5.1.1 What is vertical integration?

When we state that an organisation is engaged in vertical integration, we mean that the organisation is responsible for two intertwined steps of the manufacturing or value chain process. The manufacturing or value chain process is the sequence of transformations that one or several raw materials undertake until they are transformed into the final good. Sometimes this flow is not in just one chain, e.g. some product is the result of two different middle products, hence we have parallel transformation.
In this sense we have three possibilities of vertical integration:
(a) backward or upstream integration1;
(b) forward or downstream integration2;
(c) lateral integration3.
In practice it is sometimes difficult to distinguish lateral integration from backward integration; indeed much research material only focuses on backward and forward integration, and so we will address this matter as such: lateral integration is often considered as backward integration. Next we present examples of the value chain process, the organisation represented by the blue rectangles:

Figure 1. Types of Vertical Integration

Therefore, the backward integration leads to the organisation producing what it bought from the suppliers; and the forward integration considers that the organisation is now also producing what its consumers used to buy.

Analyse the functioning of your enterprise. Can you identify any kind of vertical integration already present? Please, identify what you would have to integrate in your firm to perform backwards integration, and to achieve forwards integration.

1 MacMillan, Hambrick & Pennings, 1986, Uncertainty Reduction and the Threat of Supplier Retaliation: two views of he backward integration decision.
2 Pennings, Hambrick & MacMillan, 1984, Interorganizational Dependence and Forward Integration.
3 Rocha, 2002.Integração vertical e incerteza.