Essay Plans

What are the advantages and disadvantages of vertical integration?

SYNOPSIS:

POINTS:

  1. Define vertical integration and support with a diagram.

  2. Go through reasons for vertical integration remembering that what is advantageous for the firm may not be for the consumer:

    • Closer control over quality and delivery (backwards vertical).

    • Factor inputs cheapen as there is no profit margin.

    • More customer contact (forwards vertical).

    • Increased control of the market.

    • Better able to deal with any periods of shortage.

    • Where, for example, a pub is tied to a brewery it is difficult for someone to set up in competition unless they are also backed by a brewery.

  3. Note that this increased control of the market may infringe existing monopoly legislation (1980 Competition Act - concentration ratios) which would explain why they are infrequent.

  4. Disadvantages:

    • If supply of components is greater than that required by the parent company then either production will have to be reduced (redundancies, industrial action etc) or the surplus will have to be sold to rival firms.

    • Customer choice may be restricted if the parent company insists on only its products being offered for sale (brewery - note current affairs on the Monopoly's Commission investigation into breweries.)

    • Vertical integration may not even be necessary to exert control - the oft quoted example is Marks & Spencers. The textile supplier of Corah (knitwear) and I J Dewhirst (suits, coats, skirts) and S R Gent (blouses, skirts, nightwear) each send in excess of 75% of their output to M&S. M&S can thus exert control and restrict profit margins, aim for stockless purchasing and insist on frequent batch delivery. In my time as a buyer at Austin Rover plc (then BL) one criteria for choosing a supplier for a new part was what amount of their output was with us already - the higher their dependence the greater our leverage in price negotiations.

  5. Finally, more comment should be made concerning the possible diseconomies of scale that may arise in terms of administration. Lack of familiarity may also cause disharmony. Just as economies of scale may be an advantage, diseconomies will work against the merger.

  6. In a recession disintegration may be favoured as other firms will work at variable costs only. A large firm that has previously merged will be faced with fixed costs more suited to higher output.

  7. In a broader sense, vertical disintegration may release land that can then be used elsewhere.

  8. Asset-stripping was a motive in the early 70's - but more so in takeovers rather than mergers. The asset-stripper takes over a company, closes it down and sells of the assets eg. Land. This is the equivalent of buying a house, knocking it down and selling the land because of the minerals buried there.
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