What Is Vertical Consolidation?
Vertical consolidation is a term that is frequently discussed in the business world. There is much debate over whether vertical consolidation is a wise change for a company to make. However, before these decisions can be made, it is important to know exactly what vertical consolidation is and what advantages and disadvantages can occur with this system.
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Features
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Vertical consolidation is the process by which a company absorbs a distribution center or supplier into its own value stream. This can occur when a company purchases a new supplier or when a company begins to offer the same services as a third-party supplier themselves. This process is also referred to as vertical integration. An example of vertical consolidation is when an oil company purchases gas stations to sell their oil products or when the same oil company conducts exploration for new oil sources.
Function
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The purpose for vertical consolidation is so that a company can eliminate as many different parties as possible to streamline a business process. Another reason to use vertical consolidation is to save money by having processes completed all under one company name. If processes are completed by the same company that sells the products, then third-party convenience payments do not have to be made. There are two types of vertical consolidation: forward consolidation and backward consolidation. Backward consolidation is when a company purchases the suppliers and manufacturers of a product. Forward consolidation is when a company purchases the distributors of a product.
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History
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Vertical consolidation has been around for many years. The 1800s were the first century to heavily employ the use of vertical consolidation. The industrial revolution brought the need for companies to control many aspects of the same production and distribution process. Economics of scale was the primary reason for vertical consolidation in the 1800s. The 1900s saw a shift in the reason companies chose vertical consolidation. The consolidation was used to ensure companies received a steady supply of inputs that were vital to operations. Late in the 20th century vertical consolidation was employed as a cost-saving measure. However, at the end of the 20th century and into the early part of the 21st century, companies were forced to eliminate much of their vertical consolidated structure due to competition.
Benefits
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There are many benefits to vertical consolidation. Vertical consolidation can reduce transportation costs if local suppliers and distributors are in the same area. It can greatly improve supply chain coordination. The control over inputs is much greater. The expansion of core services and competencies is easier to achieve. It is possible to receive profits from upstream and downstream processes. Greater amounts of distribution channels are available. It is even possible to block competitors if rare supplies can be obtained.
Disadvantages
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There are also some drawbacks to the vertical consolidation system. The bureaucratic end of a company becomes much more difficult. There is often an issue of capacity balance. The upstream suppliers may not be able to match the demand of the downstream distribution centers. Adding additional services to a company may cause an overall quality loss. Costs might become higher due to the lack of competition in the market. Product variety is much reduced. There is also the chance of reduced company flexibility because of the added processes.
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