What Is Vertical Consolidation?

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A business meeting.
A business meeting. (Image: Picturenet/Blend Images/Getty Images)

Vertical consolidation within an industry occurs when the companies in that sector are acquiring greater control over their supply chain, either by buying up or merging with other companies or by starting their own new divisions.

Supply Chain Dynamics

Imagine you own a factory that produces widgets made out of wood. For your business to succeed, you need a steady supply of wood available at reasonable prices, a reliable way to get your widgets out into the market and retail outlets to sell your widgets. You can rely on other businesses for these things, but that means ceding some control of your supply chain. Other companies' bottlenecks, breakdowns and inefficiencies can damage your business. Now imagine your company buys a lumber company, or a distributor or a chain of widget stores. You've locked in more elements of your supply chain. This is called vertical integration, because it's combining companies at different "levels" of the supply chain. (The alternative, horizontal integration, occurs when the companies are at the same level of the chain, such as Delta Air Lines acquiring Northwest.)

Vertical Consolidation

In an industry undergoing vertical consolidation, the major players are pursuing vertical integration. Each firm is moving toward becoming a dedicated pipeline that moves products from raw materials to manufacturing to distribution to retail sales. This can leave some companies in the industry "stranded," with former customers or suppliers now part of someone else's pipeline. A modern example of vertical consolidation is consumer technology, where Apple not only designs computers but also controls their operating system, sells them in retail stores and provides its own warranty service. Noting Apple's success, competitors such as Microsoft and Google have pursued similar strategies.

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