Vertical Integration

Define the term ‘Vertical integration’

When a business expands by taking control of other parts of the supply chain.

Define the term ‘Backwards-vertical integration’

When a business takes control of a business that is earlier within the supply chain and further away from the end consumer.

• Better access to raw materials

• Lower costs and improved quality of goods

Give an example of backwards-vertical integration

In 2026, Meta’s acquisition of nuclear startups to power their AI, means that instead of relying on third-party power suppliers, Meta can now scale their AI at their own pace. This is highly significant in an industry as fast-scaling as AI. This allows Meta to minimise its intermediary costs given that it has acquisitions earlier in the production process, meaning that it no longer has to pay third-party nuclear suppliers their fees.

Analysis:

This decreases Meta’s AC and MC. Assuming, Meta is a profit-maximising firm this will lower the price of its AI services from P1 to P2, in order to become more price competitive relative to competitors such as OpenAI and Alphabet. This will lead to an increase in Meta’s output from Q1 to Q2, meaning that meta will make significant levels of supernormal profits of (P2-C2) x Q2. These supernormal profits provide Meta with greater retained earnings to reinvest in R&D and the development of more advanced AI models. This increase in dynamic efficiency may lead to improvements in consumer welfare, as consumers may benefit from improvements in the quality and capabilities of Meta’s AI services, in the long-run.

Define the term ‘Fowards-vertical integration’

When a business takes control of a business that is later within the supply chain and closer to the end consumer.

• Control how products are sold

• Improved brand image & profit margins

Give an example of Foward-vertical integration

In 2017, Amazon an e-commerce and tech giant acquired the whole foods market via foward vertical integration. This allowed them to enter the brick and mortar retail space and expand its reach into the grocery industry.

What are the pros of vertical integration?

• Helps take control of the supply chain and prevent competition. For instance, if a nuclear power plant acquired a uranium mine, it could refuse to sell uranium to other power plants, preventing them from competing. If an electricity-producer buys a power grid, it can now prevent competitor firms from entering the market, by refusing to let them use the power grid. So the power plant and electricity producer will take over their markets, increasing sales and profit.

• Reduce intermediary costs like transport costs and markups. This will reduce a firm’s costs and increasing profits.

• Improves access to consumers and raw materials. Vertically integrated forward helps receive customer feedback directly, so a firm can improve its product, increase sales and increase profit. Vertically integrated backward means a firm is earlier within the supply chain, improving access to RM’s. This allows them to control quality, improving its final product’s quality, increasing sales and profit.

What are the Cons of vertical integration?

• Could lead to regulation if it prevents competition. Energy regulator Ofgem banned energy producers from vertically integrating with power grids. Firms may also be forced to pay penalties as high as 10% of annual turnover. This will increase firms’ costs, reducing profit.

• Increased Costs from diseconomies of scale and acquisitions. Ebay spent $1.5bn in acquisition to purchase paypal

• May lack expertise: If a firm integrates into a stage of the production process it has a lack of information about, it won’t know how to organise production, decreasing productive efficiency > increasing costs > decreasing profits.