# What Is Vertical Integration?

> **Definition**
>
> Vertical integration occurs when a business acquires ownership of various stages of production to streamline its production process.

## What Is Vertical Integration?

Vertical integration is a strategy that companies use to streamline their operations. It involves taking ownership of various stages of its production process. Companies achieve vertical integration through [mergers or acquisitions](https://www.investopedia.com/terms/m/mergersandacquisitions.asp) or establishing suppliers, manufacturers, distributors, or retail locations rather than outsourcing them. Vertical integration often requires significant initial [capital investment](https://www.investopedia.com/terms/c/capital-investment.asp).  

### Key Takeaways

*   Vertical integration is when a company takes ownership of suppliers, distributors, or retail locations to obtain greater control of its supply chain.
*   Vertical integration increases efficiency, reduces costs, and boosts control along the manufacturing or distribution process.
*   Upfront capital investment is required for vertical integration.  
    

![Vertical Integration](https://www.investopedia.com/thmb/JKI-_tYZJdizkuXsHm5YOQ4pmRw=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Vertical-integration-7a31b884b9564a139c5ec2f7885ff3f0.jpg)

*— Mira Norian / Investopedia*

## How Companies Use Vertical Integration

A company can broaden its footprint across the [supply chain](https://www.investopedia.com/terms/s/supplychain.asp) or manufacturing process with vertical integration, allowing for more self-reliance on aspects of the process. Vertical integration lets manufacturers directly source raw materials or sell products to consumers.  

The supply chain or sales process typically begins with [raw materials](https://www.investopedia.com/terms/r/rawmaterials.asp) from a supplier and ends with the final product to the customer. Vertical integration requires a company to buy or recreate a part of the [production](https://www.investopedia.com/terms/f/factors-production.asp), distribution, or retail sales process that was previously outsourced.

Companies can vertically integrate by purchasing their suppliers to reduce manufacturing costs. They can invest in the retail end of the process by opening websites and physical stores. They can invest in warehouses and fleets of vans to [control the distribution process](https://www.investopedia.com/terms/d/distribution-management.asp).

> **Fast Fact**
>
> As a company engages in more activities along a single supply chain, it may result in a market monopoly. A monopoly that occurs due to vertical integration is also called a vertical monopoly.

## Types of Vertical Integration

*   **Backward Integration:** A company seeks to acquire a [raw material](https://www.investopedia.com/terms/r/rawmaterials.asp) distributor or provider at the beginning of a supply chain. [Backward integration](https://www.investopedia.com/terms/b/backwardintegration.asp) moves the ownership control of its products to a point earlier in the supply chain or the production process. A furniture retailer may seek to acquire a wood distributor or a furniture manufacturer.
*   **Forward Integration:** A company expands control of the distribution process and sale of its finished products with [forward integration](https://www.investopedia.com/terms/f/forwardintegration.asp). A clothing manufacturer who sells its finished products to a [middleman](https://www.investopedia.com/terms/m/middleman.asp), who then sells them in smaller batches to individual retailers may join a retailer and be able to open stores. Forward integration is less common because it is often more difficult for companies to acquire others along the supply chain. For example, the largest retailers at the end of the supply chain have the greatest [capital on hand to be the acquirer](https://www.investopedia.com/ask/answers/041415/what-are-disadvantages-backward-integration-midsized-business-seeking-expand.asp).
*   **Balanced Integration:** A company [merges](https://www.investopedia.com/terms/m/merger.asp) with companies both before it and after it along the supply chain. A company must be the middleman and manufacture a product in balanced integration. Consider the supply chain process for Coca-Cola ([KO](https://www.investopedia.com/markets/quote?tvwidgetsymbol=KO)) where raw materials are sourced, the beverage is made, and bottled drinks are distributed for sale. Should Coca-Cola merge with its raw material providers and retailers that sell the product, the company engages in balanced integration. Due to the [diversified](https://www.investopedia.com/investing/importance-diversification/) nature of business operations, balanced integration helps a company control the entire supply chain process.

> **Important**
>
> Although vertical integration can reduce costs and create a more efficient supply chain, the capital expenditures involved can be significant.

## Advantages and Disadvantages of Vertical Integration

Vertical integration helps companies gain greater control over the supply chain and manufacturing process, leading to lower costs, [economies of scale](https://www.investopedia.com/terms/e/economiesofscale.asp), and less reliance on external parties. Through vertical integration, companies can circumnavigate external monopolies.

Companies that vertically integrate begin a long-term process that requires widespread buy-in. This also includes heavy upfront [capital expenditure](https://www.investopedia.com/terms/c/capitalexpenditure.asp) requirements to acquire the proper company, integrate new and existing systems, and ensure that staff is trained across the manufacturing or delivery process.

Because companies commit capital to a specific process or product instead of an external [vendor](https://www.investopedia.com/terms/v/vendor.asp), a company will likely have committed money that cannot be easily recovered. In addition, a company may lose the opportunity to [gain unique knowledge through different external vendors](https://www.investopedia.com/ask/answers/032415/when-outsourcing-preferable-vertical-integration.asp).

Pros

*   Long-term cost saving due to favorable pricing and minimal supply chain disruptions
    
*   Economies of scale, which increase efficiency
    
*   Reduces or eliminates the need to rely on external parties/suppliers
    
*   Greater control over the product, inputs, and process, which may lead to superior products
    

Cons

*   Requires large upfront capital requirements to implement
    
*   Reduces a company’s long-term flexibility
    
*   Loss of focus on a company’s primary objective or customer
    
*   Displeased customer base that would prefer to work with smaller retailer
    

## Vertical Integration vs. Horizontal Integration

Vertical integration involves [acquiring](https://www.investopedia.com/terms/a/acquisition.asp) a key component of the supply chain that the company has previously contracted for. It may reduce the company’s costs and give it greater control of its products. Ultimately, it can increase the company’s profits.

[Horizontal integration](https://www.investopedia.com/terms/h/horizontalintegration.asp), on the other hand, involves the acquisition of a competitor or related business. A company may do this to eliminate a rival, diversify its core business, expand into new markets, or increase its overall sales.

While a vertical integration strategy stretches a company along a single process, horizontal integration is a more pointed approach that causes a company to become more specific or niche within a certain market.

## Examples of Vertical Integration

Netflix ([NFLX](https://www.investopedia.com/markets/quote?tvwidgetsymbol=NFLX)) is an example of vertical integration. The company started as a DVD rental business before moving into online streaming of films and movies licensed from major studios. As of 2024, the company uses its distribution model to promote its original content alongside programming licensed by studios.

The merger of Live Nation and Ticketmaster in 2010 created a vertically integrated entertainment company that manages and represents artists, produces shows, and sells event tickets. The combined entity manages and owns concert venues, while also selling tickets to the events at those venues.

The fossil fuel industry is another case study in vertical integration. British Petroleum ([BP](https://www.investopedia.com/markets/quote?tvwidgetsymbol=BP)) and Shell ([SHEL](https://www.investopedia.com/markets/quote?tvwidgetsymbol=SHEL)) have exploration divisions that seek new sources of oil and subsidiaries that are devoted to extracting and refining it. Their transportation divisions transport the finished product. Their retail divisions operate the gas stations that deliver their product.

## Explain Like I'm Five

Vertical integration is a strategy where a company buys up multiple businesses at different stages of its supply chain. For example, a restaurant might buy a farm to ensure a steady supply of produce, or an oil company might buy a shipping company for transportation.

Vertical integration allows companies to reduce their costs and streamline their operations. Instead of buying necessary materials on the open market, they act as their own suppliers and take control over the production process.

## When Is an Acquisition Considered Vertical Integration?

An acquisition is an example of vertical integration if it results in the company’s direct control over a key piece of its production or distribution process that had previously been outsourced.

## Is Vertical Integration Good for a Company?

Whether vertical integration makes sense for a company depends on what’s good for it in the long run. For example, if a company makes clothing with buttons, it can either buy the buttons or make them in-house. The latter eliminates the markup charged by the button maker and any frustrations in dealing with the supplier, and may give the company greater flexibility to change styles or colors as they please.  

## Why Do Companies Use Vertical Integration?

Companies use vertical integration to gain control over the supply chain of a manufacturing or distribution process. By taking certain steps in-house, the manufacturer can control the timing, process, and aspects of additional stages of development. Owning more of the process may also result in long-term cost savings.

## The Bottom Line

Vertical integration is a business arrangement in which a company controls different stages along the supply chain. Instead of relying on external suppliers, the company strives to bring production processes in-house. Though vertical integration may result in increased upfront capital outlays, the goal is to streamline processes for more efficient and controlled operations in the long term.

> **Article Sources**
>
> 1.  U.S. Securities and Exchange Commission. “[Form 10-K for the Fiscal Year Ended December 31, 2023: Netflix, Inc.](https://d18rn0p25nwr6d.cloudfront.net/CIK-0001065280/c5e64982-659f-4726-97c9-c57767c3bec3.pdf),” Page 28.
>     
> 2.  U.S. Securities and Exchange Commission. “[Live Nation and Ticketmaster Entertainment Complete Merger](https://www.sec.gov/Archives/edgar/data/1335258/000119312510012287/dex991.htm).”
>     
> 3.  Shell. "[At a Glance](https://www.shell.com/who-we-are/shell-at-a-glance.html#iframe=L3doby13ZS1hcmUvc2hlbGwtYXQtYS1nbGFuY2UvX2pjcl9jb250ZW50L3Jvb3QvbWFpbi9zZWN0aW9uL3dlYl9jb21wb25lbnQvbGlua3MvaXRlbTAuc3RyZWFtLzE3MTA5NDk2MDAyODAvOWE5YmU0OTQ5NGNkZTRkZWVmYmIyNGU3ZjU2YWQwN2U3NWVlNzEzMi9pbmRleC5odG1s)."
>     
> 4.  British Petroleum. "[Inside Integrated Energy](https://www.bp.com/en/global/corporate/what-we-do/our-strategy/the-value-of-integration.html)."