A vertically integrated company is the... the Concept of vertical integration, examples

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2020-05-01 14:00:25

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A Vertically integrated company – this is one of the effective methods of running your own business. The formation of large structures with vertical integration is one of the most significant trends present in the contemporary Russian economy. The ambiguity which characterized any vertically integrated company – it's a pretty good reason in order to comprehensively consider its main advantages and incentives.

Incentives

vertically integrated company

Modern large integrated organizations are constantly dictating the vector of development of modern economy and represent the basis for maintaining stability in production of any developed country. A vertically integrated company – this is a pretty popular way of doing business in the Russian economy in various integration processes are becoming more and more significant. One of the most important reasons for the formation of such structures in the current sector of the national economy can be called that economic activity was favorable conditions were created, starred mutual barriers and also have the opportunity to strengthen their competitive positions and to exercise control over market conditions.

Market Analysis, which employs integrated participants provides for the active consideration of the various specific incentives for different types of integration.

What are they?

the concept of vertical integration

There are two types of incentives under which different vertically integrated company – internal and external. The latter are different requirements that apply to some special characteristics of the structure of a certain industry market to potential or current participants, as well as various actions are performed by working for it firms.

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The Concept of vertical integration also provides for the division of external stimuli into two categories – non-strategic and strategic. Non-strategic are determined depending on characteristics of the industry that do not directly depend on the activities of the company. At the same time, the strategic incentives are characteristics of the market structure and combined due to the work of the organizations.

Defining non-strategic market characteristics –

  • Capacity and saturation;
  • Economies of scale;
  • Concentration of buyers and sellers, existing at the moment;
  • Elasticity of demand;
  • Degree of infrastructure development;
  • Foreign competition;
  • Administrative barriers;
  • General economic conditions;
  • Transaction costs.

If to speak about the most important strategic characteristics of the market, then here are already included:

  • Pricing and other forms of discrimination;
  • The nature and extent of integration;
  • The concerted action of the companies;
  • The presence of potential competitors;
  • Action by firms to restrict market entry.

Internal stimuli represent any potential and real benefits that the company receives after using a type of integration. Internal integration benefits received JSC «Gazprom» and other organizations with such a structure, can be the result of effective interaction of several group members, and thus can be expressed in a variety of structural market changes that are favorable to the organization.

The Advantages and motives

management of a vertically integrated company

The Russian economy is dominated by such large organizations as OJSC “Rosneft” and the other, characterized by the presence of the trend towards vertical integration, which actually is one of the most controversial forms. Vertically integrated companies are not only all the advantages and disadvantages of large enterprises, but also have their own laws of development.

Due to the Association of enterprises (LTD «LUKOIL» and others) provided a completely different level of control, providing opportunities for a variety of options to coordinate interests, actions and motivations of management by various participating associations, thus opening the real prospects for active growth in production efficiency.

In particular, it is possible to exchange strategic information and introduction of innovations at any of the sites eventually leads to a positive result for the whole structure as a whole.

Vertical integration, which is used by OOO «LUKOIL» and other concerns, leads to the fact that the company is starting much less dependent on distributors or suppliers. The need for continuous growth of independence of an organization from its external environment is particularly relevant in dynamic markets, where there are a large number of buyers and sellers, as well as when there is a scarcity of specific resources.

Similar ways to achieve protection against arbitrariness on the part of suppliers, such as increasing inventory, applicationof substitute products, work with many different partners, and others, it is not always possible to call not only cost effective but also actually real in terms of implementation. A variety of companies that are not integrated with supplier of essential factors of production, are often faced with the need to stop its activity whenever the demand for such factors exceeds the supply or supplier is interested to change the terms of the contract. In this respect, organizations, including JSC «Gazprom», use the structure of vertical integration.

In Addition, decision-making distribution companies, which have not previously been integrated and are not interested in sale of various products of a certain company always creates some risk of oversupply and under-utilisation of the active used in production capacity, whereby the production in the end simply becomes unstable.

A Vertical integration of organizations, which used the JSC «Rosneft» and other companies, allows the use of much more efficient scheme for internal trade and to ensure optimal management of inventory, thereby fully overcome the crisis of sales in the processing chain. The accelerated turnover allows us to reduce the need for credit for working capital, and helps to achieve savings on the interest paid.

What are the risks?

In comparison with standard market relationships that are formed between two independent partners, the concept of vertical integration provides for the reduction of transaction costs, which applies not only to market coordination, but also to the risk of opportunism, asymmetric data and a certain specificity of assets.

The Risk of opportunistic behaviour of counterparties appears in the process of production for which there is no clear definition of future demand, or when there is no possibility to advance in the process of making a contract to provide any negative changes in the internal and external economic environment.

Asset Specific

vertically integrated companies of Russia

Specialized assets are the result of specialized investments: these assets cannot be converted for further use in other purposes or by other users, causing losses in production capacity. Their presence contributes to the emergence of bilateral dependence, which leads to some complication of contractual relations. Thus it is necessary to understand correctly that the specificity of assets can be several forms, among which in the main we can distinguish various features of location, human capital, technological characteristics and target investments.

The Specifics of this structure

The Specificity of location arises when the buyer of various factors of production and its supplier are close enough to each other, which considerably reduces the costs required for storage and transportation, as as a result this leads to extreme immobility of assets. As example, the steel industry, where the integration of the various operations of melting and rolling significantly reduces transport costs and eliminates the need for additional heating of the steel. Similarly, the placement of plants in close proximity to the place of production of coal significantly increases the extent of the saving businesses on transport costs.

The specificity of the different technological characteristics is manifested in the case when one or several of the parties to the transaction invest in tangible assets, having an unusual technological and structural characteristics. Ultimately, due to these attachments significantly reduced possibility of an alternative use of the resources.

The Specificity of human capital is the result of investing in the active development of staff. For example, management of a vertically integrated company may provide regular training to the specifics of the industry, skills of team work and understanding new technologies.

Targeted investments by the supplier entered in the case, if he sees a real prospect that a large volume of products will be implemented to a particular consumer. In the case of pre-termination of the contract, respectively, the supplier will remain spare capacity.

Risks

vertically integrated oil company

Companies that produce or use in the course of business, various assets, different risks, which relate to the implementation of special products, but it has such risks that are caused by uncertainty in the supply of these products, and the lack of the possibility of converting any production capacity in order to be used in some alternative purposes.

Even in that case, if completely missing, the risks of asymmetric data and uncertaintiesvertically integrated companies of Russia and other developed countries distinguished by the presence of reduced transaction costs associated with market coordination institutions. In any competitive market the buyer of various factors of production and the seller is forced to spend a lot of money searching for each other, and the subsequent conclusion and control of execution of a number of relevant contracts. Subsequently, the buyer of some production factors becomes a seller of the final product, and now he is already a need to allocate funds for its implementation. If the subject company is merged, as do vertically integrated oil companies and many others, ultimately remain only transactions that relate to the search and maintenance of the contract against the purchaser of the final product.

The result

company Rosneft

After the introduction of vertical integration also significantly reduces the overall cost of the final product, as it reduces the cost of intermediate factors due to the problems associated with the so-called double marginalizacji and double premium. Savings on costs, which is the sale of gasoline and other products in the form of vertical integration allows the company to significantly expand its presence in the market. First and foremost, it achieves lower prices for their own products and also receives greater profits with the already established market price. Therefore «Rosneft» (gas stations), and other similar structures are characterized by high market power in comparison with that which they would differ only based on their share in this market.

The Benefits for companies

The Access of competitors in the various markets of the intermediate products is limited due to the fact that there is no possibility or there are unfavorable conditions for the conclusion of contracts with companies in the integrated structure. In the market of final products «Rosneft» (gas stations) and other structures that use vertical integration are many advantages that stem from the presence of specific solution to the problem of “double mark-UPS”, reduce transaction costs and many other factors. Reduced costs increase the competitive position of the organization, and in parallel also raise the entry barriers in this industry for any new company.

In Addition, specific features of vertical integration allow us to combine the relatively low level of concentration of end products in markets with a relatively high degree of monopolization of power and, consequently, to reduce the pressure from various bodies of Executive power in the sphere of Antimonopoly regulation.

Disadvantages to market

sale of gasoline

In this regard, we can say that the consequences that entails vertical integration are ambiguous. As an example may be taken the same company «Rosneft», which, on the one hand, sets the trend towards decreasing production costs and consequently the prices, but has considerable market power and increases monopolization.


Article in other languages:

AR: https://tostpost.com/ar/business/22117-a-vertically-integrated-company-is-the-the-concept-of-vertical-integra.html

BE: https://tostpost.com/be/b-znes/39670-vertykal-na-ntegravanaya-kampan-ya---geta-panyacce-vertykal-nay-ntegra.html

DE: https://tostpost.com/de/business/39677-vertikal-integriertes-unternehmen-ist-das-konzept-der-vertikalen-integ.html

HI: https://tostpost.com/hi/business/23731-a-vertically-integrated-company-is-the-the-concept-of-vertical-integra.html

JA: https://tostpost.com/ja/business/21696-a-vertically-integrated-company-is-the-the-concept-of-vertical-integra.html

KK: https://tostpost.com/kk/biznes/39998-t-g-nen-integraciyalan-an-kompaniya---b-l-ym-t-k-integraciyany-mysalda.html

PL: https://tostpost.com/pl/biznes/41772-pionowo-zintegrowana-firma---to-poj-cie-integracji-pionowej-przyk-ady.html

PT: https://tostpost.com/pt/neg-cios/41397-verticalmente-integrada-a-empresa-o-conceito-de-integra-o-vertical-exe.html

TR: https://tostpost.com/tr/business/36718-dikey-entegre-bir-irket-bu-kavram-dikey-entegrasyon-rnekleri.html

UK: https://tostpost.com/uk/b-znes/40500-vertikal-no-ntegrovana-kompan-ya---ce-ponyattya-vertikal-no-ntegrac-pr.html

ZH: https://tostpost.com/zh/business/45037-a-vertically-integrated-company-is-the-the-concept-of-vertical-integra.html






Alin Trodden - author of the article, editor
"Hi, I'm Alin Trodden. I write texts, read books, and look for impressions. And I'm not bad at telling you about it. I am always happy to participate in interesting projects."

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