What is Vertical Combination?
In the words of Prof. Robinson, “Vertical combination is the combination of firms in successive stages of the same industry.”
In the case of vertical combination, several independent businesses operating in successive stages in the same industry come together. It is also known as sequence combination, process combination or industry combination.
It is the combination of firms which are dependent on each other – the finished product of one being the raw material for another. For e.g. a spinning mill combining with a ready made garment manufacturer, an iron and steel company combining with an iron ore mining company etc. These type of combinations are formed in case of industries where raw material has to pass through various processes before it is converted into a finished product such as cotton textile industry.
In the case of cotton textiles, the raw material has to pass through the processes such as ginning, spinning, weaving and dyeing before it is converted into cloth By combining, they become an independent industry, self sufficient in raw material for each process and producing the final product. Tata Tea which owns tea estates, Tata Iron and Steel Company which owns iron ore mines are instances of vertical combination
Types of Vertical combination in business
Vertical combination is of two types. They are:
- Backward integration and
- Forward integration.
1. Backward Integration
Backward integration implies going to the source of raw materials. It involves setting up or acquiring facilities or organizations for production of raw materials and components to ensure smooth production.
Nirma has set up a plant for manufacturing LAB, a basic raw material required for producing detergents, TISCO has acquired iron ore mines, Tata Tea owns tea gardens etc.
Combination between a foot wear company and a tannery, combination between a steel mill and iron ore mining company, combination between a ice-cream company with a dairy, combination between a tyre manufacturer and a rubber company etc are examples of backward integration.
2. Forward Integration
Forward integration implies getting closer to the consumer. If a manufacturer acquires retail outlets or advertising agencies to market its products it is known as forward integration.
For e.g. a car manufacturer acquiring outlets to markets his cars an FMCG company acquiring an advertising agency to market its products.
Advantages of Vertical Business Combination
1. Self sufficiency: A vertically combined firm is self sufficient in terms of raw materials. It need not entirely depend on outside suppliers for its raw material requirements. It is an industry producing its own raw material for successive processes.
2. Regular supply of raw material: The firm is not dependent on outside supply of raw materials. It is assured of regular supply of raw materials. Regular and uninterrupted production is possible because of the regular supply of raw materials.
3. Maintenance of quality: Since raw materials are internally produced and are of good quality, the final product would be of good quality.
4. Lower costs: Firms when they exist as independent units would have to incur substantial expenses on marketing and distribution. When they combine together into a single firm, costs are less because they enjoy economies in marketing and distribution. For e.g. if a combined firm, buys advertising time in bulk in a TV channel the cost per minute of advertising is less.
5. Elimination of middlemen: Middlemen can be eliminated and costs associated with commission, brokerage etc can be saved.
6. Customer satisfactions: A vertically combined firm is able to produce products of good quality. It is able to maintain regular supplies to the market at a lower cost. Therefore it results in the customer satisfaction and loyalty.
7. Technical economies: It can secure technical economies by linking up successive processes. For e.g. the output of ginning unit is the raw material for the spinning unit, the output of the spinning unit is the raw material for weaving unit, the output of the weaving unit is the raw material for the dyeing unit etc.
7. Opportunity for expansion: Since the vertically integrated firm is assured of raw materials and lower costs it can plan for expansion. It can enter new markets and increase its customer base.
8. Stability: It would be able to survive in all situations. Even in times of recession, the firm would be able to remain stable.
Disadvantages of Vertical business combination
1. Difficulty of vertical expansion:Large scale simultaneous expansion is difficult.If a particular stage of production has to be expanded, then the other stage of production also has to be expanded. Otherwise there would be overload in some processes and ideal capacity in the others.
2. No benefit of economies of scale: A vertically combined firm, does not enjoy economies of large scale production. This is because it is not a combination of firms in the same stage of production.
3. Higher interdependence: Any deviation at any one stage of the production process would affect the other stages of production.
4. Conflicts: There needs to be a high degree of cooperation and coordination in a vertically integrated firm. If any one businessman wants to expand capacity or change the technology. process or procedures while the others are not ready to accept changes. it would results in conflicts and disturbances in operations.
5. Inflexibility: It is very difficult to introduce changes in any process. The reason is changes introduced in one process would lead to over capacity or under utilization in other processes. Changes have to be introduced simultaneously in all processes which would be costly, difficult and risky.