Vertical integration is a risky strategy—complex, expensive, and hard to reverse. Yet some companies jump into it without an adequate analysis of the risks. This article develops a framework to help managers decide when it is useful to vertically integrate and when it is not. It examines four common reasons to integrate and warns managers against a number of other, spurious reasons. The primary message: don't vertically integrate unless it is absolutely necessary to create or protect value.
Vertical integration can be a highly important strategy, but it is notoriously difficult to implement successfully and—when it turns out to be the wrong strategy—costly to fix. Management's track record on vertical integration decisions is not good.1 This article is intended to help managers make better integration decisions. It discusses when to vertically integrate, when not to integrate, and when to use alternative, quasi-integration strategies. Finally, it presents a framework for making the decision.
When to integrate
"Vertical integration" is simply a means of coordinating the different stages of an industry chain when bilateral trading is not beneficial. Consider hot-metal production and steel making, two stages in the traditional steel industry chain. Hot metal is produced in blast furnaces, tapped...