Why Ford once made its own steel: the logic of vertical integration
In the 1920s Ford's River Rouge complex stopped buying much of its steel and started making it. Owning more links in the chain from raw material to customer can cut costs and guarantee supplies, but the same strategy can lock rivals out, which is why regulators keep a wary eye on it.
Vertical integration means a company owns several stages of its own supply chain, each producing something different that together meets one need. Horizontal integration is the opposite pattern, combining firms that handle the same stage. Economists even describe a firm's vertical position: a business selling straight to shoppers sits at 0, its supplier at 1, and so on up the chain. One way to measure how integrated a company is compares its added value with its total production value, giving a ratio between zero and one that rises as outsourcing falls.
There are three flavours. Backward, or upstream, integration means owning the makers of your inputs, like a carmaker that controls tyre, glass and metal companies; it was the dominant approach of Ford and its peers in the 1920s. Forward, or downstream, integration means owning the outlets that sell your product, such as a brewer running its own pubs, cutting distribution costs and middlemen. Doing both at once is called balanced integration. Media offers modern examples: News Corporation buying the satellite broadcaster DirecTV to carry its programmes, and Comcast acquiring NBC.
The appeal is control. A firm stops worrying about running short of materials, coordinates production and distribution more smoothly, removes the bargaining leverage of outside suppliers and can fatten its margins. It also offers a way around the hold-up problem, where one trading partner exploits another's dependence.
The drawbacks are real. Building or buying factories demands heavy capital, fast technological change can make integration costlier, and running unfamiliar businesses requires new skills. Most worrying, a company controlling supplies can deny them to newcomers, raising barriers to entry and edging toward monopoly. In the United States, guarding against communications monopolies built this way is part of the Federal Communications Commission's job. Whether consumers win or lose often depends on how differentiated the downstream products are.
Source: Vertical integration
