Page 124 - DCOM506_DMGT502_STRATEGIC_MANAGEMENT

Strategic Management

Notes Disadvantages of Vertical Integration: The following are the disadvantages of vertical integration
1. It boosts the firm’s capital investment.
2. It increases business risk.

3. It denies financial resources to more worthwhile pursuits.
4. It locks a firm into relying on its own in-house sources of supply.
5. It poses all kinds of capacity-matching problems.

6. It calls for radically different skills and capabilities, which may be lacked by the
manufacturer.

7. Outsourcing of component parts may be cheaper and less complicated than in-house
manufacturing.
Most of the world’s automakers, despite their expertise in automobile technology and
manufacturing, strongly feel that purchasing many of their key parts and components from
manufacturing specialists result in:

1. Higher quality
2. Lower costs

3. Greater design flexibility
So, they feel that vertical integration option is not preferable.
Weighing the Pros and Cons of Vertical Integration: All in all, vertical integration strategy can
have both strengths and weaknesses. The choice depends on:
1. Whether vertical integration can enhance the performance of the organisation in ways
that lower costs, build expertise or increase differentiation.

2. Whether vertical integrations impact on costs, flexibility, response times and
administrative costs of coordinating more activities, are more justified.
3. Whether vertical integration substantially enhances a company’s competitiveness.

If there are no solid benefits, vertical integration will not be an attractive strategic option. In
many cases, companies prefer to focus on a narrow scope of activities and rely on outsiders to
perform the remaining activities.
In today’s world of close working relationships with suppliers and distributors and with
efficient supply chain management systems, very few firms can make a case for backward
integration just for the purposes of ensuring a reliable supply of raw materials or components,
or to reduce production costs.

Guidelines for Vertical Integration: The guidelines for vertical integration are as follows:
1. If the performance of suppliers or distributors is satisfactory, it is not appropriate to
take over these activities.

2. Highly fluctuating sales or demand for the products of the organisation can either strain
resources (when demand is high) or result in unutilized capacity (when demand is low).
The cycle of “boom and bust” is not conducive to integration.
3. The strategy of vertical integration may be viable if there is a likelihood of expansion of
capacity in the near future.

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