Vertically integrated companies ensure market stability

Image: Leathercraft Masterclass

Most companies adhere to economic theories such as production efficiency and maintaining manufacturing profit margins. Companies buy out their external suppliers or enter into long-term agreements because they see the importance of achieving high-level growth by acquiring external parties. This acquisition reassures companies that production capacity is maximized. Companies such as Volkswagen, Prada and Hermès have integrated backward and forward vertical integrations for increased growth and stability in their own markets. Moreover, this strategy would help industry leaders to be a frontrunner when competing with others.

Economies of scale: production efficiency and quality control

When luxury companies reduce their fixed cost per unit, “economies of scale” are achieved. This is done by consolidating labor, optimizing operations, and eliminating middlemen where costly markups tend to be present.

While most fashion companies outsource raw materials to third parties, Hermès goes to great lengths and keeps the process in-house as much as possible because quality and heritage are of the utmost importance to the House. If the French luxury leather goods industry pays particular attention to securing its supply of fabrics and its production of materials, it is to guarantee the best quality of its products and this encourages the search for resources throughout the world.

Hermès Spring Summer 2022
Image: Gaspar Ruiz Lindberg

For example, in 2010, Hermès allegedly purchased crocodile farms in Australia in order to have its own standardized source of crocodile leather. As for the perfumery sector, Hermès has set up its perfumery laboratories which could potentially stimulate innovation and enable it to acquire additional know-how. This allows Hermès to pay close attention to the details that are fundamental to its success in the luxury market.

A long-term association with partners also allows for tight supply chain traceability and tight sourcing control, which could potentially help companies mitigate any potential issues. This gives shoppers confidence in the brand, knowing that it stands on its own even in adverse circumstances.

As Hermès vertically integrates its heritage preservation business model, the Prada group faces a different set of challenges. Italian craftsmanship skills are highly valued around the world, but small and medium-sized Italian factories struggle in an increasingly dynamic and demanding landscape. Since craftsmanship takes time to perfect, investing in artisans would help preserve the “Made in Italy” label. To solve the foreshadowing problem, the luxury fashion group acquired high-end knitwear maker Filati Biagioli and took minority stakes in other key factories. Continuous efforts have been made to improve Prada Group’s supply chain integrations. He built industrial sites that produced 40% of Prada products from the 23 factories owned by the group. This enables production efficiency while expanding the technical skills required for the products.

Image: Prada Group

With the Prada Group’s acquisition of Car Shoe, a company that creates exclusive driving loafers, the luxury fashion brand will gain expertise in high-performance design, leathers and craftsmanship for which Car Shoe is already known. Additionally, it aligns with Prada’s business model which spans from the creative process to sourcing raw materials, through manufacturing and all the way to distribution. While the Prada Group manages its own supply chain, the benefits outweigh the shortcomings.

Essentially, a vertically integrated business involves more control over a brand’s supply chain, pricing, and improves customer satisfaction. One of the ways Prada integrates its business is by using Sprinklr, a leading customer experience management platform to reach the next generation of luxury customers through modern channels. With this advancement in Sprinklr integration, the Prada Group can study the data provided and refine its advertising objectives to create effective marketing content and reach relevant audiences. This lays the foundation for future growth, creating an effective digital communication and social media strategy for greater consumer interest.

A change of strategy: anticipating the future

In the ongoing Covid pandemic, there are shortages of materials like nickel and labor, extreme weather events, war and sanctions have all contributed to supply chain disruptions.

In the ongoing Covid pandemic, the supply chain is in crisis where labor and material shortages abound. Extreme weather events, wars and sanctions have exacerbated the disruption and put even more pressure on an already difficult situation. The timely supply of raw materials and components is crucial for smooth production – profits are also at stake in the long term.

For example, many car manufacturers have mobilized to change their strategy by securing their supplies through vertical integration.

Image: Mining

Earlier this year, Tesla confirmed a long-term supply agreement with Vale, one of the world’s largest nickel producers, with mines in Brazil, Canada and Indonesia. Besides the deal, the electric vehicle company is also investing in securing its own source of nickel and is therefore actively looking for mines in Indonesia.

Not only is Tesla embracing vertical integration in its business plans, German automaker Volkswagen (VW) has also signed two memoranda for cobalt and nickel sourcing. The first joint venture will be a three-way partnership between VW, Huayou Cobalt and Tsingshan Group for the extraction of these raw materials from Indonesia. The second is intended for refining the nickel and cobalt sulphates needed to produce battery cathodes.

By using a multi-sourcing strategy like Tesla and VW, automakers preserve their future supply to avoid any potential issues when creating newer and more advanced technologies in the future.

These strategies will be beneficial in improving profitability and shortening car manufacturing times. Forward integration of car manufacturers is popular for many brands. Using distributors around the world could ease the burden on the automaker of having to deliver the cars to its customers living far from the head office.

Building business-to-business relationships is relevant as automakers can leverage the extensive network of distributors and its knowledge of the regional market to access a new market of buyers. The time it takes for products to reach their customer determines satisfaction levels and in a time of global disruption, automakers are increasingly reliant on distributors.

Business expansion through direct acquisition

A global coffee brand, Starbucks uses a vertically integrated supply chain to outperform rival Dunkin’ Donuts. The company is involved at every stage of its supply chain process, from coffee beans to the cup of coffee sold. With this system, Starbucks works directly with its nearly 300,000 coffee growers worldwide. The coffee giant also works with producers because the company is committed to ensuring that its suppliers meet quality standards.

Picture: Starbucks

After vertically integrating its business plans with Plantations, Starbucks is also committed to providing its suppliers with special training and education programs. Interaction with producers, as well as sourcing and corporate social responsibility standards allow suppliers to feel like key players in the business.

Having close relationships and frequent communication between its suppliers ensures that the supply chain is less susceptible to major disruptions now or in the future, such as overplanting or lack of workers. Once supply chain disruptions are kept to a minimum, the market can anticipate steady growth. The Starbucks franchise continues to grow, adding locations around the world for greater accessibility will allow the company to thrive for years to come.

The way Starbucks integrates its business after securing the upstream integration process is by working with large retailers like Walmart and 7-11 convenience stores. This allows coffee lovers to have easier access to Starbucks bottled coffee, sachets and capsules on the go. Consumers are happy when they find something they want in a short period of time. Partnerships with third-party businesses and with more physical stores in ideal locations provide greater reach for consumers. With this expansion, which strengthens the business, it would attract more investors and third-party retailers to Starbucks.

Increasing production efficiency and anticipating the future are the main reasons why companies are adopting vertical integration in their business model. However, on all the good sides of a vertically integrated company, it is difficult to do this unless the company has great resources to execute this strategy.

However, successful vertical integration is a daunting task to undertake and the company must have the financial means and the will to achieve it. In the short term, the business may incur higher costs by buying other smaller players in the market, but in the long term, the benefits will prove to be a worthwhile investment that will take the business to greater heights.

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