The 5 Types of Business Integration Explained
One corporation buys a fleet of companies, but they each remain distinct entities.
Two companies become one with a hyphenated name.
Three organizations join together to form an industry titan.
Each of these examples, and many more, describe various types of business integration. Often explained in simple terms like ‘merger,’ ‘acquisition,’ and ‘takeover,’ these decisions can be complex and nuanced, involving unique processes and resulting in distinct outcomes.
Business leaders eager to see their organizations grow will likely engage in integration in order to reduce costs, grow revenue, or increase market share. By understanding the five types of integration, such professionals can prepare to lead successful change for their companies.
The What and When of Business Integration
Integration, the purchase of one company by another, is one of the more common business processes that companies engage in to reach their goals.
The timing of and form integration depends on the company’s goals and the availability of other corporations. For example, a well-established corporation may regularly set out to acquire startups that develop technology relevant to its business goals, or to remove that competition from the market. In another example, a company may decide to merge with another after a season of immense growth that increases their need for skilled professionals in their shared field.
The Benefits of Integration
Research shows that business integration can make a significant positive difference for organizations that participate in mergers or acquisitions. With strong leadership, a strategic plan, and clear communication, companies can weather the early days of transition. Those that do tend to perform well in the future. For example, McKinsey found that of the organizations that outperformed their peers 18 months after closing a business integration deal, 79 percent continued to outperform three years later.
The primary benefits of integration include:
- Reduced competition
- Expanded customer base
- Cost reduction
- Increased market share
- Revenue growth
- Improved efficiencies
- Greater product and service differentiation
- Access to new markets
- Increased market power
Business leaders who want to engage in integration must keep potential cons in mind, such as leadership disagreements, culture clashes, and regulatory issues. These challenges, though, can often be overcome if they are addressed in the early days of exploring integration.
The Five Types of Integration for Business
Business experts have identified five primary types of integration, each with specific nuances related to the purchasing company’s position in the marketplace. These five types are:
- Horizontal integration
- Vertical integration
- Forward integration
- Backward integration
- Conglomeration
Consider each of the five types of business integration.
Horizontal Integration
Horizontal integration occurs when two or more companies with similar positions in the production supply change merge. While these organizations may or may not be in the same industries, their shared stage in company growth and market placement establishes them as participants in a horizontal integration. When Exxon and Mobile merged in 1998, they were the first and second largest energy corporations in the United States.
By entering the business process of horizontal integration, the two companies pooled their resources to become one of the biggest oil companies in the world. The organizations increased their market share, reduced their competition, and greatly expanded their reach.
Vertical Integration
Vertical integration describes the acquisition of one or more companies at various stages of the buying company’s supply chain. One example is when a company purchases a supplier rather than establishing a contract with them. In doing so, the purchasing company streamlines its operations and reduces its reliance on outsourcing.
Vertical integration can boost efficiency, reduce costs, and increase a company's level of control over its manufacturing, distribution, and sales processes. While vertical integration requires a significant capital investment, companies that can afford that upfront cost often cite later savings and heightened profits.
IKEA is a standout example of vertical integration. Rather than continuing to rely upon outside vendors for its wood supply chain, the company acquired almost 100,000 acres of woodland in Romania and the Baltic States. In doing so, IKEA ensured a reliable supply of furniture-building materials.
Forward Integration
At its core, forward integration is “cutting out the middle man.” As a type of vertical integration, forward integration refers to companies acquiring other companies that were once customers. This advances the purchasing company’s ownership in the supply chain.
Digital transformation plays a key role in forward integration. As data solutions have made technologically dense processes more accessible, companies may be better positioned to acquire organizations rather than outsource to them.
Risks of forward integration include organizational inefficiencies, potentially high costs, and decreased organizational focus. With these possibilities in mind, teams can ensure that their forward integration aligns with their company’s overall goals.
Examples of forward integration include:
- Nike’s shift from exclusively traditional retail sales to direct-to-consumer sales.
- The Walt Disney Company’s launch of Disney+ rather than relying on other streaming services to share Disney content.
- McDonald’s acquisition of Dynamic Yield, which specializes in digital customer experience.
When managed strategically, forward integration can produce considerable benefits, including increased market share.
Backward Integration
While forward integration means a company is purchasing an organization operating in the next step of the supply chain, backward integration means purchasing an organization operating in an earlier supply chain step.
Backward integration often refers to a company purchasing a supplier of raw materials used in the buying company’s products. This is often done to ensure better quality control, reduce supply costs, and increase agility. Such an acquisition also changes the purchasing company’s position in the market, shifting it from a customer to an owner.
Potential risks of backward integration include considerable financial investment, lack of competency for performing due diligence, and increased bureaucracy. Product delays and the inability to switch suppliers are also worth considering.
Despite the risks, there are several real-world examples of its success, including clothing retailer Zara. Rather than relying on outside suppliers for textiles, Zara acquired its largest textile supplier, IndiPunt, bringing an earlier stage in the supply chain in-house.
Conglomeration
A conglomerate is a corporation in which a parent company owns the majority stake of several smaller and unrelated businesses. Conglomeration tends to occur via the merger of several different companies into a larger entity or through takeovers. Conglomeration also refers to when a parent company acquires subsidiaries.
The pros of conglomeration include revenue stream diversification, reduction of market risk, and greater immunity against a takeover. Alternatively, the cons of conglomeration include decreased accountability, too many layers of management, and convoluted branding.
While these risks are important to consider, many conglomerations have proved successful, including Procter & Gamble, Unilever, and Johnson & Johnson.
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