What is Vertical and Horizontal Integration - Essay Example

? Strategic Management Inserts His/Her Inserts Grade Inserts (25, October, Introduction In today’s business world competition has increased so much that firms are constantly searching for ways to sustain their markets share. Problems like inventory costs and untrained suppliers are making the production process even more difficult. Also when there are so many competitors then there is no room for any mistake. In such a competitive world it is not easy to gain market share. Firms therefore make use of different strategies to gain new customers and compete with rival firms. Vertical and horizontal integration are two techniques that are used by firms to achieve economies of scale and gain competitive advantage over other firms. In this essay both of these techniques of integration will be discussed with respect to the automobile company Toyota. Toyota is a well known automobile company all over the world. It is one of the largest companies, by sales, in the world. The growth of the company has been tremendous and it is mainly due to its unique inventory and production system. The company has huge market share in the developing as well as in the developed world. Toyota uses both vertical and horizontal integration in order to expand its business activity and gain more customer base. We will discuss below the vertical and horizontal integration at Toyota and how it helps the company to grow and gain competitive advantage. What is Vertical and Horizontal Integration? Vertical integration is a kind of management style where a firm owns its supply chain itself. This means that all the functions that are required to make the final product are carried out by only one firm. An example would be of a restaurant that makes its own raw materials. Vertical integrations helps a firm better control the process of production as it escapes from the dependence on other businesses (suppliers). Often businesses have little or no control on their supply chain, and this increases uncertainty related to the supplies. A garments manufacturer cannot make products when there is no supply of cotton. The manufacturer therefore becomes dependent on the supply chain and bears the risk of losing business in case of any unforeseen event. This is how a need for vertical integration springs in some businesses. The idea of vertical integration was made famous by Henry Ford. He wanted to make everything on his own without relying on any foreign trade. Vertical integration gives a firm monopoly power over other firms. A vertically integrated company has a flexible supply chain and therefore can afford to hold fewer inventories. Lowered costs and greater control are major advantages of vertical integration. The problem associated with vertical integration is that it is very hard and expensive to implement. It is also not easy to reverse vertical integration in a particular firm (The Economist, 2009). Horizontal integration, on the other hand, refers to a kind of ownership in which a firm merges or buys another company which is in the same business. For example an automobile company buying another automobile company will be an example of horizontal integration. It is the expansion or growth of the firm at the same level of the value chain. This means that an automobile company buying an investment firm will not come under horizontal integration. The merger should be between two firms involved in the same business activity. Horizontal integration also offers many advantages for a firm. It allows a firm to gain more market share by catering to more customers. It helps a company expand into newer markets. It also helps a company gain economies of scale and in turn increases the market power of the firm. The process of horizontal integration is also not easy to manage because there may be many differences between two firms that can cause problems. For example there can be a gap in technological expertise of firms or culture of the two firms can be different. These differences make management of two companies difficult. Vertical Integration at Toyota Toyota is a good example of vertical integration as it works closely with its supplier to assist them in their production of raw materials that are eventually used by Toyota in its cars. Toyota is not a fully vertically integrated firm but it applies the concept to a great extent. The company owns shares and stakes in its suppliers business and by doing so Toyota can exert its influence on its suppliers which is the main aspect of vertical integration. The main focus of the company is to develop a supply chain that can eventually add value to the end users and at the same time can reduce costs related to inventory and supplies. Minority Stakes in Supply Companies It is an extremely effective strategy that is used by Toyota. An automobile company has enough to do itself so it is not feasible to wholly operate all the supply chain rather partially ownership is a good solution. This strategy offers all the benefits of the vertical integration like control over supply chain and also does not exert great pressure on the company. In today’s tough competitive world the Henry Ford’s model of vertical integration is no longer feasible in the automobile industry. The market of automobiles has grown significantly and companies have to manufacture many models to satisfy the needs of many types of markets. This has already made the life of automobile companies difficult so they can no longer own their own supply chain. American Apparel is a garments company that has applied the model of vertical integration to the fullest. The company owns all its supply chain as it manufactures its products from the start and retails it to the customers (Greenberg, D. 2004). This model can be applied to a garment manufacturer because the relative easiness of the manufacturing process. It is obviously easy to make garments than making a car. Cars are a high involvement product and on the other hand garments are low involvement products. This is why full vertical integration is not possible in the automobile industry. Oil industry is another industry that can apply vertical integration because of the scarce nature of the raw materials. Raw materials of fuel are not easily retrieved therefore companies own the whole supply chain to recover costs. Oil industry can also not be compared to the automobile industry where target market is relatively large and demand is inelastic. Toyota is actually saving money by changing the trends that are prevalent in the automobile industry. The company is trying to integrate vertically by working with its suppliers and seems to be working as Toyota is saving money in the process (Bryant, 2005). Cost cutting is usually associated with outsourcing but Toyota is saving money by doing most of the things itself. This is mainly due to efficient functioning of supply chain and lower inventory costs which are results of vertical integration. The company is holding equity stakes in about 55 companies which include key suppliers of Toyota (Ohnsman & Kitamura, 2009). These suppliers include auto part makers and transmission makers. This allows Toyota to control the operations of its suppliers. Toyota can invest and also change the design and production system of the suppliers. Inventory costs can also be reduced significantly and availability of raw materials can also be ensured. Holding stakes is an interesting way to control the suppliers instead of owning them. This strategy has worked well for Toyota as in 2008 it passed GM to become the largest automobile company of the world by sales. But there are also downfalls of this strategy. Owning stakes in suppliers works well when profits are growing and business is good but when business is not and company is facing loses then loses are multiplied. The income of suppliers decreases if Toyota is not selling enough cars and in turn the investment income of Toyota decreases. Toyota was facing this situation in 2009 when it had to recall its cars (Ohnsman & Kitamura, 2009). Production System Production system of Toyota is famous for its efficiency. Toyota follows a Just-in-Time (JIT) inventory system where inventory cost is zero. A Toyota car is produced from scratch when a customer places an order for a particular car. Such a production system has no room for error because everything has to be on time otherwise customer will not get the cars in time. The production system of Toyota is famous not only in the automobile industry but all over the business world. Many companies have attempted to copy the production system of Toyota but have failed. The lean production system of Toyota is famously known as Toyota Production System (TPS). Toyota follows the philosophy of lean management to its core where the aim of the production system is add value to the end user and nothing else. Toyota production system is just an extension of idea forwarded by Henry Ford. Vertical integration at the centre of Toyota Production System (TPS) and TPS organizes manufacturing and logistics for the company including interaction with customers and suppliers. TPS requires the support of management because it is not easy to follow. The supply line is kept perfectly aligned with the needs of the customers. The specificity of the processes at Toyota is simply amazing. For example when car seat is installed at Toyota, bolts are tightened in a particular order and same time is allocated for the turning of bolts, and also the torque to which the bolt should be tightened (Spear & Bowen, 1999). This exactness is extremely difficult to achieve in an automobile company. The company treats all human functions with the same exactness. Everyone has to complete a task in a particular time with accuracy. This is the main reason of success of TPS. In Toyota all employees have a direct relationship. This means that all employees have a supplier customer relationship. Every employee who is making something is a supplier to the customer (another employee who needs something). This relationship exists throughout the company and all relationship should be direct (Spear & Bowen, 1999). This makes sure that there are no confusions about the product or the timing. TPS is therefore is a system that is extremely accurate and saves time and money for the company. Brand Value for the Customer The vertical integration of Toyota is aimed at providing maximum value to the customers. This means that every activity at Toyota is done keeping in mind the customers. The basic principle of lean management is to remove all the activities from a production line that are not adding valuing to the customer. The company delivers value by providing the customers with the right kind of prices at affordable prices. This is the main reason behind the success of the company. Toyota has understood the demand of customer, especially the third world counties, and has developed cars that are suiting customers. Toyota has a wide range of products that are aimed to satisfy many types of customers. The models Toyota has to offer are of a wide range and therefore the company can cater to many target markets. The company makes different models in large number but still its production lines run smoothly. This is because of the vertical integration Toyota follows. Everyone in the company is well aware of his or her job and there are no confusions. All models are made in a similar way so there is no major problem that the company faces. Making this many models may cause management problems but not in Toyota. The strict control that the company has on its supply chain ensures that all the production process run smoothly, and at the same time value is delivered to the consumers. The company is famous for making durable vehicles that last long. Customers do not usually complain about the cars manufactured by Toyota. Especially in the third world country where roads are not very developed Toyota’s toughness brings a vast amount of customers. Brand value of Toyota can be owed to the vertical integration of the company because products of Toyota speak for themselves. Horizontal Integration Horizontal integration involves owning another business in the same industry. In the automobile industry, again, horizontal integration cannot work by the books. Toyota cannot buy other automobile companies because it is not feasible for Toyota. Instead horizontal integration works when firms in the similar business collaborate for a joint venture. This gives the two companies opportunity to work together but at the same time does not take toll on the management system. Handling two companies especially in the automobile sector can be a cumbersome tasks therefore joint ventures and collaborations work well instead. Horizontal integration can also be adopted by producing same products in several divisions for example Toyota is making Corolla at Van Nuys, California, and Cambridge (Fisher & Waschik, 2002). According to this description of horizontal integration, Toyota is also horizontally integrated. By making products at different regions Toyota is saving costs like transportation costs. The company is also mitigating its risk by dividing the production of its most famous model in three regions. In case of any mishap in one region the company can easily make use of its other plants to cater to the demand. Toyota is a role model because of the flexibility of its production system. Also there are regions that have tremendous demand for some models therefore those models are made in the regions where they are popular. This is how Toyota reduces it costs. In the end every business is about saving money. The golden principle of money making is to make money by not losing it. Toyota seems to follow it by heart as the company saves every possible dollar it can save. This is evident in the production system of Toyota as the processes in the production system are timed by seconds, not minutes or hours. This management philosophy works for Toyota and saves the company valuable money. Toyota has recently bought equity stake in an electric car manufacturing company Tesla (Tournemille, 2010). This is an example of horizontal integration as the company is looking to enter in new markets. The electric car market is the future market and Toyota is already eyeing that market. Such collaborations is easy to manage as Toyota does not have to total control of the company, but at the same time Toyota enjoys the benefits of Horizontal integration. Toyota is making full use of its resources to gain new markets. Conclusion The tough competitive markets of today are forcing business to change their strategy in order to gain competitive advantage over rival firms. Vertical and horizontal integration are two strategies used by companies to control their supply chain and gain market share. Toyota is using both these techniques to excel in the automobile industry. The company is applying a form of vertical integration in its production system. Toyota owns equity stakes in its supplier which allows the firm to control its supply side. Toyota is also holding equity in electric car manufacturer Tesla and this is an example of horizontal integration. The success of the company is because of is mainly associated with its strategy to use vertical integration. Bibliography Bryant, E. 2005. Toyota saves money by doing more itself. Autoblog.com. Accessed on 25th October 2011 from http://www.autoblog.com/2005/10/24/toyota-saves-money-by-doing-more-itself/ Greenberg, D. 2004. Sew what? American Apparel founder Dov Charney wants to de-emphasize the fact he doesn't use sweatshop labor; he's just trying to sell a better T-shirt – People. Los Angeles Business Journal. Accessed on 25th October 2011 from http://web.archive.org/web/20080401023818/http://findarticles.com/p/articles/mi_m5072/is_22_26/ai_118184828 Fisher, T., & Waschik, R. 2002. Managerial economics: a game theoretic approach. London: Routledge Ohnsman, A., & Kitamura, M. 2009. Toyota-Backed Supplier Woes Magnify Carmaker’s Pain (Update2). Bloomberg. Accessed on 25th October 2011 from http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aP1XVLlS4vOU Spear, S., & Bowen, K. 1999. Decoding the DNA of the Toyota Production System. Harvard Business Review. Accessed on 25th October 2011 from http://twi-institute.com/pdfs/article_DecodingToyotaProductionSystem.pdf Tournemille, H. 2010. Toyota Buys $50 million of Tesla and Forms Specialist team to build electric vehicles. Energy Boom. Accessed on 25th October 2011 from http://www.energyboom.com/transportation/toyota-buys-50-million-tesla-and-forms-specialist-team-build-electric-vehicles Vertical Integration. 2009. The Economist. Accessed on 25th October 2011 from http://www.economist.com/node/13396061 Read More