Virtual Vertical Integration

Vertical integration is the degree of control and ownership that a company has on the value chain it is a part of. Vertical integration allows a company to be self-sufficient in terms of intermediate goods and distribution of the final products or services. Apple, a premier computer and consumer electronics company, is a vertically integrated company. Apple has its own hardware-building facilities, software engineering department, exclusive distributorship, and service centers for its products.

Vertical integration reduces the cost and uncertainty of transactions with outside firms and facilitates quality control measures across the entire value chain. Under vertical integration, all the business entities in the value chain are under the same ownership, so they coordinate their activities much better than they would if they were competing firms.

While the advantages of vertical integration are tremendous, it also poses great challenges to a company. The company trying to take over its suppliers' or distributors' business may not have the industry knowledge to run those businesses properly. Vertical integration also increases the bureaucratic, accounting, and management costs. These drawbacks frequently offset the benefits of vertical integration.

Virtual vertical integration is a business integration model based on information sharing that captures the advantages of traditional vertical integration, but bypasses the disadvantages associated with it. Virtual vertical integration is an important strategy to consider for any firm with global presence. For firms that engage in business in vertically related activities across different countries, forming traditional ownership-based vertical integration is very difficult because of foreign country regulations, differences in business culture, and exchange rate volatility. Virtual integration offers these companies an attractive strategy to reap the benefits and avoid the pitfalls of vertical integration. Dell, a leading tech firm, and Toyota, the auto industry giant, successfully employ the virtual vertical integration model to gain competitive advantage in their respective industries.

The trick to successful virtual integration is to establish mutually beneficial business relationships that facilitate vertical transactions between companies. The main advantage of vertical integration stems [Page 1685]from the direct link between the distributors, manufacturers, suppliers, and other players in the value chain. The direct link lets the different players of the value chain coordinate their activities efficiently. This direct link can be established because the different divisions of a vertically integrated firm can share their business information without restrictions such as different management styles, incompatible data systems, concern for competition, and corporate strategy secrecy.

In virtual vertical integration, a company builds strong and dependable partnerships with its suppliers and distributors and freely shares its information with them. Together, they form a direct link from one end of the value chain to the other end, which leads to reduced lead times, inventory costs, and returned goods. Virtual integration is based on cooperation rather than ownership. Hence virtual vertical integration allows a company to enjoy the benefits of vertical integration while avoiding the need to invest its assets in unfamiliar businesses. In a sense, virtual integration is similar to outsourcing, but it is unique in that companies share their business information, expertise, and profits across the value chain.

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