The decision to vertically integrate or outsource depends on the nature of the business activities and the industry the business is operating in. It's advised that companies that decide to outsource also hire a lawyer to review (and possibly amend) the terms of the contract. Chapter 19 - Vertical Integration And Outsourcing CHAPTER 19 VERTICAL INTEGRATION AND OUTSOURCING CHAPTER SUMMARY This chapter analyzes the vertical boundaries of the firm. Parts where shipping and handling costs between vendors is significant can be good candidates for vertical integration at … Companies decide to outsource to reduce the costs of their operations or to increase their efficiency. Outsourcing is the business practice of hiring another company to be responsible for a business activity that could be done internally. Vertical integration, especially if coupled with co-location, can provide significant cost benefits in the form of reduced material related overhead. Vertical integration expands the presence and influence of your business, while outsourcing involves contracting some of your business operations to external service providers. Outsourcing vs. Subcontracting: An Overview . How is Zara organized with respect to its vertical integration and outsourcing decisions? Instead, the reversal results from outsourcing to a vertically integrated retail rival. Horizontal integration is the process of acquiring and merging with industry comeptitiors to achieve competitive advantage that arise from a large size & scope operation The most obvious advantage of vertically integrating is that the strategy saves a company money, and those savings can be passed onto the consumer in the form of lower prices. Zara mainly targets on young and urban female customers and acceptable prices are offered (Christopher 2005 p58) There are always new products in Zara stores… Companies like GAP, Victoria’s Secret, Old Navy, Zara etc are all vertical operations. It involves going up or going down the supply chain. Also, the time and investment required to maintain these operations can reduce the nimbleness of a company. In some cases, it's in the best interest of companies to outsource—and rely on the expertise of others—rather than make the decision to vertically integrate. Vertical disintegration and the outsourcing of production One of the key SCM trends within the mid-market high street sector has been the vertical disintegration and outsourcing of the production function to a global network of independent subcontractors, usually within lower labour cost countries. A company can avoid paying the salaries, benefits, and payroll taxes of additional employees if they outsource the tasks. Plus, you have more flexibility and time to focus on the core aspects of your business and how to make them more efficient. Business executives often blur the line between outsourcing and subcontracting; however, in reality, the two practices are quite distinct. By using Investopedia, you accept our. Vertical integration is a business strategy in which a company acquires or has control over the operations of its suppliers, distributors, or retail stores in order to control its supply chain, reduce costs, and improve efficiency. Outsourcing is a practice used by different companies to reduce costs by transferring portions of work to outside suppliers rather than completing it internally. Vertical integration allows you to perform additional functions in the chain of production. ¾ The EU clothing industry was chosen to broader explain what theories missed. The most significant advantage of vertical integration is avoiding any supply disruptions. Businesses within the retail industry are rolling out vertical integration supply chain models to keep up with fast fashion. There are four stages of the supply chain: A company has vertically integrated when it controls two or more of these stages. ... Products in this industry … The expansion of free trade – Strategic concentration is a key issue for manufacturing companies when designing a supply chain. Another problem companies that attempt vertical integration can encounter is the different skill sets required to run a company that ranges from retail to factory operations. Learn what the style entails, what the benefits are and follow with us … Vertical integration occurs when two firms at different stages of production merge. Thesis and Introduction 1.1 Thesis 1.2 Purpose 1.3 Introduction into the topic 2. Businesses within the retail industry are rolling out vertical integration supply chain models to keep up with fast fashion. Threats over quality Quality maintenance is the first need for every fashion sector to excel, and any compromise on quality can bring down the business. This allows you to concentrate on the core aspects of your business, enhance efficiency and cut operational costs. Hello! While vertical integration offers many advantages, the process is time-consuming and expensive in practice, and outsourcing can also provide a competitive advantage for a business. Strategic Management Insight: Vertical Integration, Time: How Apple Made "Vertical Integration" Hot Again -- Too Hot Maybe. In a perfect world, vertical integration is considered ideal because it reduces your operating costs. Opponents of outsourcing claim that it results in a loss of domestic jobs. Many apparel retailers outsource their production to Asian factories. The reason for adopting a vertical integration strategy or an outsourcing strategy is to make a business's operations more efficient. In the model economy, an industrial structure emerges as the result of optimal investment decisions that firms undertake under uncertainty. Methodology and Justification of Sections 4. Globalization is the spread of products, investment, and technology across national borders and cultures. Financing is the process of providing funds for business activities, making purchases, or investing. Published, 3 years ago. When making the decision to outsource, a company should always take extra steps to make sure that their data is protected. In business terms, we know that vertical integration refers to the consolidation of all business operations but reducing the need for outsourcing and managing activities in-house. Plus, you will always be tied to the financial well-being of any company that you outsource to. ... but this often resulted in “fashion misses”, while Zara, through its responsive supply chain strategy, is able to produce and deliver styles that capitalize on what the customers are looking for. A company that is vertically integrated can avoid suppliers with a lot of market power. For others, outsourcing is the most viable approach. Backward integration is a type of vertical integration that includes the purchase of, or merger with, suppliers. This eliminates middle men in your supply chain by expanding your activities in the supply chain. For example, many companies in the U.S. have outsourced their customer service centers to lower-cost locations. An additional disadvantage of outsourcing is that confidentiality can be compromised when you release certain documents to another company. Vertical integration to be distinguished from horizontal integration Horizontal integration is the addition of other business activities at the same level of the value chain. Vertical integration is a strategy where a firm acquires business operations within the same production vertical, which can be forward or backward in nature. It allows you to invest in assets that are highly specialized. Outsourcing makes the most sense in industries where the cost of labor and capital resources is high. Zara is a Spanish fashion clothing manufacturer and retailer, formed in the 1970’s It is known that only two weeks are required for Zara to complete the development and shipment of a new product to its stores, which outweighs the average of fashion industry of six months, thanks to the collaborative relationship with customers and suppliers. In business terms, we know that vertical integration refers to the consolidation of all business operations but reducing the need for outsourcing and managing activities in-house. ZARA’s core competitiveness lies in the model used by it, called Vertical Integration. Keywords: Vertical integration, Outsourcing, Transaction cost 1. However, logistics and supply chain management stands out as one industry where you can effectively adopt vertical integration, because vertical integration elevates your operation to different levels of your supply chain. How to Maximize Your Profit in a Multinational Corporation. Why Has Supply Chain Management Become Such an Important Topic? The viability of vertical integration is not limited to any specific industry. 1 RomÆn Fossati2 Department of Economics University of Bristol September 2012 Abstract: Empirical evidence shows that vertically integrated producers are more productive, bigger and are matched to better suppliers (with high productivity and size). The offers that appear in this table are from partnerships from which Investopedia receives compensation. The challenge for small and medium-sized companies is that the initial process of vertical integration requires a significant investment of resources. This way, you get to supply your dogs directly to customers seeking trained dogs, rather than supplying the dogs to dog trainers. For example, it may be more appropriate to outsource the storage and warehousing functions of your cargo haulage business than to maintain a network of your own stores and warehouses. Vertical Integration vs. Outsourcing “Following the Crowd” Collaboration issues in an SCM context Table of Content 1. The capital required to set up or buy factories or acquire retail stores, plus the costs of maintaining those operations after the fact, can be prohibitive for many companies. Only the EU clothing industry was studied since both firms home countries, Sweden and Spain are members of the EU. Outsourcing is ideal for industries, such as manufacturing, that require huge work force and capital resources. For some companies, vertical integration will give them a competitive edge. This strategy makes it possible for an agency to control or own its distributors, suppliers, and retail locations to control the supply chain or its overall value. When you outsource parts of your business, you can avoid the cost of expensive equipment and machinery. ¾ When the business-models of H&M and ZARA are mentioned, we mean the fact that H&M focuses on outsourcing while ZARA focuses on in-house production. However, a business can provide a contract service to another business without necessarily insourcing that business process. Finding leadership that is well-versed in all of these industries can be challenging. Inditex’s closest comparable competitors had narrower vertical scope than Inditex but outsourced all productions. Financing: What It Means and Why It Matters, What You Should Know Operating Activities. You cannot tie down outsourcing to any particular industry because it is applicable across different sectors. Many apparel retailers outsource their production to Asian factories. The current paper presents a dynamic stochastic model of an industry with heterogeneous firms that interact as buyers and sellers and endogenizes the vertical integration and outsourcing of firms. Suppliers can be unreliable if they are poorly-run. These cultural differences can lead to conflict and low productivity. Finally, if a company outsources to a business outside of the U.S., there is the potential for communication barriers or cultural conflicts. It begins by defining the vertical chain of production. Suppliers are also sometimes impacted by labor strikes or disputes. For example, you may opt to process dog food for your dog breeding business instead of buying processed foods from veterinary suppliers. ZARA’s core competitiveness lies in the model used by it, called Vertical Integration. The benefits of acquiring inputs through competitive markets (when they exist) is stressed. It begins by defining the vertical chain of production. The findings support the cost-driven concern of the decisions on vertical integration level changes and certain performance benefits that the changes would bring to the companies. A larger company can purchase items in bulk and also reduce their fixed costs by consolidating management. Adoption of efficient operations structures enhances the competitive profile of your business. You can outsource functions such as payroll, information technology, research and development and customer care services. Vertical integration is typically the preferred strategy for long-term business growth and development. If the company is operating in a different time zone, it's possible that your business "partner" will be working while you are sleeping because your business hours are different. Control over different stages of production becomes a barrier to entry. Research on the global fashion industry predicts an increase from ‘$481.2 billion in 2018 to $712.9 billion by 2022’. After decades of focusing on specialization and outsourcing to maximize profits, food and beverage companies are now extending their expertise up and down the supply chain through vertical integration. Outsourcing versus Vertical Integration: A Dynamic Model of Industry Equilibrium. Inditex’s closest comparable competitors had narrower vertical scope than Inditex but outsourced all productions. Outsourcing entails giving out different business operations to companies that specialize in providing these services. Vertical integration can give you a great advantage over your competitors, allowing you to invest and develop the products that you are currently offering. Outsourcing entails giving out noncore, process-intensive or capital-demanding operations to companies that specialize in providing these services. An obvious disadvantage of outsourcing is that you are turning over control of some of the management of your company to another company. These are completely different economic phenomena. How Can a Production Plant Increase Sales & Reduce Costs? In apparel, a vertical manufacturer is one who produces and sells their own stuff. Inditex’s unique business model mainly focuses on vertical integration and in-house production, while at the same time outsourcing is becoming a popular trend in clothing industry. Vertical disintegration and the outsourcing of production One of the key SCM trends within the mid-market high street sector has been the vertical disintegration and outsourcing of the production function to a global network of independent subcontractors, usually within lower labour cost countries. For instance, backward vertical integration makes you a supplier of your raw materials, while forward integration grants you greater roles in the production and distribution activities of your industry’s supply chain. Vertical integration is hard to implement. He has been working as a senior accountant for leading multinational firms in Europe and Asia since 2007. As such, you can raise your share within the market and s… Chapter 19 - Vertical Integration And Outsourcing CHAPTER 19 VERTICAL INTEGRATION AND OUTSOURCING CHAPTER SUMMARY This chapter analyzes the vertical boundaries of the firm. Nonetheless, the strategy is viable across many other industries for as long as it fits with your overall business strategy. You can apply it in any industry depending on the goals you want to achieve. Companies that outsource get to benefit from the differences in labor and production costs in other countries. With the huge increase of freelancers and small businesses in the UK it is not surprising that outsourcing is a quickly growing industry. Example of vertical integration. Proponents of outsourcing argue that it encourages businesses to allocate resources where they are the most cost-efficient. The expansion of free trade Vertical integration is the combination of two or more production stages in one company that normally operate out of separate organizations. Backward vertical integration prevails when you extend the scope of your production activities toward the sources of your raw materials. vertical integration or insourcing bringing business processes or activities previously conducted by outside companies in-house -companies that participate in many or all stages of the industry value change from exploration to final sale are highly vertically integrated For example, the high cost of maintaining a workforce and the expensive machinery required in the manufacturing industry means that outsourcing is often applied by manufacturing companies. Tier 1 suppliers appear the most vulnerable to Boeing’s push for vertical integration, as the strategy results in more consolidation in the industry. 6. In addition, if a company is reliant on a supplier that has a monopoly in the industry, that supplier will be able to dictate the terms (which could mean setting higher rates). If another company has access to your payroll documents, medical records, or any other documents with proprietary company data, you may be risking leaks of information. The biggest disadvantage of vertical integration is the upfront costs. In addition, the outsourcing company will be the one to create a contract for their services. Vertical integration is merging different types of business that represent different stages of production. CiteSeerX - Document Details (Isaac Councill, Lee Giles, Pradeep Teregowda): Deficiencies in existing theories used to explain outsourcing activities, often stem from the fact that the underlying incentives and constraints are far more complex than what these theories presume. One advantage of outsourcing is that you can trust that the outsourcing company is an expert in the service that it is providing. Innovative technologies are a direct contributor to this progression, as they help companies create ‘experiential eCommerce’ for shoppers. There may be hidden costs that are not immediately apparent if you don't have an accurate understanding of the contract's terms. What Is a Vertically Integrated Business Model? Inditex’s unique business model mainly focuses on vertical integration and in-house production, while at the same time outsourcing is becoming a popular trend in clothing industry. 5. Logical Problems and Sub-questions 3. By being able to acquire highly specialized assets, you will be able to differentiate your business from the rest of your industry, with a highly competitive advantage. For example, they may lack the flexibility to follow consumer trends and introduce products to the market that would have to be produced outside of their factories. Vertical integration is a supply chain management style that many businesses decide to use. https://strategicmanagementinsight.com/topics/vertical-integration.html Baseline: Is Outsourcing Losing Its Appeal? Similarly, if you are outsourcing certain aspects of production, you can avoid the investment of purchasing expensive equipment. Learn what the style entails, what the benefits are and follow with us … Traditionally, auto manufacturers outsource seat production due to high labor and design costs; in contrast, Tesla created their own seat assembly line in a “commitment to a vertical integration strategy not seen in the auto industry for decades” [7]. Outsourcing makes the most sense in industries where the cost of labor and capital resources are high and is usually the best choice for young businesses that cannot afford the high costs associated with implementing vertical integration. choices on the change of vertical integration level and the performance implication of such changes. Example of a Vertical Integration vs. Outsourcing Industry. Outsourcing spares you the burden of acquiring costly equipment, machinery or license rights to expensive software products. Vertical integration and outsourcing are some of the viable approaches for advancing your competitive edge. Horizontal integration and vertical integration are competitive strategies that companies use … In recent years, outsourcing has become controversial. The company you outsource to may not have the same standards as your company, and they will be driven primarily by making a profit. The opposite of outsourcing is called insourcing, which entails bringing processes handled by third-party firms in-house, and is sometimes accomplished via vertical integration. Outsourcing, vertical integration, and price vs. quantity competition ... Bertrand competition can produce higher prices, higher industry profit, lower consumer surplus, and lower total surplus than Cournot competition. 1. The suitability of vertical integration and outsourcing depends on the nature of your activities and industry of specialization. If a company had to train its own staff to perform that same task, there would be a transitional period when the service was not being performed to the expected standard. Outsourcing allows companies to focus on streamlining their daily operations and encourages international business and trade. What Is Forward Vertical Integration in Business? Vertical integration is merging different types of business that represent different stages of production. Paul Cole-Ingait is a professional accountant and financial advisor. Similarly, the type of employee that is attracted to working at a retail business can be very different than the type of employee that works at a factory. For instance, you may choose to incorporate dog training in your dog breeding business. Vertical integration to be distinguished from horizontal integration Horizontal integration is the addition of other business activities at the same level of the value chain. Some functions that companies may decide to outsource include payroll, information technology, research and development, and customer care services. Outsourcing versus Vertical Integration: A Dynamic Model of Industry Equilibrium. At the end of the day, this can increase efficiency. Innovative technologies are a direct contributor to this progression, as they help companies create ‘experiential eCommerce’ for shoppers. As a result, outsourcing is a more favorable option in some situations. Operating activities are those that pertain to a company's core business activities, such as manufacturing, distributing, marketing and selling a service. A retail company that is vertically-integrated can also identify popular brand-name items and make "knock-off," store-brand items with the same ingredients and manufacturing process, and offer them to consumers at a lower price. When it comes to labor costs, outsourcing helps you streamline your work force, as contracting firms remain responsible for the welfare of their own employees. Stages in the Process of Starting a New Business. Vertical integration is a risky strategy because it is complex and expensive. An additional benefit of outsourcing certain services is that you have a new partner in business. 1 RomÆn Fossati2 Department of Economics University of Bristol September 2012 Abstract: Empirical evidence shows that vertically integrated producers are more productive, bigger and are matched to better suppliers (with high productivity and size). Adoption of efficient operations structures enhances the competitive profile of your business. The Role of Operations in Organizational Effectiveness. However, it mostly applied in industries that incur huge costs of labor and capital resources. ... it could charge high prices to any new firm trying to enter the supermarket industry. Forward integration occurs when you take up roles that are closer to the final consumers in the supply chain. Over time, most companies save money and increase quality by implementing vertical integration. If that company goes bankrupt, you will be left paying the price. Investopedia uses cookies to provide you with a great user experience. Hello! Outsourcing vs vertical integration James R. Markusen and Yiqing Xie One thing that comes up repeatedly in the international business literature is that multinational firms (with owned foreign subsidiaries) are intensive in what we now broadly refer to as knowledge-based assets or capital. Companies use outsourcing to reduce labor costs, lower their business expenses, and to focus on the core aspects of the business. Outsourcing and the Fashion Industry. It isn’t simple. Horizontal integration is the process of acquiring and merging with industry comeptitiors to achieve competitive advantage that arise from a large size & scope operation Vertical integration requires companies to get involved in new aspects of the supply chain where they are usually unfamiliar. These are completely different economic phenomena. In addition, it can cost less to pay an outsourcing company to perform certain services than to employ several individuals to do the same job. Vertical integration is a supply chain management style that many businesses decide to use. Another advantage of vertical integration is lowering per-unit costs. The benefits of acquiring inputs through competitive markets (when they exist) is stressed. Horizontal vs. Vertical Integration: An Overview . Fashion industry excels when the agents have a knowhow of latest trends, and thus outsourcing to specialists, outsourcing is necessary. Outsourcing makes the most sense in industries where the cost of labor and capital resources are high and is usually the best choice for young … Outsourcing is present under both vertical separation and vertical integration, and the standard conclusions prevail under vertical separation. Cole-Ingait holds a Bachelor of Science Degree in accounting and finance and Master of Business Administration degree from the University of Birmingham. Literature Review 4.1 Literature Concerning the Terminology However, the process of implementing vertical integration is time-consuming and expensive in practice. As a corporate strategy and a supply chain governance strategy, vertical integration relates to organisational economics and strategic supply chain management. Research on the global fashion industry predicts an increase from ‘$481.2 billion in 2018 to $712.9 billion by 2022’. New forward or backward vertical integration efforts may require building new facilities, hiring new staff, and understanding new processes that are unfamiliar to the corporation. Vertical integration expands the presence and influence of your business, while outsourcing involves contracting some of your business operations to external service providers. 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