A retail company that is vertically-integrated can also identify popular brand-name items and make "knock-off," store-brand items with the same ingredients and manufacturing process, and offer them to consumers at a lower price. The most obvious advantage of vertically integrating is that the strategy saves a company money, and those savings can be passed onto the consumer in the form of lower prices. Published, 3 years ago. Logical Problems and Sub-questions 3. Nonetheless, the strategy is viable across many other industries for as long as it fits with your overall business strategy. The suitability of vertical integration and outsourcing depends on the nature of your activities and industry of specialization. Zara mainly targets on young and urban female customers and acceptable prices are offered (Christopher 2005 p58) There are always new products in Zara stores… Another problem companies that attempt vertical integration can encounter is the different skill sets required to run a company that ranges from retail to factory operations. Forward integration occurs when you take up roles that are closer to the final consumers in the supply chain. Outsourcing allows companies to focus on streamlining their daily operations and encourages international business and trade. The reason for adopting a vertical integration strategy or an outsourcing strategy is to make a business's operations more efficient. choices on the change of vertical integration level and the performance implication of such changes. Similarly, if you are outsourcing certain aspects of production, you can avoid the investment of purchasing expensive equipment. Some functions that companies may decide to outsource include payroll, information technology, research and development, and customer care services. Finally, if a company outsources to a business outside of the U.S., there is the potential for communication barriers or cultural conflicts. Chapter 19 - Vertical Integration And Outsourcing CHAPTER 19 VERTICAL INTEGRATION AND OUTSOURCING CHAPTER SUMMARY This chapter analyzes the vertical boundaries of the firm. This strategy makes it possible for an agency to control or own its distributors, suppliers, and retail locations to control the supply chain or its overall value. Outsourcing versus Vertical Integration: A Dynamic Model of Industry Equilibrium. Horizontal integration is the process of acquiring and merging with industry comeptitiors to achieve competitive advantage that arise from a large size & scope operation In addition, the outsourcing company will be the one to create a contract for their services. Stages in the Process of Starting a New Business. In business terms, we know that vertical integration refers to the consolidation of all business operations but reducing the need for outsourcing and managing activities in-house. What Is a Vertically Integrated Business Model? Businesses within the retail industry are rolling out vertical integration supply chain models to keep up with fast fashion. CiteSeerX - Document Details (Isaac Councill, Lee Giles, Pradeep Teregowda): Deficiencies in existing theories used to explain outsourcing activities, often stem from the fact that the underlying incentives and constraints are far more complex than what these theories presume. Research on the global fashion industry predicts an increase from ‘$481.2 billion in 2018 to $712.9 billion by 2022’. Keywords: Vertical integration, Outsourcing, Transaction cost 1. Vertical integration allows you to perform additional functions in the chain of production. While vertical integration offers many advantages, the process is time-consuming and expensive in practice, and outsourcing can also provide a competitive advantage for a business. For example, it may be more appropriate to outsource the storage and warehousing functions of your cargo haulage business than to maintain a network of your own stores and warehouses. Horizontal integration and vertical integration are competitive strategies that companies use … How Can a Production Plant Increase Sales & Reduce Costs? Innovative technologies are a direct contributor to this progression, as they help companies create ‘experiential eCommerce’ for shoppers. Outsourcing vs. Subcontracting: An Overview . Many apparel retailers outsource their production to Asian factories. Outsourcing, vertical integration, and price vs. quantity competition ... Bertrand competition can produce higher prices, higher industry profit, lower consumer surplus, and lower total surplus than Cournot competition. An additional disadvantage of outsourcing is that confidentiality can be compromised when you release certain documents to another company. Business executives often blur the line between outsourcing and subcontracting; however, in reality, the two practices are quite distinct. Instead, the reversal results from outsourcing to a vertically integrated retail rival. Outsourcing vs vertical integration James R. Markusen and Yiqing Xie One thing that comes up repeatedly in the international business literature is that multinational firms (with owned foreign subsidiaries) are intensive in what we now broadly refer to as knowledge-based assets or capital. Outsourcing makes the most sense in industries where the cost of labor and capital resources are high and is usually the best choice for young businesses that cannot afford the high costs associated with implementing vertical integration. The Role of Operations in Organizational Effectiveness. Finding leadership that is well-versed in all of these industries can be challenging. For instance, you may choose to incorporate dog training in your dog breeding business. As such, you can raise your share within the market and s… One advantage of outsourcing is that you can trust that the outsourcing company is an expert in the service that it is providing. Vertical integration, especially if coupled with co-location, can provide significant cost benefits in the form of reduced material related overhead. Parts where shipping and handling costs between vendors is significant can be good candidates for vertical integration at … You can apply it in any industry depending on the goals you want to achieve. Vertical integration is merging different types of business that represent different stages of production. The current paper presents a dynamic stochastic model of an industry with heterogeneous firms that interact as buyers and sellers and endogenizes the vertical integration and outsourcing of firms. It's advised that companies that decide to outsource also hire a lawyer to review (and possibly amend) the terms of the contract. Companies decide to outsource to reduce the costs of their operations or to increase their efficiency. However, the process of implementing vertical integration is time-consuming and expensive in practice. Why Has Supply Chain Management Become Such an Important Topic? Vertical integration is a supply chain management style that many businesses decide to use. In business terms, we know that vertical integration refers to the consolidation of all business operations but reducing the need for outsourcing and managing activities in-house. If another company has access to your payroll documents, medical records, or any other documents with proprietary company data, you may be risking leaks of information. Cole-Ingait holds a Bachelor of Science Degree in accounting and finance and Master of Business Administration degree from the University of Birmingham. Baseline: Is Outsourcing Losing Its Appeal? Suppliers can be unreliable if they are poorly-run. For instance, backward vertical integration makes you a supplier of your raw materials, while forward integration grants you greater roles in the production and distribution activities of your industry’s supply chain. Opponents of outsourcing claim that it results in a loss of domestic jobs. When making the decision to outsource, a company should always take extra steps to make sure that their data is protected. Vertical integration is merging different types of business that represent different stages of production. If that company goes bankrupt, you will be left paying the price. Vertical integration is a risky strategy because it is complex and expensive. Vertical integration to be distinguished from horizontal integration Horizontal integration is the addition of other business activities at the same level of the value chain. ... Products in this industry … The findings support the cost-driven concern of the decisions on vertical integration level changes and certain performance benefits that the changes would bring to the companies. – Strategic concentration is a key issue for manufacturing companies when designing a supply chain. The challenge for small and medium-sized companies is that the initial process of vertical integration requires a significant investment of resources. As a result, outsourcing is a more favorable option in some situations. The benefits of acquiring inputs through competitive markets (when they exist) is stressed. After decades of focusing on specialization and outsourcing to maximize profits, food and beverage companies are now extending their expertise up and down the supply chain through vertical integration. When it comes to labor costs, outsourcing helps you streamline your work force, as contracting firms remain responsible for the welfare of their own employees. Threats over quality Quality maintenance is the first need for every fashion sector to excel, and any compromise on quality can bring down the business. These cultural differences can lead to conflict and low productivity. Vertical integration is a strategy where a firm acquires business operations within the same production vertical, which can be forward or backward in nature. Another advantage of vertical integration is lowering per-unit costs. You cannot tie down outsourcing to any particular industry because it is applicable across different sectors. Research on the global fashion industry predicts an increase from ‘$481.2 billion in 2018 to $712.9 billion by 2022’. vertical integration or insourcing bringing business processes or activities previously conducted by outside companies in-house -companies that participate in many or all stages of the industry value change from exploration to final sale are highly vertically integrated Also, the time and investment required to maintain these operations can reduce the nimbleness of a company. There are four stages of the supply chain: A company has vertically integrated when it controls two or more of these stages. 1 RomÆn Fossati2 Department of Economics University of Bristol September 2012 Abstract: Empirical evidence shows that vertically integrated producers are more productive, bigger and are matched to better suppliers (with high productivity and size). It isn’t simple. ¾ When the business-models of H&M and ZARA are mentioned, we mean the fact that H&M focuses on outsourcing while ZARA focuses on in-house production. Globalization is the spread of products, investment, and technology across national borders and cultures. For some companies, vertical integration will give them a competitive edge. In recent years, outsourcing has become controversial. 6. Proponents of outsourcing argue that it encourages businesses to allocate resources where they are the most cost-efficient. Example of a Vertical Integration vs. Outsourcing Industry. ZARA’s core competitiveness lies in the model used by it, called Vertical Integration. Many apparel retailers outsource their production to Asian factories. In some cases, it's in the best interest of companies to outsource—and rely on the expertise of others—rather than make the decision to vertically integrate. Only the EU clothing industry was studied since both firms home countries, Sweden and Spain are members of the EU. By using Investopedia, you accept our. Innovative technologies are a direct contributor to this progression, as they help companies create ‘experiential eCommerce’ for shoppers. This eliminates middle men in your supply chain by expanding your activities in the supply chain. If the company is operating in a different time zone, it's possible that your business "partner" will be working while you are sleeping because your business hours are different. The opposite of outsourcing is called insourcing, which entails bringing processes handled by third-party firms in-house, and is sometimes accomplished via vertical integration. Vertical disintegration and the outsourcing of production One of the key SCM trends within the mid-market high street sector has been the vertical disintegration and outsourcing of the production function to a global network of independent subcontractors, usually within lower labour cost countries. Inditex’s closest comparable competitors had narrower vertical scope than Inditex but outsourced all productions. Plus, you have more flexibility and time to focus on the core aspects of your business and how to make them more efficient. Companies that outsource get to benefit from the differences in labor and production costs in other countries. The benefits of acquiring inputs through competitive markets (when they exist) is stressed. Businesses within the retail industry are rolling out vertical integration supply chain models to keep up with fast fashion. Hello! Plus, you will always be tied to the financial well-being of any company that you outsource to. This way, you get to supply your dogs directly to customers seeking trained dogs, rather than supplying the dogs to dog trainers. Inditex’s unique business model mainly focuses on vertical integration and in-house production, while at the same time outsourcing is becoming a popular trend in clothing industry. How is Zara organized with respect to its vertical integration and outsourcing decisions? Vertical integration to be distinguished from horizontal integration Horizontal integration is the addition of other business activities at the same level of the value chain. The company you outsource to may not have the same standards as your company, and they will be driven primarily by making a profit. The capital required to set up or buy factories or acquire retail stores, plus the costs of maintaining those operations after the fact, can be prohibitive for many companies. Outsourcing is ideal for industries, such as manufacturing, that require huge work force and capital resources. 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