What is vertical integration? How Best Buy and Starbucks use vertical integration? What are the benefits to vertical integration and who is it not good for?
You might not know what vertical integration is, but chances are you use it every day.
Maybe you stopped in a Starbucks recently and bought a cup of coffee. If you did that and you purchased a CD while you were there, or a pack of mints, you've used a form of vertical integration.
What is vertical integration?
Vertical integration is a process to companies use to help gain more business. When a company is making money and they want to increase their profits, (make more money), they look for ways to add more businesses into their parent company. This would be something that could happen if Pizza Hut merged with Pepsi to ensure that they could sell sodas and pizza together. The process of vertical integration is a little bit more in depth. Let's take a look at the example of Best Buy.
How Best Buy uses vertical integration
Have you ever gone into Best Buy to purchase a computer? Maybe you bought a computer at Best Buy when it was on sale, but you had problems with it later on.
Best Buy has a feature department called the Geek Squad where you can have IT support work on your computer. This is an on-site facility that they've used, where they outsource (hire staff outside of their company staff) technicians. That means they let technicians work alongside their employees in their stores. When they do this, not only are they selling your products like tablets, phones, and computers, but they're also selling you a service if you need repairs on your equipment. That's an example of vertical integration.
What are the benefits to vertical integration?
When a company uses vertical integration, they're looking for ways to increase manufacturing or production and decrease costs. What that means is they want to make more money, but they want to have to do less to get it done. In our Best Buy example, by renting out space to the Geek Squad techs, they're letting people come in who can service equipment and they make money on that. This cuts down on them having to send your equipment out to be repaired. It also means the turnaround time is better so the time frame to when you get your computer back would be shorter.
Remember that cup of coffee that we mentioned back at Starbucks? If you buy coffee beans at Starbucks, you're using vertical integration. If you go in for coffee and to use your computer, in addition to the music, you are using their wi-fi. You are utilizing other services that they have into one store. Even if you buy a gift card while you’re at Starbucks, this is a form of vertical integration.
What you’re doing is purchasing products of one store that you could get elsewhere. You could be going to Starbucks for coffee, the library for internet access and a card store for gift cards. That's why in some stores, you see so much of a variety on the shelves that might not even be related to coffee!
They know that as they have a limited window in between when you stop in at a store versus when you leave, so they have to try to sell you a variety of products. There are other benefits to vertical integration.
Have you ever heard of farm to table restaurants?
Restaurants that grow their own produce and animals are considered farm to table. They raise the animals they cook and grow their own vegetables. They can sell restaurant quality food in the restaurant that is food that they have prepared there on-site. What that means is they don't have to call ahead and say “Hey, we're out of radishes and carrots!” All they have to do is go in their backyard. The reason this is beneficial to them is it's saving them from having to hire someone to go in a truck and go across town to get the vegetables. They also don't have to store them because they're making them fresh.
Should I use for vertical integration for my business?
That's a good question. If you're thinking about it, ask yourself these questions:
- Are there supplies that I order that I can make myself?
- Is there a way to set up a factory or plant so that it on-site (here) and we don't have to have it shipped?
- How can we save costs in transportation?
Because your answer will vary depending on the type of company you have, vertical integration may or may not work for you.
Who is vertical integration not good for?
If you had a furniture company that made really expensive furniture that you ordered from all over the world, vertical integration might not work for you. That's because you may have different places and different plants that assembled your products. For example, you might order the silk fabric from Thailand, you may have the upholstery done in China. You may even have the actual manufacturing done someplace else.
That's why car companies are able to use vertical integration. They have assembly plants where they can do everything in one place.
The next time you're in Starbucks, or even Best Buy or Target for that matter, remember to look around at the products they have. Ask yourself what products they have that they probably couldn't make on-site. When you look at a Target store, for example, you might not think that they're making their own products, but they are. Companies like Target and Wal-Mart make a lot of their own merchandise under different parent company names. To sell them to you, they just change the name. They know a lot of people don't want the Target brand because they might think it sounds generic or cheap.
They give their products different names such as Delish, so when you go to buy cookies, candies or ketchup in Target, if you see this brand, they own it and still get the money.
Lastly, you want to remember that vertical integration is about strategy. You have to strategically think about what can be produced and made closer to home to save money! So go get that coffee and your Delish cookies and strategize!
Reference:
http://www.investopedia.com/terms/v/verticalintegration.asp
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