Can you distinguish between joint venture, vertical and horizontal integration

Can you distinguish between joint venture, vertical and horizontal integration

If you are in business environment or enroll in professional programmes such as MBA or CIPS Diploma, probably you have heard the words such as joint venture, vertical integration and horizontal integration. These are strategies in business management and supply chain management. These terms may closely related but differentiate from each other. Knowing these terms may help you make a strategic plan for your company in the next 5 years, or just helps you to pass the upcoming CIPS exams.

Joint venture

First, we will discover the term “Joint Venture”. Imagine the following scenario:

You and your four other friends decide to buy a farmland and do agribusiness. The required capital is so enormous that no one can spend alone. Furthermore, the risks are high and devastating if any happens. One of the solution is all five aggregate each one’s personal savings to buy the land and other farming machineries. This solution creates some other problems: 

  • Who will take the ownership of the assets?
  • How are the profits and losses divided?

Now you can see that the easiest way to solve all of these problems is to establish a new company. The act of forming a company to solve specific tasks is called joint venture. Investopedia defines joint venture as:

“A joint venture (JV) is a business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity.”

Example: Volvo and Uber

Recently, Volvo and Uber have also announced that they would form a joint venture to produce self-driving cars. The ratio would be 50%-50%. As per the agreement, they are doing a $300 million investment for this JV.

Vertical integration

On the other hand, when someone talks about integration, he/she probably means M&A. Integration in the supply chain has two types: vertical and horizontal integration. Vertical integration is a strategy whereby a company owns or controls its suppliers, distributors or retail locations to control its value or supply chain.

Vertical integration can occur either “forward” or “backward.”

Forward vertical integration occurs when a company absorbs one or more entities to move “up” in the supply chain, taking over parts of the process that are closer to customers. 

One example of forward integration is Amazon’s 2017 acquisition of Whole Foods. This acquisition meant that Amazon would assume the responsibility of distributing and selling products to customers, as opposed to just wholesale distribution.

Backward vertical integration is just the opposite: A company absorbs or merges with a company (or companies behind them) in the supply chain. 

Apple, for example, is well-known for purchasing many of the companies that manufacture the parts used in its various products. Since manufacturers have to mark up their finished parts in order to turn a profit, these acquisitions allow Apple to cut the cost of its goods because the company is effectively able to purchase component parts at cost. Apple, in turn, ends up adding to its own profit margins. These increased profits can cover the costs of acquiring manufacturers over time.

Though vertical integration can help the organisation control its costs and quality, this act require the business to spend a huge sum of acquisition. A business must consider costs and benefits carefully before deciding to integrate distributor/supplier’s business. Otherwise, partnership can brink the same benefits without such high cost of acquisition.

Horizontal Integration

Horizontal integration is the process of a company increasing production of goods or services at the same part of the supply chain. A company may do this via internal expansion, acquisition or merger.

Example: Practical – Vodafone & Hutchison

Vodafone was established in 1983 as Racal Telecom in the United Kingdom while Hutchison Essar was founded in 1985 in Hong Kong as a telecommunication services provider to several Asian countries. Sometimes, it is just not the acquiring entity’s interest that gives rise to the merger, rather it could also be the underperforming entity that attracts the merger. For Hutchison, the urban markets were below par with falling average revenue per user. It wanted additional funds to expand its business operations in Europe. Overall the lower returns on its investments were not making things easier for it.

For Vodafone, the objective was to consolidate its position as one of the leading telecommunications companies with increased expansion in markets such as India where Hutchison had already established itself for a few years. The western markets were saturating and as a means for a growth trajectory in developing countries, this deal sounded just about right.

Vodafone acquired a 67% stake in Hutchison Essar with the deal valued at $11.1 billion. There was a considerable increase in net profit ratio, return on investment and earnings per share post the merger. Finally, partnership can bring the benefits of market consolidation without the burdens of M&A. However, it is still an investment that both businesses must be careful about. The first question that needs to be answer is whether or not you should form a partnership with your supplier. Lambert driver-facilitator framework is a good start. 

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