time and investment required to maintain these operations can reduce the nimbleness of a company. Financing: What It Means and Why It Matters, What You Should Know Operating Activities. Research on the global fashion industry predicts an increase from ‘$481.2 billion in 2018 to $712.9 billion by 2022’. Why Has Supply Chain Management Become Such an Important Topic? Some functions that companies may decide to outsource include payroll, information technology, research and development, and customer care services. Innovative technologies are a direct contributor to this progression, as they help companies create ‘experiential eCommerce’ for shoppers. Vertical disintegration and the outsourcing of production One of the key SCM trends within the mid-market high street sector has been the vertical disintegration and outsourcing of the production function to a global network of independent subcontractors, usually within lower labour cost countries. In addition, if a company is reliant on a supplier that has a monopoly in the industry, that supplier will be able to dictate the terms (which could mean setting higher rates). Outsourcing versus Vertical Integration: A Dynamic Model of Industry Equilibrium. It involves going up or going down the supply chain. Baseline: Is Outsourcing Losing Its Appeal? Example of a Vertical Integration vs. Outsourcing Industry. Hello! Backward integration is a type of vertical integration that includes the purchase of, or merger with, suppliers. Vertical integration is a supply chain management style that many businesses decide to use. 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