Businesses that operate at one level – manufacturing, for example – may find themselves at the mercy of economic conditions if their source of supplies dry up. Likewise, if retailers decide to carry the products of competing companies, they will lose market share and profitability. Vertical integration can be an effective way for a firm of any size to gain control over the whims of the marketplace.
Vertical integration is the control of multiple levels of a product’s supply chain. In a three-tier model – manufacture, wholesale and retail – vertical integration occurs if a firm controls two or more levels. There are numerous benefits to vertical integration. A vertically-integrated firm assures itself of steady access to critical materials, quality manufacturing procedures and dependable distribution outlets. The downside of vertical integration is the risk of too much bureaucracy needed to coordinate activities and maintain efficiency at different levels, Vertical integration can be achieved through mergers and acquisitions or by internal growth.
Zara, a Spanish clothing and accessory company, has more than 1,000 outlets worldwide. The secret to their success is vertical integration – from design to manufacture to retail. Unlike companies like Gap and H&M that purchase their clothes from suppliers, Zara makes most of its own. Sixty percent of its goods are made in house. This helps the company manage its inventory with extreme efficiency. It also allows the company to respond to seasonal and fashion changes very quickly. While Gap and H&M may take up to nine months to introduce a new line of clothing, Zara can do it in two to three weeks. The firm can respond quickly to any market contingency.
Luxottica may not be a familiar name to many, but almost everyone would recognize its brands and subsidiaries like Ray-Ban, Oakley, Sunglass Hut and LensCrafters. Luxottica, an Italian company, began as a small workshop, making components for the optical industry. Through the 1960s it grew vertically, so that by 1970 it was selling complete glasses to independent distributors. In the 1970s it began acquiring other firms, and it continued to expand internationally in the 1980s. In 1995 it bought U.S. Shoe Company to gain access to its LensCrafters subsidiary. Other acquisitions followed – Ray-Ban in 1999, Sunglass Hut in 2001 and Oakley in 2007. From manufacture to distribution to retail outlets, Luxottica has become a global vertically-integrated giant.
Some businesses are vertically integrated and remain on a comparatively small scale. Hilo's Seafood Restaurant in Hilo, Hawaii, was founded in 1921. Now under the management of the third generation, this family-run enterprise raises the fish it serves in its restaurant. Fish are raised from fingerlings, fed two to three times a day until they reach maturity in four to six years. By controlling the supply through good food and constant water turnover, the restaurant is able to insure quality. With an average of 200 fish cooked and sold each week, the restaurant is testimony to the benefits of vertical integration.