Supply Chain Management - The Vertical Integration Decision

What are the scenarios where vertical integration of the supply chain is a good solution?

Well as it turns out, there are very heavy capacity implications when making acquisition decisions up the chain. Each layer of the supply chain adds value (and challenges) in unique ways. What are the key metrics for creating a compelling case for vertical integration? If your organization:

• needs more control over your supply chain management (planning, synchronization, JIT inventory practices)
  
• requires a greater degree of customization not currently available through third parties
• has the capacity demand to generate your own economies of scale (lower costs)
  
• can experience growth and efficiency and capture synergies in the new vertical integration
  

Conversely, in a scenario where an organization has too much capacity or cannot maximize the benefits of a division, rather than shut down it down, they can also sell of capacity to other organizations who can make more efficient use of those resources or spin it off.

Vertical integration can either be backwards (up the supply chain) to encompass inputs or forwards (down the supply chain) to encompass distribution channels.

What are the challenges to vertical integration? Each layer reflects a value added component and therefore is fraught with its unique challenges such as market sizing, competitiveness, industry regulations etc.

However, as a word of caution companies that do forward integrations (cutting out the "middle man") are often in danger of venturing into unknown territory as well as damaging relationships with other distributors (who can see this move by a company as repositioning from cooperative to competitive). This is exactly what happened between Harlequin and Simon & Schuster in the late 70's.

[Case Study] Today, Pepsi Co has put a set a $6 billion bid to acquire two of it's largest independent bottlers for Pepsi Bottling Group and Pepsi Americas. In this particular case, the decision for vertical acquisitions was driven by the need to gain a strategic advantage through controlling over 80% of their distribution. Each of the acquired companies shares are currently valued at 17% over their Friday closing price.