Chapter 6: Corporate-Level Strategy 183
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When firm pursue vertical integration more information is processed
at headquarters and thus more knowledge processing is needed as
illustrated by these servers. External relations with suppliers are also
supported by such information networks.The actions taken by UPS and FedEx in two
markets, overnight delivery and ground ship-
ping, illustrate multipoint competition. UPS
moved into overnight delivery, FedEx’s strong-
hold; in turn, FedEx bought trucking and
ground shipping assets to move into ground
shipping, UPS’s stronghold. Similarly, J.M.
Smucker Company, a snack food producer,
recently bought Big Heart Pet Brands which
specializes in snacks such as Milk-Bone dog
biscuits, treats and chews and has over $2.2
billion in annual revenue. Smucker’s competi-
tor, Mars, had acquired a significant portion
of Proctor & Gamble’s dog and cat food divi-
sion in 2014. Apparently Smucker’s was seek-
ing to keep up its size and cross-industry
positions relative to Mars by also diversifying
into snacks for pets.^52
Some firms using a related diversification
strategy engage in vertical integration to gain
market power. Vertical integration exists
when a company produces its own inputs
(backward integration) or owns its own source of output distribution (forward integra-
tion). In some instances, firms partially integrate their operations, producing and selling
their products by using company-owned businesses as well as outside sources.^53
Vertical integration is commonly used in the firm’s core business to gain market
power over rivals. Market power is gained as the firm develops the ability to save on its
operations, avoid sourcing and market costs, improve product quality, possibly protect
its technology from imitation by rivals, and potentially exploit underlying capabili-
ties in the marketplace. Vertically integrated firms are better able to improve product
quality and improve or create new technologies than specialized firms because they
have access to more information and knowledge that are complementary.^54 Market
power also is created when firms have strong ties between their productive assets for
which no market prices exist. Establishing a market price would result in high search
and transaction costs, so firms seek to vertically integrate rather than remain separate
businesses.^55
Vertical integration has its limitations. For example, an outside supplier may produce
the product at a lower cost. As a result, internal transactions from vertical integration may
be expensive and reduce profitability relative to competitors.^56 Also, bureaucratic costs
can be present with vertical integration.^57 Because vertical integration can require sub-
stantial investments in specific technologies, it may reduce the firm’s flexibility, especially
when technology changes quickly. Finally, changes in demand create capacity balance and
coordination problems. If one business is building a part for another internal business
but achieving economies of scale requires the first division to manufacture quantities
that are beyond the capacity of the internal buyer to absorb, it would be necessary to
sell the parts outside the firm as well as to the internal business. Thus, although vertical
integration can create value, especially through market power over competitors, it is not
without risks and costs.^58
Around the turn of the twenty-first century, manufacturing firms such as Intel and
Dell began to reduce vertical integration by reducing ownership of self-manufactured
parts and component. This trend also occurred in some large auto companies, such
Vertical integration exists
when a company produces
its own inputs (backward
integration) or owns its own
source of output distribution
(forward integration).