How Does Vertical Integration Work? Full Guide (2025)

Companies always look for ways to improve their efficiency, manage their supply chains, and gain an edge over competitors.

One method they use is vertical integration.

When done well, vertical integration can bring many benefits, but it also comes with some risks.

At Konvoy, we prepared this guide on vertical integration to help those who are curious about this strategy.

Let’s get started!

What is Vertical Integration?

Vertical integration happens when a company owns different stages of making its products.

This can happen when a company merges with or buys other businesses or even sets up its own suppliers, factories, stores, or distributors instead of outsourcing those tasks.

For instance, if a car maker buys a tire company, that's backward integration. But if that same car company starts its own dealerships to sell cars directly to customers, that's forward integration.

Types of Vertical Integration

Whether you're looking to invest in a company or you've got some experience as a VC or angel investor, getting a grasp on the different types of vertical integration can really open up your perspective on the industry.

1. Backward Vertical Integration

This occurs when a company takes control of the businesses that provide its raw materials or inputs, effectively moving upstream in the supply chain.

A great example of this is Starbucks purchasing coffee farms.

2. Forward Vertical Integration

The company is taking charge of the distribution or retail side of things.

A well-known example is Apple running its own stores.

3. Balanced Vertical Integration

Some companies handle both sides of the game by managing both supply and distribution.

Take Coca-Cola, for example.

They get their raw materials, produce the drinks, and then ship them out for sale.

If Coca-Cola decided to team up with both their suppliers and the retailers that sell their products, they’d be doing something called balanced integration.

Why Start a Vertical Integration?

Companies often go for vertical integration for plenty of strategic reasons:

1. By making raw materials or handling distribution themselves, companies can cut costs by avoiding supplier or distributor fees.

2. Integration helps align production and distribution, which reduces delays and lowers inventory costs.

3. Owning the production and distribution processes helps keep the quality in check, which means products stay consistent and the brand looks good.

4. Vertical integration can make it tougher for competitors to get their hands on important resources or distribution channels.

5. Controlling different parts of the supply chain enables companies to keep more profit that would usually go to outside suppliers or retailers.

6. Companies become less dependent on suppliers or distributors, which increases their operational independence and security.

For example, a video game company might improve its operations by acquiring or creating its own game engine technology, like Epic Games did with Unreal Engine.

This approach removes the costly licensing fees that come with using third-party engine providers.

Challenges of Vertical Integration

Vertical integration has benefits, but it also comes with major risks:

• Companies need to spend a lot of money to acquire or build operations, which raises financial risk.
• Managing different operations can be complicated and may require new skills and structures.
• If vertical integration is not managed well, it can lead to inefficiencies compared to using specialized suppliers.

Examples of Vertical Integration

Some companies have successfully used vertical integration, and we believe it’s important to understand how and why they do this.

1. Nintendo

Nintendo is a well-known company that uses vertical integration to strengthen its business.

It designs and produces both its hardware, like the Nintendo Switch, and its popular games, such as Zelda and Mario.

Nintendo also controls how its products are sold through its online store, the Nintendo eShop.

By taking charge of everything from the consoles to the game development and sales, Nintendo makes sure the quality stays high and rakes in more profits since they don’t rely on middlemen.

2. Amazon

Amazon operates in various areas, including online shopping, owning warehouses, and managing delivery services through Amazon Logistics.

It also makes its own products, such as Amazon Basics.

3. Sony

Sony has several AAA in-house studios that create exclusive games for PlayStation consoles.

Additionally, Sony runs the PlayStation Store, which allows it to sell games digitally without needing retailers.

By handling everything from making consoles to developing those must-have exclusive games and distributing them digitally, Sony creates a closed ecosystem.

In Summary

Vertical integration offers great opportunities for businesses that can handle its challenges.

Many companies, from tech to retail, know how to adapt, and customers will eventually connect with their innovations.

For example, Nintendo and Sony transformed the market with their online stores, just like Apple did with its own locations.

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