It leads to reduction of transportation costs as the common ownership results in closer geographic proximity. The transaction costs can be controlled if a firm acquires the other firms in the vertical chain, then one division of the same company will transfer goods to other divisions. So, transaction costs in form of transport, cost of negotiation, cost of control etc. will be eliminated. The overall average cost of the firm will decrease because if the divisions are under same management control then there will be in house supply and departmental heads will determine the transfer price. An example could be pokarna granites limited.
The company was established in 1991 as a partnership firm quarrying black galaxy granite in India. Transportation of granite to factories where they can be cut and polished is quite difficult. Since that time, the company has grown to a major quarrier and fabricator of stones from India and around the world. From the very beginning, the company has believed in vertical integration.
They begin with the finest raw materials, invariably from their very own quarries, assuring consistent, high quality suppliers. Uniform governance; If a firm purchases semi finished goods from an outside source then the work culture will be different and there are chances of dispute regarding terms and conditions of supply or if the outside supplier makes breach of contract and does not supply the goods on time then the firm can not fulfil its commitment to the third party and the goodwill of a firm will come to an end.
Organizational inferences; If the supplier supplying the raw materials to a firm is big, in terms of size and structure, then it will dictate the terms and conditions. On the other hand if an in-house source is used then there will be no market variation and the supplier can not impose any unfavourable conditions.
Due to this reason in November 1999, Exxon Corporation and Mobil Corporation, two of the largest petroleum and petrochemical companies merged to form the Exxon Mobil Corporation. Today Exxon Mobil explores for and produces oil, natural gas and coal in 49 countries around the globe. It sells fuels in over forty thousand service stations in one hundred and eighteen countries. For firms who are purchasing semi finished goods from outside supplier will make a contract for a long period and due to repeated relationship the firm will be dependent on the outside supplier. In the case of termination of contract, the firm can not make regular supply of goods and services to its customers.
There is also a problem of leak of information, information regarding quality and quantity of inputs. For say, grasim is India's pioneer in viscose staple fibre, manmade, biodegradable fibre with characteristics akin to cotton. Grasim is a part of aditya birla group and it is world's largest producer of viscose staple fibre.
They have three plants along with research institutes. They are also into production of various principal raw materials required for viscose staple fibre production. Made from wood pulp through an eco friendly, non polluting process developed and patented by the aditya birla group. It is the world's only heavy metal free viscose fibre. Grasim has earned prestigious awards for its technology and its innovative range of fibres therefore they make sure that there is no leak of information by controlling all the aspects of producing the product.
After vertical integration a firm will purchase the goods from dimension of some group so it can maintain the balance between the demand and supply of goods. If demand and final goods increases than the supply of all dimensions can be erased and demand of suppliers can be met, if the firm is dependent on outside source then production will be delayed and there will be problem with coordination of production flows. Indal is a member of the aditya birla group and is a part of India's aluminium industry for over six decade. It has a nationwide spread of plants and aluminium value chain from bauxite mining, alumina refining, aluminium smelting with captive power to downstream sheet and foil rolling and extrusions.
The country's first scrap recycling facility commissioned by Indal reflects it commitment to promoting aluminium as the eco friendly metal that can be recycled over and over again, consuming less power and conserving natural resources. In Indal there is capacity utilization of all the divisions, so there will be no wastage of time and goods. Even in the case of Raymond there is capacity utilization of all the divisions. Raymond has a group enjoys a huge advantage over the competition that of vertical integration right from manufacturing to ready to wear distribution. If in the market there is an imperfect competition then the different firms will have different market shares so the advantage cost will be different leading to control of market imperfection.
DISADVANTAGES OF VERTICAL INTEGRATION Vertical integration boosts capital requirements. The oil and natural gas commission (ONGC) is putting in more than 12,000 crores in 15 projects. A firm may need to build excess upstream capacity to ensure that its downstream operations have sufficient supply under all demand conditions. The oil and natural gas commission (ONGC) was an upstream company but it is now going downstream as well. They are doing so because, if they are confined to one sector, upstream or downstream, then they are totally vulnerable to that one cycle which means that when it is up, ONGC makes a lot of money but if it is down, they have to pay out of their pocket.
It results in fixed sources of supply and less flexibility in accommodating buyer demands for product variety. It extends firm's scope of activity, locking it deeper into the industry. Vertical integration poses problems of balancing capacity at each stage of value chain. It can reduce a firm's manufacturing flexibility, lengthening design time and ability to introduce new products. Vertical integration may not even be necessary to exert control. e.g. Marks and Spencer. The textile supplier of corah (knitwear) and IJ Dewhirst (suits, coats, skirts) and SR Gent (blouse, skirts, nightwear) each send in excess of 75% of their output to Marks and Spencer.
Marks and Spencer can thus exert control and restrict profit margins, aim for stockless purchasing and insist on frequent batch delivery. If supply of components is greater than that required by the parent company then either production will have to be reduced or the surplus will have to be sold to rival firms. Customer choices may be restricted if the parent company insists on only its products being offered for sale. The disadvantages also include higher costs due to lower efficiencies, requires radically different skills and that there are increased bureaucratic costs.