A forward vertical integration strategy involves a firm moving further down the value chain to enter a buyer’s business. Disney has pursued forward vertical integration by operating more than three hundred retail stores that sell merchandise based on Disney’s characters and movies. This allows Disney to capture profits that would otherwise be enjoyed by another store. Each time a Hannah Montana book bag is sold through a Disney store, the firm makes a little more profit than it would if the same book bag were sold by a retailer such as Target.
Forward vertical integration also can be useful for neutralizing the effect of powerful buyers. Rental car agencies are able to insist on low prices for the vehicles they buy from automakers because they purchase thousands of cars. If one automaker stubbornly tries to charge high prices, a rental car agency can simply buy cars from a more accommodating automaker. It is perhaps not surprising that Ford purchased Hertz Corporation, the world’s biggest rental car agency, in 1994. This ensured that Hertz would not drive too hard of a bargain when buying Ford vehicles. By 2005, selling vehicles to rental car companies had become less important to Ford and Ford was struggling financially. The firm then reversed its forward vertical integration strategy by selling Hertz.
eBay’s purchase of PayPal and Apple’s creation of Apple Stores are two recent examples of forward vertical integration. Despite its enormous success, one concern for eBay is that many individuals avoid eBay because they are nervous about buying and selling goods online with strangers. PayPal addressed this problem by serving, in exchange for a fee, as an intermediary between online buyers and sellers. eBay’s acquisition of PayPal signaled to potential customers that their online transactions were completely safe—eBay was now not only the place where business took place but eBay also protected buyers and sellers from being ripped off.
Apple’s ownership of its own branded stores set the firm apart from computer makers such as Hewlett-Packard, Acer, and Gateway that only distribute their products through retailers like Best Buy and Office Depot. Employees at Best Buy and Office Depot are likely to know just a little bit about each of the various brands their store carries.
In contrast, Apple’s stores are popular in part because store employees are experts about Apple products. They can therefore provide customers with accurate and insightful advice about purchases and repairs. This is an important advantage that has been created through forward vertical integration.
KEY TAKEAWAY
- Vertical integration occurs when a firm gets involved in new portions of the value chain. By entering the domain of a supplier (backward vertical integration) or a buyer (forward vertical integration), executives can reduce or eliminate the leverage that the supplier or buyer has over the firm.
EXERCISES
1. Identify a well-known company that does not use backward or forward vertical integration. Why do you believe that the firm’s executives have avoided these strategies?
2. Some universities have used vertical integration by creating their own publishing companies. The Harvard Business Press is perhaps the best-known example. Are there other ways that a university might vertical integrate? If so, what benefits might this create?
- 3157 reads
