In order to grow, businesses need to expand their operations. Horizontal integration and vertical integration are two common strategies businesses use for expansion. Though both strategies involve acquiring other companies for growth, yet both are very different from each other. To understand the relevance of both strategies, we must know the differences between horizontal vs vertical integration.
Before we list the differences between horizontal vs vertical integration, we need to understand what both these concepts mean.
Horizontal vs Vertical Integration – Meaning
Under horizontal integration, a company acquires the business that offers the same level of product or services. Such an acquisition makes the company stronger against competitors. Moreover, it helps a business expand capacity and grow bigger in size compared to the competitors. Facebook acquiring WhatsApp is an example of horizontal integration. Both companies deal with social media, and FB acquired WhatsApp to remain competitive in the segment.
On the other hand, vertical integration is about acquiring companies in the value chain. It basically means the acquisition of different entities involved in different stages of distribution or supply chain. For example, a car company acquiring or merging with a steel company. A real-world example is Google acquiring Motorola (before Lenovo) to enter the smartphone segment.
Horizontal vs Vertical Integration – Differences
Following are the differences between horizontal vs vertical integration:
Horizontal integration is about integrating similar products. Mostly, the businesses of the acquired and the acquiring company are the same. To some extent, even the products are also the same.
On the other hand, vertical integration involves a company taking over another business that is not similar to its current business. Instead, the acquired company would help the acquiring company manage its business better.
Horizontal integration works in increasing the revenue due to the acquisition of the business of the acquired company. Other objectives are boosting market share and reducing competition. Vertical integration is done to increase efficiency and address issues in distribution and transportation. Another objective of vertical integration is to reduce costs and gain more control over the supply chain.
Horizontal integration helps boost the profit margin by giving the company more pricing power by eliminating competition. Vertical integration helps to boost the profit margin by reducing excess costs.
Horizontal integration usually involves lower capital requirements as it allows others to hold assets of production and distribution. Vertical integration, on the other hand, has higher capital. Under this, the company needs funds to create and manage all components of the end product.
An acquisition under vertical integration helps make a company self-sufficient and lower dependence on suppliers. On the other hand, horizontal integration does not make a company self-sufficient.
Vertical integration can be of two types – backward integration and forward integration. On the other hand, we can’t further categorize horizontal integration.
Under vertical integration, the profitability of all the companies, including the acquired ones, will depend on the success of the end product. On the other hand, under horizontal integration, the success of every company in the value chain helps other companies.
Manufacturing and Assembling
Under vertical integration, a company needs to create almost everything on its own. However, under horizontal integration, a company uses components from outside vendors. Thus, its primary goal is to assemble these components to come up with a final product.
There is a larger requirement for custom components and interfaces in vertical integration. The idea is to make the whole machinery work in a tightly integrated way. And this can only be achieved if most of the components are custom built.
On the other hand, the standard interface is the characteristic of a horizontally integrated product. This helps a company negotiate with various vendors, lower the risk and make highly scalable plans.
Under horizontal integration, scaling is quick not just for the company but also for the competitors. This is because the acquisition helps the company to increase its size almost overnight. However, scaling potential is limited under vertical integration when compared to horizontal integration.
Under horizontal integration, the focus is more on the operations, procurement, and supply chain. Under vertical integration, the focus is more on the R&D to ensure the best components for the product.
In horizontal integration, there is less customization, so that it may result in a lower customer experience. The level of customization is more in vertical integration resulting in an optimized product that helps enhance the customer experience.
A vertically integrated company is more prone to disruptions and faces a higher risk. On the other hand, the risk is less in horizontal integration.
In the case of horizontal integration, the ecosystem is vast as there are multiple competitors selling similar products. On the other hand, vertical integration enables the company to sell a limited amount of products, and therefore, the ecosystem is smaller.
Both horizontal and vertical integration play a crucial role in shaping the growth of a business. For all-around growth, a company should make use of both strategies.