Define Vertical Consolidation

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Vertical consolidation is a process that companies use to increase their control over the construction and distribution of a product. In industries that create a product, most companies only work with a single aspect of the process: gathering raw materials, manufacturing, assembly or distribution.

Example

  • A company that chooses to pursue vertical consolidation purchases businesses that perform a different function in the production and distribution process of a product or service.

    Example: If a business that assembles action-figure toys bought a company that marketed and distributed those toys, that would be vertical consolidation.

Purpose

  • Vertical consolidation is the opposite of out-sourcing. Some businesses choose to consolidate to improve coordination in the supply and distribution chain.

    Normally, if a different business controlled each individual step of the chain, each would make a profit off of the next company in the chain. When a single company owns two, three or even all of the steps in the chain, then it could increase its profit margins and eliminate availability issues.

Forward And Backward

  • There are two types of vertical consolidation, froward and backward.

    Forward consolidation or integration describes a company that acquires another business that works on a later step in the chain. Example: A company that gathers raw materials purchases a company that processes raw materials.

    Backward consolidation or integration is the acquisition of a company that performs an earlier step in the chain. Example: The company that markets a product purchases a business that assembles the product.

Advantages

  • Vertical consolidation reduces the cost of each step in the supply and distribution chain, which increases profits and streamlines the transitions between steps. A company that makes and markets a product doesn't need to hire an expensive outside marketing service, which could cost millions of dollars.

    Vertical consolidation also strengthens a company against its competitors and allows it to diversify.

Drawbacks

  • Vertical consolidation is not always the right move for a company, it can be a risky and costly venture. Some companies that vertically consolidate must invest resources into integrating and expanding newly purchased companies after they consolidate.

    A business may also loose its "edge" or focus by diversifying through consolidation. This decision can compromise a company's business model, forcing a re-structuring or even the ultimate failure of the business.

References

  • Photo Credit schattenspiele image by Martina Berg from Fotolia.com
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