Vertical integration of the software market. Vertical integration concept. Motives for vertical integration

Vertical integration occurs primarily where there is a technological interdependence between successively occurring production processes. It is a cooperation between several companies belonging to the holding or divisions (branches) of the corporation, thereby providing sufficient flexibility in solving technological and managerial problems. At the same time, one should distinguish vertical integration, which unites several independent businesses, from a sequential production cycle in one company.

A fairly large number of works have been devoted to the issue of vertical integration. This is due to the great importance that it plays in the life of many companies.

The choice of a scheme for implementing vertical integration in the form of subsidiaries or branches depends, first of all, on the laws in force in the country, adopted business practices and is determined within the framework of the corporate strategy.

Vertical integration plays an important role in the oil and gas business. It is a combination of various production processes within one company or group of companies, which can be carried out in several geographic regions: from exploration of oil and gas fields to hydrocarbon production, their further processing and sale to the end consumer ("from a well to a gas station"). Production processes such as well drilling and workover,

transportation of hydrocarbons and others, many companies are included in the upstream or downstream. Companies doing this kind of work are called service companies. They make it possible to achieve a more efficient performance of the relevant functions in the main business of the oil company. Vertical integration enables companies to mitigate business risks while increasing their market and economic value.

Vertical integration classification:

Full integration, while the company carries out the entire cycle of the production and technological process, a single value chain arises;

Incomplete or partial integration, while part of the products are produced by the company independently, and the other part is purchased on the market;

Quasi-integration occurs as a result of interaction with other companies (through the creation of alliances, associations) without incurring costs (except for organizational costs), but also without transferring ownership.

The classification of vertical integration is shown in Figure 2.1.

By the nature of the direction of integration and the position of companies in the technological chain or value chain, vertical integration can be divided into direct and reverse integration.

Companies can integrate "back" to suppliers of raw materials and semi-finished products - bottom-up integration - providing guaranteed supplies to complete their manufacturing process. Another goal of such integration may be the desire to gain access to new technology critical to the core business.

Companies integrating “forward” join forces with manufacturers of semi-finished products, final products, retail chains, depending on the location of the integrating company in the operating chain - top-down integration. This type of integration allows you to get more information about your customers and monitor the state of affairs in the subsequent links of the production chain.

In the oil and gas business, upstream refers to exploration and production of hydrocarbons, while downstream refers to refining and marketing (sales).

* Without exception, all oil companies in Russia are created on the basis of state-owned privatized enterprises. Only subsidiaries created by the oil Group itself can be classified as new JSCs.

Figure 2.1- Classification of vertically integrated oil companies

The efficiency of vertical integration is especially high when creating a complete production cycle with sales and service to end users of products, excluding the appearance of resellers.

One of the main goals of vertical integration is to reduce costs by replacing market exchange with internal organization. This is achieved by reducing transaction costs in the markets for semi-finished products, when organizing sales of finished products, that is, through internalization, which is a replacement of market exchange with internal organization. In this case, individual businesses can be incorporated into the corporation as a division. However, starting at a certain size of the corporation, the cost of administrative and organizational costs can exceed the savings from internalization, so market exchange becomes more attractive.

In cases where businesses are represented by subsidiaries or even groups of companies, it is possible to use the transfer pricing mechanism to reduce turnover taxes and VAT, thereby increasing the value of companies.

With the help of vertical integration, it becomes possible to reduce the emerging risks:

Integration "back" guarantees the provision of raw materials at the time of their shortage and protection from price diktat from independent suppliers;

Forward integration allows you to influence the markets, ensuring the sale of your products and protection from price dictates by resellers.

In the process of preparing a unified strategy for a group of companies by a vertically integrated holding company, it becomes possible to better understand what is happening in each of the businesses and changes, to coordinate and coordinate the actions of each company separately and the entire group as a whole. Having our own domestic production and consumption, partially covering needs or providing sales, allows us to seek the best conditions from independent suppliers or consumers, increasing profits and maintaining flexibility.

The intensity of vertical integration depends both on the industry and on the capabilities of a particular company.

A vertically integrated oil concern is a group of companies belonging to the holding and united in several businesses: oil exploration and production, its refining, petrochemicals and chemistry, filling networks, as well as service companies, which can also be separated into independent businesses.

Vertical integration allows the company to reduce capital and operating costs by reducing the amount of taxes paid, the cost of costs by reducing risks, saving time spent on preparing contracts, ensuring the stability of prices and supplies. The latter condition can be met with the use of measures such as abandoning conservation of wells, even with the existence of low oil prices, as well as by maximizing well loading and reducing downtime.

The disadvantages of vertical integration are manifested in an unsuccessful market environment, when a company needs to cover fixed costs from unprofitable businesses. In addition, low-profit or low-potential businesses reduce the market value of a vertically integrated company.

Measuring the degree of vertical integration. Vertical integration in the oil business has existed for over 100 years, and today almost all oil and gas companies are vertically integrated. Leading oil companies own significant oil reserves, refineries, pipelines and filling networks.

The degree of integration of the oil industry is the highest of all industries, according to this figure is 0.67, for comparison, in mechanical engineering - 0.305, food industry - 0.303.

Nevertheless, there are still non-integrated or, in other words, independent companies in the oil industry that cannot or do not want to integrate for various reasons. Despite the fact that their number is decreasing, they occupy a certain niche. Independent companies can survive in the market by reducing profit margins, specialization, abandoning large business sizes, using as their advantage not economies of scale, but flexibility and efficiency in working with customers, or by occupying niches that are not interesting to large companies for such reasons like: geographic features, low ROI or market size.

Deciding on the degree of vertical integration of a company or group of companies depends on the benefits acquired and the price to be paid for them. In this case, it becomes necessary to choose which is better: the creation of a small vertically integrated company or a rather large specialized company, for example, an oil producing company? Increasing capital by attracting new shareholders or joining a large vertically integrated holding?

When making a decision, it is necessary to take into account not only the direct economic effects that arise, but also the effects created by a unified corporate strategy and more efficient operational management of companies.

The benefits obtained from vertical integration must exceed the costs of its implementation, taking into account possible changes in the business environment, the time value of money and possible risks. When determining the degree of vertical integration, the condition of maintaining the financial stability of the company must be taken into account. Excessively acquired capacities can create a negative effect in the event of a change in market conditions, the occurrence of unforeseen situations (accidents, hostilities in the area, etc.) or mistakes that may be made by managers when managing a company or individual businesses.

If the market conditions deteriorate, a situation may arise when the company's sales decrease, which will entail an increase in fixed costs. Therefore, it becomes necessary to take into account possible changes in the environment and select the parameters of the company's structure in such a way as not to "unbalance" it in such situations. The restrictions on the degree of integration “from above” are high risks and a drop in profitability due to the emerging negative economies of scale.

To assess the degree of integration between oil production and oil refining, the Refining Self Sufficiency Ratio (Refining Self Sufficiency Ratio) has been proposed, which is divided into internal (KSVin) (Domestic Self Sufficiency Ratio) and global (KSNsum) (World Wide Self Sufficiency Ratio):

KSN int = VDN / VPN; (2.1)

SVN sums = (VDN + VNDN) / (VDN + VNPN). (2.2)

where VDN - internal oil production;

VNDN - external oil production;

VPN - internal refining of oil at a refinery;

VNPN - external refining of oil at a refinery.

The degree of vertical integration is measured using the index of vertical integration, which is the ratio of the annual volume of produced liquid hydrocarbons to the annual volume of processed, which actually coincides with the coefficient of self-sufficiency.

Indicators of vertical integration of some oil companies for the period 2003-2005 based on the research are presented in table 2.1.

Table 2.1 - Change in the average value of indicators of vertical integration of oil companies for the period 2003-2005.

Taking into account the time elapsed since the study, it is clear that too much integration has a negative effect on the viability of companies - much more than insufficient.

Thus, we can say that the optimal indicator of vertical integration is 0.5-0.6.

A confirmation of the trend towards a reduction in the number of independent producers, while at the same time leveling the degree of their integration, is the example of Philips Petroleum, which in February 2001 carried out a takeover of the independent oil refinery Tosco for USD7 billion, which, according to the chairman of the board of Philips Petroleuim J. Malwa was "the final milestone in an 18-month odyssey to transform Philips Petroleuim into one of the largest integrated companies." As a result, the ratio between production and processing of the company was 60:40. However, after a short period of time, a new merger took place - ConocoPhilips was formed, making the new company the sixth largest in the world in terms of oil reserves and production. In October 2003, the management of the company, in order to further restructure its assets, decided to sell the network of gas stations and shops at them, leaving only those located in the central and western states of the United States in their possession.

Another example is the takeover of ARCO and Amoko by British Petroleum, and the merger of Exxon and Mobil (2000).

The leading Russian vertically integrated oil companies, against the background of world oil companies, have rather low integration indicators, this is largely due to the relatively short period of their formation in the conditions of the domestic market. However, despite this, LUKOIL, Rosneft and other large Russian companies are building up their potential, increasing vertical integration indicators, trying to bring them to optimal values.

John Stuckey Director McKinsey, Sydney
David White former McKinsey employee
McKinsey Bulletin # 3 (8) 2004

The leaders of any large company sooner or later have to deal with issues of vertical integration. The authors of this article, which has become a classic in the decade since its first publication, has not lost its relevance, take a closer look at four of the most common reasons for vertical integration. Most importantly, they urge business leaders not to seek vertical integration if value can be created or maintained differently. Vertical integration is successful only in one case - if it is vital.

Vertical integration is a risky, complex, expensive and nearly irreversible strategy. The list of successful cases of vertical integration is also small. Nevertheless, some companies undertake to implement it without first even conducting a proper risk analysis. The purpose of this article is to help leaders make smart integration decisions. In it, we consider different situations: some companies really need vertical integration, while others are better off using alternative, quasi-integration strategies. Finally, we describe a model that is appropriate to use when making such decisions.

When to integrate

Vertical integration is a way to coordinate the various components of an industry chain in an environment where bilateral trade is not beneficial. Take, for example, the production of molten iron and steel, two stages of traditional steel production. Liquid iron is produced in blast furnaces, poured into insulated ladles and transported in liquid form to a nearby steel shop, usually at a distance of half a kilometer, where it is then poured into steel-making units. These processes are almost always carried out by a single company, although liquid metal is sometimes traded and bought. For example, in 1991, Weirton Steel sold liquid iron to Wheeling Pittsburgh, located almost 15 km away, for several months.

But such cases are rare. The specificity of fixed assets and the high frequency of transactions force technologically closely related pairs of buyers and sellers to negotiate the terms of a continuous flow of transactions. Against this background, transaction costs and the risk of abuse of market power are growing. Therefore, from the point of view of efficiency, cost and risk reduction, it is better for all processes to be performed by one owner.

Figure 1 shows the types of costs, risks, and coordination issues to consider when making integration decisions. The difficulty is that these criteria often contradict each other. For example, vertical integration, although it usually reduces some risks and transaction costs, at the same time requires large start-up capital investments, and, in addition, the effectiveness of its coordination is often highly questionable.

There are four valid reasons for vertical integration:

• too risky and unreliable market (there is a "failure" or "failure" of the vertical market);
• companies operating in related links of the production chain have more market power than you;
• integration will give the company market power, since the company will be able to set high barriers to entry into the industry and conduct price discrimination in different market segments;
• the market is not yet fully formed, and the company needs to vertically "integrate forward" for its development, or the market is in decline, and independent players are leaving adjacent production links.

Between these reasons cannot be equated. The first premise, vertical market failure, is the most important.

Vertical market failure

A vertical market is considered insolvent when it is too risky to transact on it, and it is too expensive or impossible to draw up contracts that could hedge against these risks and control their execution. A failed vertical market has three characteristics:

• a limited number of sellers and buyers;
• high specificity, durability and capital intensity of assets;
• high frequency of transactions.

In addition, uncertainty, limited rationality, and opportunism — that is, problems that affect any market — are particularly pronounced in a failing vertical market. None of these characteristics by themselves indicate the failure of a vertical market, but together they almost certainly warn of such a danger.

Sellers and buyers. The number of buyers and sellers in a market is the most important, albeit the most volatile, variable that signals the failure of a vertical market. Problems arise when there is only one buyer and one seller in the market (bilateral monopoly) or a limited number of sellers and buyers (bilateral oligopoly). Figure 2 shows the structures of such markets.

Microeconomists believe that in such markets, rational forces of supply and demand do not by themselves set prices or determine the volume of transactions. Rather, the terms of the deals, especially the price, depend on the balance of the forces of buyers and sellers in the market, and this ratio is unpredictable and unstable.

If there is only one buyer and one supplier in the market (especially in a long-term relationship with frequent deals), then both have a monopoly position. As market conditions change in unpredictable ways, there are often disagreements between players and both can abuse their monopoly position, which creates additional risks and costs.

For bilateral oligopolies, the problem of coordination is especially urgent and complex. When the market, for example, has three suppliers and three consumers, then each player sees five others in front of him, with whom he will have to share the total surplus. If market participants act recklessly, then in a fight with each other, they will pass on the surplus to consumers. This development could have been avoided by creating a monopoly at every link in the industry chain, but this is not permitted by antitrust laws. There remains another option - to integrate vertically. Then, instead of six players, three will remain on the market, each competing with only two contenders for their share of the surplus and, probably, behaving more sensibly.

We took advantage of this concept when a company turned to us for help: they couldn't decide whether to keep the repair shop for the needs of the steelmaking industry. The analysis showed that outside contractors would be much cheaper for the company. However, the opinions of the company's leaders were divided: some wanted to close the shop, others were against it, fearing disruptions in production and dependence on small external contractors (there was only one enterprise operating within a radius of 100 km, which repaired large equipment).

We recommended that the repair shop be closed if it cannot withstand the competition in performing scheduled preventive maintenance and work that does not require complex machining. The scope of these works was known in advance, they were performed on standard equipment and could be easily handled by several external contractors. The risk was low, as was the level of transaction costs. At the same time, we advised leaving the department for the repair of large-sized parts at the plant (but significantly reducing it) so that it only performs emergency work, for which very large turning and turning-boring lathes are needed. It is difficult to predict the need for such repairs, only one external contractor could do it, and the costs of equipment downtime would be enormous.

Assets. If problems of this kind arise only with a bilateral monopoly or a bilateral oligopoly, are we not talking about some kind of market curiosity that has no practical significance? No. Many vertical markets that seem to have many players on either side are actually made up of closely intertwined groups of bilateral oligopolists. These groups are formed because the specificity, longevity and capital intensity of assets increase the costs of switching to other counterparties so much that out of the visible multitude of buyers, only a small part have real access to sellers, and vice versa.

There are three main types of asset specificity that determine the division of industries into bilateral monopolies and oligopolies.

• Location specificity. Sellers and buyers place fixed assets, such as a coal mine and a power plant, close to each other, thereby reducing transport and inventory costs.
• Technical specificity. One or both parties invest in equipment that can only be used by one or both parties and have little value in any other use.
• The specificity of human capital. The knowledge and skills of the company's employees are of value only to individual buyers or customers.

Asset specificity is high, for example in the vertically integrated aluminum industry. The production consists of two main stages: bauxite mining and alumina production. Mines and processing plants are usually located close to each other (specific location) for several reasons. Firstly, the cost of transporting bauxite is incomparably higher than the cost of bauxite itself, secondly, during enrichment, the volume of ore decreases by 60-70%, and thirdly, enrichment plants are adapted to processing raw materials from a certain deposit with its unique chemical and physical properties. Finally, fourthly, changing suppliers or consumers is either impossible or is associated with prohibitively high costs (technical specificity). That is why the two stages - ore mining and alumina production - are interrelated.

Such bilateral monopolies exist despite the apparent multitude of buyers and sellers. In fact, there is no bilateral monopoly at the pre-investment phase of interaction between the mining and processing enterprises. Many mining companies and alumina producers cooperate around the world and participate in tenders every time a new field is proposed to be developed. However, in the post-investment stage, the market quickly turns into a bilateral monopoly. The miner and the ore processor developing the deposit are economically tied to each other by the specificity of the assets.

Because industry players are well aware of the dangers of vertical market failure, mining and alumina production are usually handled by a single company. Almost 90% of bauxite transactions take place in vertically integrated environments or quasi-vertical structures such as joint ventures.

Auto assemblers and parts suppliers can also become highly dependent on each other, especially when some parts are only suitable for one make and model. With a high investment in the development of a component (capital intensity of assets), the combination of an independent supplier and an independent car assembly company is very risky: it is too likely that one of the parties will seize the opportunity and renegotiate the terms of the contract, especially if the model was very successful or, conversely, failed. Auto assembly companies, to avoid the dangers of bilateral monopolies and oligopolies, tend to "integrate back" or, like the Japanese automakers, to create very close contractual relationships with carefully selected suppliers. In the latter case, the reliability of relationships and agreements protects partners from abuse of market position, which often happens when technology-dependent companies keep their distance.

Bilateral monopolies and oligopolies that arise in the post-investment stages due to asset specificity are the most common cause of vertical market failure. The effect of asset specificity is multiplied when assets are capital-intensive and designed for a long service life, as well as when they maintain a high level of fixed costs. With a bilateral oligopoly, the risk of disruption to the delivery or sales schedule is generally high, and the high capital intensity of assets and high fixed costs especially increase the losses caused by the disruption of production schedules: the scale of direct losses and lost profits during downtime is too significant. In addition, the long life of the assets increases the period of time during which these risks and costs can arise.

Taken together, specificity, capital intensity and long-term operation often cause high switching costs for both suppliers and customers. In many industries, this explains most of the decisions in favor of vertical integration.

Frequency of transactions. Another factor in vertical market failure is frequent transactions with bilateral oligopolies and high asset specificity. Frequent bargaining, negotiation and bargaining increases costs for the simple reason that it creates more opportunities for the abuse of market power.

Figure 3 shows the relevant vertical integration mechanisms depending on the frequency of transactions and the characteristics of the assets. If buyers and sellers rarely interact, then, regardless of the degree of asset specificity, vertical integration is usually unnecessary. If the specificity of assets is low, markets operate effectively using standard contracts, say leasing or merchandise credit agreements. With high asset specificity, contracts can be quite complex, but there is still no need for integration. An example is large government orders in construction.

Even if the frequency of transactions is high, low asset specificity mitigates its negative effects: for example, going to the grocery store does not involve a complex negotiation process. But when assets are specific, long-term and capital intensive, and deals are made frequently, vertical integration is likely to be justified. Otherwise, the transaction costs and risks will be too high, and the drafting of detailed contracts that exclude uncertainty will be extremely difficult.

Uncertainty, bounded rationality and opportunism. Three additional factors have an important, though not always clear, influence on vertical strategies.

Uncertainty prevents companies from drafting contracts to guide them if circumstances change. The uncertainty in the work of the above-mentioned repair shop is due to the fact that it is impossible to predict when and what breakdowns will occur, how difficult the repair work will be, what will be the ratio of supply and demand in the local markets for equipment repair services. In an environment of high uncertainty, it is better for the company to keep the repair service: the presence of this link in the technological chain increases stability, reduces the risk and costs of repairs.

Limited rationality also prevents companies from drafting contracts detailing the details of transactions in all possible scenarios. According to this concept, formulated by the economist Herbert Simon, the ability of people to solve complex problems is limited. The role of bounded rationality in market failure was described by Oliver Williamson, one of Simon's students.

Williamson also introduced the concept of opportunism into economic circulation: when possible, people often violate the terms of commercial agreements in their favor, if it is in their long-term interests. Uncertainty and opportunism are often the driving forces in the vertical integration of markets for R&D services and markets for new products and processes derived from R&D. These markets often fail because the main product of R&D is information about new products and processes. In a world of uncertainty, the value of a new product is unknown to the buyer until he or she tastes it. But the seller is also reluctant to disclose information until the moment of payment for the goods or services, so as not to reveal the "company secret". Ideal conditions for opportunism.

If specific assets are needed to develop and implement new ideas, or if the developer cannot protect their copyright by patenting the invention, companies are likely to benefit from vertical integration. For buyers, this will be the creation of their own R&D units. For sellers - “integration forward”.

For example, EMI, the developer of the first computed tomography scanner, would have to “integrate forward” into distribution and service, as other high-tech medical device manufacturers usually do. But at that time she did not have the corresponding assets, and it took a lot of time and money to create them from scratch. General Electric and Siemens, with their integrated R&D, process engineering and marketing structures, have performed the design analysis of the tomograph, developed their own better models, provided training, technical support and customer service, and gained a leading position in the market.

While uncertainty, bounded rationality, and opportunism are ubiquitous, they are not always equally pronounced. This explains some of the interesting features of vertical integration by country, industry and time period. For example, Japanese steel and automobile companies are less “backward-integrated” in supplying industries (components and components, engineering and technological services) than their Western counterparts. But they work with a limited number of contractors with whom they maintain strong partnerships. Probably, among other things, Japanese manufacturers are ready to trust external counterparties also because opportunism is a much less typical phenomenon for Japanese culture than for Western culture.

Defending Against Market Power

Vertical market failure is the biggest argument for vertical integration. But sometimes companies integrate because subcontractors have better market positions. If there is more market power in one of the links in the industry chain and therefore abnormally high profits, players from the weak link will tend to penetrate the strong. In other words, this link is attractive in itself and can be of interest to players both from the industry chain and from outside.

The concrete industry in Australia is known for fierce competition as barriers to entry are low and the demand for homogeneous and generic products is cyclical. Market participants often wage price wars and have low incomes.

In contrast, the extraction of sand and gravel for concrete producers is an extremely profitable business. The number of quarries in each region is limited, and the high costs of transporting sand and gravel from other regions pose high barriers for new players to enter this market. A few players, defending common interests, set prices much higher than those that would have developed in a competitive market environment, and receive significant excess profits. High-value raw materials account for a significant share of the costs of concrete production, which is why concrete companies have “integrated back” into the quarry business, mainly through acquisitions, and now three large players control almost 75% of industrial concrete production and quarrying.

It is important to remember that entering the market through a takeover does not always bring the desired benefits to the acquiring party, because it can give the capitalized equivalent of the surplus in the form of an inflated price for the acquired company. Often, players from less powerful links in an industry chain pay too high a price for companies from stronger links. In the Australian concrete industrial sector, at least a few quarry acquisitions have wiped out the value to buying companies. Recently, a major concrete producer took over a smaller integrated gravel and concrete producer, paying so much that the company had a price-to-cash flow ratio of 20: 1. With the acquisition company's capital cost of about 10%, it is very difficult to find an excuse for such a high overpayment.

Players from less powerful parts of the industry chain certainly have incentives to move into more powerful ones, but the question is whether they can integrate in such a way that the costs of integration do not exceed the expected benefits. Unfortunately, in our experience, this rarely succeeds.

As an industry insider, CEOs of these companies often mistakenly believe that it is easier for them to enter other links in the industry chain than outside challengers. However, technologically different parts of the industry chain are usually so different from each other that “outsiders” from other industries, even if they have the same knowledge and skills, are much more likely to enter a new market. (New players, by the way, can also destroy the potential of the industry link: since one company overcomes barriers to entry, others can do the same.)

The creation and use of market power

Vertical integration can be strategically sensible if its goal is to create or use market power.

Barriers to entry. When the majority of competitors in an industry are vertically integrated, it is generally difficult for non-integrated players to enter the market. To become competitive, they often have to maintain a presence in all parts of the industry chain, which increases capital costs and economically justified minimum levels of production, which in fact increases barriers to entry.

The aluminum industry is one of the industries in which vertical integration has increased barriers to entry. Until the 1970s, six large, vertically integrated companies - Alcoa, Alcan, Pechiney, Reynolds, Kaiser, and Alusuisse - dominated all three sectors: bauxite mining, alumina production and metal smelting. The markets for intermediate raw materials, bauxite and alumina were too small for non-integrated traders. But even integrated companies were reluctant to shell out the $ 2 billion (in 1988 prices) needed to enter the market as an integrated player on a reasonable scale.

Even if a newcomer overcome this barrier, he would need to immediately find ready markets for selling his products - about 4% of the global aluminum production, by which production would increase. Not an easy task in an industry that is growing at a rate of about 5% per year. Not surprisingly, the industry's high barriers to entry are largely due to the vertical integration strategy followed by large companies.

Roughly the same barriers to entry exist in the automotive industry. Automakers are usually “forward-integrated” - they have their own distribution and dealer (franchise) networks. Companies with a strong dealer network usually own it entirely. For newcomers to the market, this means that they must invest more time and money in developing new and extensive dealer networks. If it were not for the strong dealer networks of American companies established over many years, Japanese manufacturers would have won a much larger market share from American auto giants like General Motors.

However, it is often very expensive to create vertically integrated structures to erect barriers to entry. Moreover, success is not guaranteed, and if the amount of super-profit is quite large, then inventive beginners will eventually find loopholes in the erected fortifications. Aluminum producers, for example, lost control of the industry at some point, mainly because foreign companies infiltrated it through joint ventures.

Price discrimination. By “integrating forward” into specific customer segments, a company can further benefit from price discrimination. Take, for example, a market power supplier whose customers occupy two segments with varying degrees of price sensitivity. The supplier would like to maximize its profit by charging a higher price in the low sensitivity consumer segment and a lower price in the high sensitivity segment. But he cannot do this, because consumers receiving the product at a low price will resell it to higher consumers in the neighboring segment and will ultimately undermine this strategy. By “integrating forward” into low-price consumer segments, a supplier will be able to prevent the resale of its products. It is known that aluminum producers are integrating into the most sensitive to price changes in the production sector (production of aluminum cans, cables, molding of components for auto assembly), but do not strive for sectors in which there is almost no danger of substitution of raw materials and suppliers.

Types of strategy at different stages of the industry life cycle

When an industry is in its infancy, companies often “integrate forward” to develop the market. (This is a special case of vertical market failure.) In the early decades of the aluminum industry, manufacturers integrated into aluminum products and even consumer goods to push aluminum into markets that traditionally used steel and copper. Similarly, early fiberglass and plastics manufacturers found that the benefits of their products over traditional materials were only appreciated through “forward integration”.

However, in our opinion, this justification alone is not enough for vertical integration. Integration will be successful only if the acquired company owns a unique patented technology or a well-known brand that is difficult for competitors to copy. It makes no sense to acquire a new business if the buying company cannot receive excess profits for at least several years. In addition, new markets will develop successfully only if the new product has clear advantages over existing or similar products that may appear in the near future.

As the industry reaches its aging stage, some companies integrate to fill the void left by the departure of independent players. As the industry ages, weak independent players leave the market, and the position of key players is vulnerable to increasingly concentrated suppliers or consumers.

For example, after the cigar business began to decline in the United States in the mid-1960s, the country's leading supplier, the Culbro Corporation, had to acquire all distribution networks in key US East Coast markets. Its main competitor, Consolidated Cigar, was already in the marketing business, and Culbro's distributors lost interest in cigars and were more willing to sell other products.

When vertical integration is unnecessary

Vertical integration should be dictated only by vital necessity. This strategy is too expensive, risky, and very difficult to reverse. Sometimes vertical integration is necessary, but very often companies over-integrate. This is explained by two reasons: firstly, integration decisions are often made on dubious grounds, and secondly, managers forget about a large number of other, quasi-integration strategies, which, in fact, may turn out to be much preferable to full integration in terms of costs and economic benefits.

Doubtful grounds

Often, decisions about vertical integration are unwarranted. It is extremely rare that the drive to reduce cyclicality, ensure time-to-market, break into higher value-added segments, or get closer to the consumer could justify such a move.

Reducing the cyclicality or volatility of income. This common but often not compelling reason for vertical integration is a variation on the old theme that diversifying the corporate portfolio is beneficial to shareholders. This argument is invalid for two reasons.

First, incomes in adjacent links of the industry chain are positively correlated and influenced by the same factors, such as changes in demand for the final product. This means that combining them in one portfolio will not noticeably affect the overall level of risk. For example, this is the case in the zinc mining and zinc smelting industries.

Second, even if earnings are negatively correlated, smoothing out the cyclicality of corporate profits is not so important for shareholders - they can diversify their own investment portfolios to reduce non-systemic risk. Vertical integration in this case is beneficial to the company's management, but not to shareholders.

Supply and sales guarantees. It is generally accepted that if a company has its own sources of supply and distribution channels, then it is significantly less likely that it will be pushed out of the market, that it will fall victim to price fixing or suffer from the short-term imbalance of supply and demand that sometimes arises in intermediate product markets.

Vertical integration can be justified when the threat of market exclusion or “unfair” pricing indicates either the failure of the vertical market or the structural bargaining power of suppliers or consumers. But where the market is functioning properly, there is no need to own sources of supply or distribution channels. Market players will always be able to sell or buy any quantity of a commodity at the market price, even if it seems “unfair” in relation to the cost. An integrated company operating in such a market is only deceiving itself by setting internal transfer prices that differ from market prices. Moreover, a company that has integrated on this basis may make the wrong decisions regarding the level of production and capacity utilization.

The structural characteristics of the buying and selling sides of the market are the same subtle but critical factors that determine when to take over sourcing and distribution. If the principles of competition are characteristic of both sides, then integration will not be beneficial. But if structural features are causing vertical market failures or persistent imbalances in market positions, integration may be warranted.

On several occasions we have witnessed an interesting situation: a group of oligopolists - suppliers of raw materials for a rather fragmented industry with weak buying power - “integrated forward” to avoid price competition. Oligopolists understand that fighting for market share by waging price wars is shortsighted, except perhaps for very short periods, but they still cannot resist the temptation to increase their market share. Therefore, they "integrate forward" and thereby secure all major consumers of their products.

Such actions are justified when players avoid price competition and when the price that oligopolistic companies pay to take over their industrial customers does not exceed their net present value. And “forward integration” is beneficial only if it helps to maintain oligopoly profits at the top of the industry chain, where there is a constant imbalance of power.

Providing additional value. The opinion that companies should strive for links in the industry chain with higher added value is usually expressed by those who adhere to another rather outdated stereotype: you need to be closer to the consumer. Following these tips leads to higher “forward integration” - towards the end user.

It may be that there is a positive correlation between the profitability of a link in the industry chain, on the one hand, and the absolute value of its added value and proximity to the consumer, on the other, but we believe that this correlation is weak and unstable. Vertical integration strategies based on these premises tend to destroy shareholder value.

Surplus, not added value or proximity to the customer, is what brings really high profits. Surplus is the income a company receives after covering all the costs of doing business. The amount of surplus and value added (which is defined as the sum of all costs and markups minus the cost of all materials and / or components purchased in an adjacent link in the industry chain) of one of the links in the industry chain can be proportional only as a result of a coincidence. However, the surplus is most often formed at the stages closest to the consumer, because it is there, according to economists, that direct access to the consumer's wallet and, accordingly, the consumer's surplus opens.

Therefore, the general recommendation should be: "Integrate into those links in the industry chain where you can get the maximum surplus, regardless of proximity to the consumer or the absolute value of added value." However, remember that consistently high surplus links need to be protected by barriers to entry, and the cost of overcoming these barriers for a new player entering the sector through vertical integration should not exceed the surplus they can obtain. Typically, one of the entry barriers is the specialized knowledge required to run a new business, and newcomers often do not have it, despite the experience gained in related links in the industry chain.

Consider, for example, the cement and concrete industry chain in Australia (see Figure 4). In each individual link, the surplus is not proportional to the value added. In fact, the segment with the highest added value, that is, transportation, does not provide a decent return, while the sector with the least added value - ash and slag production, creates a significant surplus. In addition, the surplus is not concentrated in the sector closest to the consumer, and if it is formed, then at the primary stages. The amount of surplus at different links in the industry chain varies considerably and needs to be determined on a case-by-case basis.

Quasi-integration strategies

The management of companies sometimes goes for excessive integration, overlooking many alternative quasi-integration solutions. Long-term contracts, joint ventures, strategic alliances, technology licenses, asset ownership, and franchising require less investment while leaving companies more leeway than vertical integration. In addition, these strategies reliably protect against vertical market failure and against suppliers or consumers with more market power.

Joint ventures and strategic alliances, for example, allow companies to exchange certain types of goods, services or information while maintaining formal business relationships on all other items, maintaining their status as independent companies and not being exposed to the risk of antitrust prosecution. Potential mutual benefits can be maximized and conflicts of interest inherent in trade relations can be minimized.

That is why in the 1990s most of the smelters in the aluminum industry turned into joint ventures. Through such structures, it is easier to exchange bauxite, alumina, know-how and local knowledge, establish oligopolistic coordination and manage relations between global corporations and the governments of the countries in which they operate.

Asset ownership is another type of quasi-integration structure. The owner retains the ownership of key assets in adjacent links in the industry chain, but gives them to external contractors to manage. For example, automobile or steam turbine manufacturers own specialized tools, tooling, templates, punching and casting molds, without which key components cannot be produced. They enter into contracts with contractors for the production of these components, but they remain the owners of the means of production and thus protect themselves from possible opportunistic behavior of contractors.

Similar agreements can be entered into with companies from the lower links of the industry chain. Franchise agreements allow an enterprise to control distribution without diverting significant financial and managerial resources to this, which would be inevitable with full integration. The franchisor does not seek to own tangible assets, since they are not specific or long-term, but remains the owner of intangible assets such as a trademark. By having the power to cancel the franchise agreement, the franchisor controls the standards. For example, the McDonald's corporation in most of the countries in which it operates, strictly monitors prices, product quality, level of service and cleanliness.

When it comes to buying or selling technology, licensing agreements should be considered as an alternative to vertical integration. Technology and R&D markets are at risk of failure as inventors find it difficult to protect their copyrights. Sometimes an invention is of value only when combined with special complementary assets, such as experienced marketing or customer support professionals. A license agreement might be a good solution to the problem.

Figure 5 presents a decision-making methodology for a developer of a new technology or product. We see, for example, that when a developer is protected from counterfeiting by patents or trade secrets, and additional assets are either not of great importance, or they can be found on the market, then it is necessary to conclude licensing agreements with everyone and pursue a long-term pricing policy.

This strategy is usually suitable for industries such as petrochemicals and cosmetics. As technology becomes easier to copy and the importance of complementary assets grows, vertical integration may be necessary, as we have shown with the CT scanner.

Changing vertical strategies

As the market structure changes, companies must adjust their integration strategies. Among structural factors, the number of buyers and sellers and the role of specialized assets change most often. Of course, companies should rethink their strategies, even if they just turned out to be wrong, without waiting for any structural changes.

Sellers and Buyers

In the mid-1960s, the oil market exhibited all the symptoms of vertical failure (see Chart 6). The four largest sellers controlled 59% of the industry's sales, the eight largest 84%. The situation with the buyers was about the same. There were very few possible combinations of adequate buyers and sellers, since refineries could only work with certain grades of oil. Assets were capital intensive and long-term, transactions were very frequent, and the need to constantly modernize factories increased the level of uncertainty. Not surprisingly, there was almost no spot market for oil, most transactions were carried out within the company, and if contracts with external contractors were concluded, then for 10 years - to avoid transaction costs and risks associated with trading in an unstable, vertically insolvent market.

However, over the next 20 years, the structure of the market underwent fundamental changes. As a result of the nationalization of oil reserves by OPEC countries (replacing the Seven Sisters with many national exporting companies) and an increase in the number of non-OPEC exporters (such as Mexico), the concentration of sellers has dropped significantly. By 1985, the market share controlled by the four largest sellers had dropped to 26% and by eight to 42%. The concentration of ownership of oil refineries has significantly decreased. Moreover, technological improvements have reduced asset specificity as modern refineries can process significantly more grades of oil and do so with lower switching costs.

All of this has pushed the development of an efficient crude oil market and markedly reduced the need for vertical integration. According to rough estimates, in the early 1990s, about 50% of transactions took place in the spot market (where even large integrated players are traded), and the number of non-integrated players began to grow rapidly.

Disintegration

The shift towards vertical disintegration in the 1990s was driven by three main factors. First, in the past, many companies integrated without sufficient justification and now, although no structural changes took place, they had to disintegrate. Second, the emergence of a powerful M&A market increases the pressure on over-integrated companies and forces them to restructure - either voluntarily or under the coercion of the buyers of their shares. And third, structural changes have begun in many industries around the world that enhance the benefits of trade and reduce the associated risks. The first two reasons are obvious, and the third, in our opinion, requires clarification.

In many industry chains, an increase in the number of buyers and sellers has reduced the costs and risks of trading. Industries such as telecommunications and banking have been deregulated, allowing new entrants to enter markets previously occupied by national monopolies or oligopolies. In addition, with the economic development of many countries, including South Korea, China, Malaysia, more and more potential suppliers appear in many industries, such as consumer electronics.

Also, the globalization of consumer markets and the need to become “local” in any of the countries where they operate, is forcing many companies to create production facilities in the regions to which they previously exported their products. This, of course, increases the number of component buyers.

Another factor that reduces costs and increases the positive effects of trade is the growing need for greater manufacturing flexibility and specialization. An automobile manufacturer, for example, which uses thousands of components and assemblies in its production (while they are constantly becoming more complex, and their life cycle is shortening), it is very difficult to maintain a leading position along the entire chain. It is much more profitable for him to focus on design and assembly, and to purchase components from specialized suppliers.

Significantly, today's managers are adept at using quasi-integration strategies, such as long-term privileged supplier relationships. In many industries, the supply chain is trying to develop closer relationships with suppliers. In the US auto industry, for example, companies are moving away from tight vertical integration, reducing the number of suppliers, and developing stable partnerships with only a few independent suppliers.

However, there is also an opposite tendency - towards consolidation. As conglomerates are downsized, their constituent parts end up in the hands of companies, which, with their help, increase their shares in certain markets. But, in our opinion, the factors that stimulate the formation of sectoral structures that can compete at the global level are much stronger.

It is not only industry chains that are disintegrated: under the influence of the market, many companies are forced to disintegrate their own business structures. Cheaper foreign manufacturers are forcing companies from developed countries to constantly cut costs. Technological advances in information and communication technologies are driving down the costs of bilateral trade.

While all of these factors contribute to the disintegration of industry chains and business structures, there is one caveat to be made. We suspect that some executives, seeking to get rid of "excess assets" and "make the company more flexible," may end up throwing out a child with the water - and not even one. They disintegrate some of the functions and activities that are vital in a failing vertical market. As a result, it turns out that some of the strategic alliances to which they have switched are legalized piracy, and some "partners" -suppliers are not averse to showing their temper, as soon as their competitors are kicked out the door.

In any case, decisions to integrate or disintegrate should be based on careful analysis and not be taken out of fashion or on a whim. Therefore, we have developed a step-by-step methodology for vertical restructuring (see Figure 7). The basic idea is still the same: integrate only if it is vital.

Using the methodology

We have successfully applied this methodology in situations where our clients had to decide whether to keep this or that production at home or purchase the required products (services) on the side. These dilemmas include the following:

• Should the steel mill keep the repair shop as it was?
• Does a large mining company need its own legal department or is it more profitable to use the services of a law firm?
• Should the bank print checkbooks on its own or order them from specialized printing houses?
• Does a telecommunications company with 90,000 employees need to set up its own training center, or is it better to involve outside instructors?

We also used our methodology to analyze strategic issues such as:

• What parts of the business — product development units, branch network, ATM network, data center, and so on — should a retail bank own?
• What mechanisms should a public research organization use when it provides services and sells its knowledge to private sector clients?
• Should a mining and processing company integrate into metal production?
• through what mechanisms does an agricultural company penetrate the Japanese market for imported meat?
• Should the brewery get rid of its beer restaurant chain?
• Should a gas producer buy pipelines and power plants?

Process

The process shown in Figure 8 speaks for itself, but a few points are still worth clarifying.

First, when making a strategic decision, companies must take seriously the quantification of various factors. As a rule, it is important to know exactly the costs of switching (in case the company has to change the supplier, under the agreement with which it invested in specific assets), as well as the transaction costs inevitable in the case of purchasing or selling to third parties.

Second, in most cases, when analyzing the advantages or disadvantages of vertical integration, it is important to assess the behavior of small groups of buyers and sellers. Techniques such as supply and demand analysis help to see the full range of possible actions, but they cannot be used for deterministic forecasting of behavior (although it is quite suitable for analyzing more competitive market structures). In order to predict the actions of competitors and choose the optimal strategy, it is often necessary to use dynamic modeling and competitive games. These problem-solving techniques are both a science and an art, and our experience has shown that it is imperative that senior executives are involved to understand and acknowledge the assumptions that often have to be made about competitors' behavior.

Third, this process involves a lot of analytical work, and it takes a lot of time. The initial, most general analysis of the proposed steps identifies key problems, allows you to develop hypotheses and gather material for further in-depth analysis.

Fourth, those who use our methodology must be prepared to face serious opposition. Vertical integration is one of those last bastions of business strategy where intuition and tradition are revered above all else. It is difficult to offer a universal solution to this problem, try to give examples of other companies from your or a similar industry that will clearly illustrate your theses. Another way is to attack the erroneous logic "head-on", decompose it into its component parts and find weak links. But perhaps the best thing is to involve all stakeholders in the analysis and decision-making process.

Vertical integration is a complex, capital intensive and long-term strategy, and therefore carries with it risk. Not surprisingly, sometimes leaders make mistakes — and give visionary strategists the opportunity to learn from others’s mistakes.

See, for example: R.P. Rumelt. Structure, and Economic Performance. Harvard University Press, 1974.

See: H.A. Simon. Models of Man: Social and Rational. New York, John Wiley, 1957, p. 198.

See: O.E. Williamson. Markets and Hierarchies: Analysis and Antitrust Implications. New York, Free Press, 1975.

See: D.J. Teece. Profiting from Technological Innovation // Research Policy, vol. 15, 1986, p. 285-305.

The concepts of "excess profit" and "seller's surplus" are synonymous.

See: E.R. Corey. The Development of Markets for New Materials. Cambrige, MA, Harvard University Press, 1956.

See: K.R. Harrigan. Strategies for Declining Business. Lexington Books, 1980, chapter 8.

In economic theory, there is the concept of integration. Integration is a process of developing stable relationships between neighboring states, leading to their gradual economic merger, based on the implementation of a coordinated interstate economy and policy by these countries. Distinguish between horizontal and vertical integration.

Horizontal integration is accompanied by the acquisition by one firm of others engaged in the same business. A type of horizontal integration is diversification, which means the amalgamation of firms whose technological processes are not related in any way (for example, the production of chemical fibers and aircraft).

Vertical integration is a method by which a company creates (integrates) its own input or output stages of the technological chain. Integration can be complete (combining all inputs or outputs) or narrow (the company buys only a part of the input elements and produces the rest on its own).

A company using vertical integration usually motivates it with a desire to strengthen the competitive position of its key original business, which should be facilitated by: cost savings; a departure from market value in integrated industries; improving quality control of production and management processes; protection of our own technology.

However, vertical integration also has negative sides: increased costs; inevitable financial losses due to rapid technology change and unpredictability of demand.

Vertical integration can increase costs if a company uses its own input production with cheap external sources of supply. This can also happen due to the lack of competition within the company, which does not induce its suppliers to reduce production costs. When technology changes, there is a risk of over-tying the company to an outdated technology. With constant demand, a higher degree of integration allows you to more reliably protect and coordinate the production of products. When demand is unstable and unpredictable, such coordination is difficult with vertical integration, which increases the cost of management. Under these conditions, tight integration may turn out to be less risky than full integration, since it reduces costs compared to full integration and, under certain conditions, allows the company to expand vertical integration. While tight integration can reduce management costs, it cannot eliminate them entirely, and this really limits the expansion of the limits of vertical integration.

It is all of the above that emphasizes the relevance of the chosen topic of the course work.

The purpose of this course work is to research vertical integration. The objectives of this work are to find a definition of vertical integration, study the reasons for vertical integration, consider vertical constraints and mergers, study this topic at the present stage.

For the production of any type of product, it is necessary to carry out a series of stages, each of which includes a sequence of technological conversions. For example, it is necessary to prospect for raw materials, extract raw materials, deliver them to the place of processing, process them into intermediate and then final products, distribute them and deliver them to the consumer.

Vertical integration is a collection of two or more of these production steps. In theory, it can include all stages - for example, from the extraction of raw materials to the distribution of the final product among manufacturers. In this case, all transformations of the product at each stage must be internal within the firm. In fig. 1 shows the elements and options for vertical integration. The sequence of technological operations T 1 - T Q characterizes the completed production cycle, which includes a sequence of production stages E 1 - Em, the increase in value added goes from the initial to the final operation, and it rises to the product output of the production process. If, at each stage, the product is produced by a sole firm, then there is no vertical integration, and each subsequent stage is implemented through an open market transaction.

In reality, almost every firm has several intermediate stages of integration, i.e. carries out a certain sequence of technological redistribution, combining them with the purchase of initial resources from other firms. In the product flow, they can integrate upstream (lagging), or downstream (leading).

In the operation of non-integrated firms, products move from one stage to another through market transactions based on free market prices. In integrated firms, the internal transfer of products from stage to stage is carried out at internal (conditional) transfer prices, which do not require equivalence to market prices and are completely dependent on the internal interests and strategy of the firm's behavior. In this regard, it is necessary to note the reasons for choosing the integration of stages, since:

Market transactions can provide close, efficient and controlled contacts and strict ownership;

Highly representative control in integration can be powerful, authoritative, and relatively inexpensive.

The question of the scope of vertical integration and its very expediency is a complex issue of theory and practice, which is still largely debatable. In particular, the connection between integration and monopoly forces remains the core of the dispute.

Economists at the UCLA School of Chicago tend to argue that integration cannot transform monopoly forces from one level to another, cannot create more market forces than exist at horizontal levels. Other opinions boil down to the fact that integration, on the contrary, generates a deal, excludes the market and therefore can exclude the rivalry of sellers for access to resources. In this regard, it is important to note the actualization of the problem of the possibility of both determining and measuring the level (value) of integration, as well as the reasons for the use of this process by firms.

From the standpoint of measuring the level of vertical integration, intuitive simplicity rests on the measurement technique itself. You can count the number of stages with broad integration, but there is uncertainty in the definition of the very concept of "stage" - it can include many individual, relatively independent stages. For example, in the electronics industry, the processes of preparing integrated circuits include 2.5-3 thousand technological stages (transitions), which are sometimes quite difficult to separate into separate stages. Alternatively, the value added of a firm to its final sales income can be used as an index of the degree of integration of these firms. An integrated producer adds value through many stages, so the score will be high. For example, the value added of a retailer will be low. At the same time, there are examples of other polarities - brick production is one-stage and has a high added value, while multi-stage industries have a low added value. The value added indicator may be lower for industries that are ahead in the production chain (raw materials, processing).

Thus, to date, there are no perfect (reliable) measurement of the level of integration, conceptual approaches require clarification and refinement.

Efficiency assurance includes the use of technical specifications and savings in transaction costs.

Some of the technical efficiencies are physical - for example, in metallurgical production, thermal resources can be saved by smelting iron and making ingots and processing them while maintaining a hot state. (The heat can be used for heating water, heating greenhouses and subsidiary farms, etc.).

Savings and efficiency gains can also be obtained by increasing the level of organization, clearer coordination and interpenetration of technological processes, eliminating additional costs and risk, as well as adherence to clear schedules and regulatory procedures.

Vertical integration- production and organizational association, merger, cooperation, interaction of enterprises connected by common participation in the production, sale, consumption of a single final product: suppliers of materials, manufacturers of assemblies and parts, assemblers of the final product, sellers and consumers of the final product.

Vertical integration refers to that part of the value added that is produced within the framework of joint ownership. The price of the item sold will most likely include the costs of materials, components and systems. The high purchase price of this investment means a low level of integration. If the majority of the total sales value is generated within one organization, the level of integration will be high. Horizontal integration is much less common in the past and refers to the use of a wide range of products in order to maximize customer satisfaction.

Vertical integration is the process of replacing market transactions with intra-corporate transactions, resulting in a planned economy in which suppliers enjoy a monopoly and consumers simply have no other choice. Vertical integration, like diversification, was once very popular in the management of commercial organizations, but the peak of this popularity passed several decades ago. A classic example is Singer, an American sewing machine company that at one point integrated all of its operations from primary sources of raw materials (forests and iron mines) to finished sewing machines.

Vertical integration within a company is closely related to outsourcing and make-or-buy analysis and raises philosophical questions such as “Did Ronald Coase win the 1992 Nobel Prize?” or "where does the company start and end, and why?"

Experience shows that a low level of competition leads to a high level of integration, that is, diversification. Those countries of the world where competition was at a low level experienced too strong the influence of the planned economy to be competitive in the modern world with its globalization. This led to a thorough revision of the entire business chain and, as a result, consideration of outsourcing opportunities. As a result, traditional value chains were broken and new companies were created. At the same time, the productivity of older companies was declining. The production of components and the supply of auxiliary systems in the telecommunications industry were outsourced to specialized companies whose main activity was the production of electronics.

Most industries are already in a phase of decreasing integration, where they produce fewer end products themselves and purchase more components from third-party suppliers.

In theory, all functions could be performed by separate companies. We can separate the computer department, factory, sales company and other parts of the management staff. The decision to vertically integrate essentially involves a choice between producing goods and / or providing services on their own, and purchasing them from someone else.

The disadvantages of advanced vertical integration gradually came to light. The high level of vertical integration has become a problem and an object of struggle for Mikhail Gorbachev in the Soviet Union. ”Approximately the same problem arises for all traditional airlines. The largest European companies have always been relatively free from the stress of competition, and, accordingly, they were characterized by a high level of vertical integration. In a competitive battle with newcomers such as Ryanair or Easy.Jet, older companies faced challenges not only with their cost structures, but also with advanced vertical integration. These companies did their own engine maintenance, cleaned their aircraft, ran their own ground support and handling services, etc., which, of course, led to a number of intermediary deals.

Centralized organizations are characterized by excessive belief in their own abilities, which is expressed in the desire to do everything on their own. By contrast, organizations that are more entrepreneurial tend to have a different tendency: they make the entire chain more efficient by purchasing the goods and services they need from other companies. The following are the negative features of Advanced Vertical Integration:

• 1. It eliminates market forces, and with them the possibility of correcting unnecessary transactions.
• 2. It makes the provision of subsidies attractive, which distorts the picture of competition and distorts the question of the meaning of the company.
• 3. It creates a deceptive sense of power that does not correspond to the realities of the free market.
• 4. It creates interdependencies that can lead to the collapse of any of the functions involved if one of them finds itself in a difficult situation.
• 5. The closed market it organizes (guaranteed distribution channels) lulls the company's vigilance and creates a false sense of security.
• 6. A false sense of security dulls the organization's desire and ability to compete.

Many examples of vertical integration are based on misconceptions and self-deception. The most common misconception is the belief in the possibility of eliminating competition in a single link in the production chain by controlling it. Some of the illusions prevailing in the world of vertical integration are listed below:

Illusion 1: A strong market position at one stage of production can be transformed into a strong position at another.

This assumption has often led to inappropriate investment decisions in the operations of the Swedish Consumers' Cooperative * and other conglomerates, which subsequently suffered from the above disadvantages.

Illusion 2: Commercial transactions that do not go beyond the scope of a single firm eliminate the involvement of sales agents, simplify the management process, and thus make transactions cheaper.

This is nothing more than the classic credo of all adherents of a planned economy, who believe that centralized control is the only right way, and the free market is worthy of anathema.

Illusion 3: we can resurrect a strategically weak unit by buying out the unit following it in the production chain, or the unit before it.

This is possible in rare cases. The logic of each industry must be judged by its own metrics. This rule also applies here, except in situations of diversification in order to distribute risks.

Illusion 4: Industry knowledge can be used to gain competitive advantage in both upstream and downstream phases.

It is worth taking a closer look at the potential benefits and ensuring that this logic does not mislead the pass.

There are many examples of tremendous profitability gains achieved by breaking down vertically integrated structures. Perhaps this is why commercial organizations in general are moving towards less integration. Car manufacturers with their own supply chains do not supply their cars to export markets at a lower cost than those who use independent supply companies. They also make their own gearboxes no less expensive than the gearbox makers.

One of the reasons vertical integration was so popular in the technocratic era was the apparent economies of scale that were tangible and measurable, as opposed to small scale benefits such as entrepreneurial spirit and competitive energy that cannot be quantified.

In certain specific situations, vertical integration has a positive side, especially when the control of key resources allows you to achieve competitive advantages.

Some are listed below:

• - higher level of coordination of operations with better control capabilities
• - closer contact with end users thanks to vertical integration
• - creating stable relationships
• - access to technical know-how relevant to the industry
• - confidence in the supply of necessary goods and services.

The integration of the travel firm VingrevSor into the hospitality business through the creation of holiday villages in tourist resorts is an example of growth from the sale of vouchers to accommodation during vacations, a move that was seen as a likely strategic advantage.

SAS has also invested in hotels, and IKEA, with its backward integration from furniture sales to design and production planning, is balanced by forward integration, leaving the final stage of production (furniture assembly) to the consumers themselves.

Self-admiration or over-pride is often at the core of vertical integration, so you should carefully consider your own inner motives.

Tired of the look of the kitchen? Do you want to change something? Order kitchens to order for individual orders.

This strategy means that the company is expanding in activities related to the promotion of goods to the market, their sale to the end customer (direct vertical integration) and related to the receipt of raw materials or services (reverse).

Direct vertical integration protects customers or the distribution network and ensures product purchase. Reverse vertical integration aims to anchor suppliers that deliver products at lower prices than competitors. Vertical integration also has a number of advantages and disadvantages, some of which are listed below.

Advantages:

New savings opportunities arise that can be realized. This includes better coordination and management, lower handling and transportation costs, better use of space, capacity, easier gathering of market information, less negotiation with suppliers, lower transaction costs and the benefits of stable relationships.

Vertical integration should guarantee the organization of delivery in tighter terms and, conversely, the sale of its products during periods of low demand.

It can give the company more leeway to participate in a differentiation strategy. This is because it controls a large portion of the value chain, which can provide more room for differentiation.

This route allows the significant bargaining power of suppliers and buyers to be resisted.

Vertical integration can enable a company to increase its overall return on investment if the proposed option offers a return greater than the company's alternative capital price.

Vertical integration can have technological advantages because the acquiring organization gains a better understanding of the technology, which can be fundamental to business success and competitive advantage.

Disadvantages:

Vertical integration tends to increase the proportion of fixed costs. This is due to the fact that the company must cover the fixed costs associated with reverse or direct integration. The consequence of this increased operating dependence is that the enterprise's risk will be higher.

Vertical integration can lead to less flexibility in decision making due to changes in the external environment. This arises because the competitive advantage of a company is related to the competitiveness of the suppliers or buyers involved in the integration process.

It can also create significant barriers to exit, as it increases the loyalty of the company's assets. They will be much more difficult to sell in the event of a downturn.

There is a need to balance the initial and final stages of the main

The activities of modern companies take place in a rapidly changing competitive environment, which is due to the processes of globalization, market liberalization, as well as technological progress. The success of a company in such a situation largely depends on the effectiveness of interaction with other companies at various stages of creation and promotion of the final product or service to the end consumer, in other words, on the effectiveness of vertical integration.

The main purpose of this article is to consider the concept of vertical integration, a comprehensive analysis of theoretical approaches to explaining this phenomenon, which has not been given much attention in the literature before, as well as to create a theoretical basis for explaining the processes of vertical integration in the automotive industry. The main source of information when writing this article was the work of R. Coase, O. WilliamsonM. Adelman K. R. Harrigen, J. Stigler, W. Abernasie, K. Arrow, R. Blair, R. Basel, devoted to the consideration of issues of vertical integration, as well as a number of articles in scientific journals.

The object of research in this article is economic theories that are used to explain the vertical integration of a company. At the same time, the object of analysis, the arguments in defense of vertical integration, the contribution to the theoretical justification of vertical integration, as well as their limitations are considered.

Vertical integration is the process of incorporation into the structure of a company of firms that are linked to it by a single technological chain, or the merger of production stages of a single technological chain and the establishment of control of one company over them. In this case, the production stage is understood as a process as a result of which added value is added to the initial cost of the product, and the product itself moves along the chain to the final consumer.

The main difference in the definitions of vertical integration by scientists is the degree of control of one firm over another, which arises from the integration of different stages of the value chain.

Thus, professor at the Massachusetts Institute of Technology M. Adelman believes that a firm is vertically integrated when goods and services are moved from one division to another inside it, which could be sold on the market without further processing. This definition reflects the opinion of the majority of scientists that vertical integration implies 100% control of the firm over several stages of production. This definition excludes the firm's flexibility in choosing the degree of vertical integration, as well as the possibility of implementing quasi-integration strategies.

Harvard professor K.R. Harrigen gives a broader definition of vertical integration as a way to increase added value when creating a product or service and moving it to the final consumer. This point of view presupposes a variety of forms and the degree of control over the relationships between different stages of production, including their disintegration. The latter phenomenon is observed in many industries, for example in the automotive industry.

Depending on the direction of vertical integration, there are:

• - integration "forward", or direct integration, which involves the combination of one of the stages of the value added chain with subsequent stages of production and marketing. An example of such integration would be the integration of the stages of vehicle assembly and distribution;
• - integration "back", or reverse integration, in which there is a combination of one of the stages of the value added chain with the previous links of the technological process. For example, a car assembly firm vertically integrates with a supplier of assembly supplies.

Depending on the degree of integration, the following are considered:

• - full integration;
• - quasi-integration, requiring less capital investment and allowing companies to remain more free.

Quasi-integration can exist in the form:

• - long-term contracts;
• - joint ventures and strategic alliances. In this form, firms combine certain resources to achieve a common result, while remaining independent in addressing other issues;
• - licenses for the right to use technologies. In this case, we are talking about vertical integration, in which one of the integrated stages is technology development and R&D. Full vertical integration can be replaced by a licensing agreement if the developed technology is difficult to copy and the sale of such technologies does not require additional assets, for example, marketing specialists;
• - ownership of assets. The firm holds title to certain assets at various stages of the process chain, and these assets are managed by external contractors. For example, car manufacturers own specialized tools, tooling, templates, stamping and casting molds, without which the production of components is impossible. They enter into contracts with contractors for the production of such components, while remaining the owner of the means of production, thus preventing contractors from breaching contracts and guaranteeing delivery;
• - franchising. The franchisor is the owner of intangible assets (for example, a trademark), controls prices, product quality, level of service, while minimizing financial and management resources.

At the moment, there is no general theory of vertical integration in economics, and its existence is explained using various theories and approaches.

For a long time in neoclassical direction of economic theory Taking into account one of the assumptions about the existence of competitive markets, through which the efficient allocation of resources occurs, the only justified case of vertical integration was the existence of a continuous technological relationship between various stages of production. It is assumed that common ownership is required to achieve the efficiency of sequential processes that coincide in time and space, as, for example, in the production of steel. According to this approach, vertical integration in the automotive industry as a discrete manufacturing makes no sense.

This approach is unjustified, since, as various scientists later proved, the market is not an ideal mechanism for allocating resources; moreover, in the history of the automotive industry there are many examples of successful vertical integration.

 

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