5.1.5 Example/Case Study on vertical integration

When we consider a small or medium-sized enterprise, it is hard to think that they can monopolize a market share or the production of a product, which could be achieved through vertical integration. This could be a good solution to a big enterprise.

According to the recent events, technology information and communication, and the growing uncertainty of the market, transaction costs are already reduced, which lead to the vertical disintegration of big enterprises, and specialization of medium and small enterprises, and adopting of outsourcing schemas. Is vertical integration deemed to disappear? Maybe it is possible that the vertical disintegration offers the opportunity to some SME to develop or create a sector that can be fully performed by SMEs serving the multi-national enterprises (MNE), and these SMEs can use vertical integration with positive results.

The COLEP case study

Let us look at the case of the Portuguese firm COLEP1, a Portuguese packaging company, which was founded in 1965 as a metallic packaging manufacturer. COLEP gradually widened its product and activity portfolio through vertical integration of the packaging value chain. Founded as a decorative-cans-producer for industrial products, COLEP integrated lithography (in 1970), the production of aerosol containers (1972), the manufacturing of plastic components (1973), contract filling of aerosol cans (1975), production of plastic containers (1982), contract filling of liquids (1983), and, in 1984, the production of metallic containers for food products (source: company reports). These activities comprise the entire value chain of selected product segments. Thus, vertical integration allows COLEP to offer a full service that corresponds to the (full) outsourcing needs of selected products and activities of client firms. In 1975, COLEP established a partnership with the multinational Johnson Wax (JW), and, in 1993, acquired Johnson Wax's Spanish contract‐filling subsidiary in Valdemoro. More recently, COLEP advanced its internationalization strategy with a greenfield operation in Poland.

The metal packaging industry is very heterogeneous, with significant variations in the final product, and where standardization in some segments co‐exists with differentiation in others. COLEP's distinctiveness is built on a high level of vertical integration. Although there are numerous manufacturers of metal packaging and plastic components, and contract fillers, there is no other firm (at least in the EU) that carries such a wide array of activities of the packaging value chain in house: from lithography to distribution.

In the metal packaging industry, and particularly in the case of COLEP, we observe interesting features of the benefits of vertical integration worth revealing. COLEP's vertical integration is a response to both its clients' needs, and its internal efficiency requirements. The clients seek partners to whom they might outsource the entire value chain of selected products (generally small to medium batches of uniform products, or products in which they have a competitive disadvantage). Internally, vertical integration permits COLEP to increase the products' value added, and to overcome market imperfections in inputs (e.g. lithography). For example, although manufacturing of metallic containers is COLEP's traditional business, COLEP has been shifting its strategy to concentrate on the contract filling segment (roughly 40% of the revenues in 1996) and aerosols, which are higher value added segments.

Transaction costs supported by COLEP's clients are lessened for a variety of reasons. First, the risk of opportunistic behaviours by COLEP is low. Even considering that COLEP has access to the chemical formula of the contract filling products, possible opportunistic behaviours could only provide short‐term gains because COLEP's reputation would be damaged (Gulati, 1998) if, for example, it breached a contract. Furthermore, the risk of opportunistic behaviours is reduced because the clients outsource the production of mature products, where competitive advantage no longer relies on the exclusive control of know how (Vernon, 1966). In fact, COLEP has maintained some ties for more than thirty years, which reflects its ability to create stable, durable, and trusting relationships (Ring; Van de Ven, 1992; Granovetter, 1985) that reduce transaction costs when the exchange frequency is high and the client made some commitment (Ghemawat, 1991) to the relationship.

Second, transaction costs are reduced because the assets are not specific to the transaction. COLEP's assets are easily redeployed to any client or product with minimal adjustments. Therefore, COLEP has alternative uses for its assets without a significant loss of value or productivity. In fact, COLEP works within polygamous relations (Jones et al, 1997) and supplies several competing firms from which it accesses proprietary knowledge. On the other hand, clients do not make irreversible commitments to the relation because their assets (i.e., knowledge) may be adjusted to other suppliers (Bensaou; Anderson, 1999).

Third, COLEP is able to reduce transportation costs by vertically integrating. How is this done? It has actually to do with the economics of the packaging. The costs accruing from the transportation of containers to the customer are the main barrier to the international expansion of the metallic packaging producers. Packaging seems to be immobile to long distance transportation. However, this problem may be mitigated by either transporting a higher value added product (for which vertical integration of adjacent value activities is a solution) or minimizing geographic distance to the client. Only products with high value added, such as full aerosols, are mobile to distant markets: UK, France, Poland, Russia, and the US.

Partnerships in the home market frequently contribute to develop firm's capabilities and growth (Root, 1994). Small firms' capabilities are often developed passively through the supply of MNEs in the home market. This was the case with COLEP's supply of Shell, British Petroleum, Lever, Johnson Wax, Colgate‐Palmolive, Mobil, and Reckitt & Colman. However, COLEP's knowledge, quality standards, and know‐how were originally developed through the supply of large national companies such as Carnes Nobre, Victor Guedes, Cin, Robbialac, and Petrogal.

Vertical integration by suppliers may be a strategic choice to respond to the growing dis‐internalization and international specialization of MNEs' activities. Through vertical integration suppliers may assume the clients' full product value chain activities. COLEP developed a broad array of capabilities that facilitated the expansion into foreign markets both through the full supply of its clients and through the development of special contracts (e.g. the turnkey operations).

EXERCISE:

  1. What does the case study mean to you?
  2. Did COLEP perform the vertical strategy with success?
  3. How can this case help you in deciding to do, or not, vertical integration in your organisation?

1  Ferreira, Armagan, Li, 2008, ?Vertical integration for full outsourcing: growth and internationalization of a Portuguese packaging firm?.