Identify and briefly discuss four disadvantages of a vertical integration system.

Question

What will be an ideal response?

Answer 1

The most serious drawbacks to vertical integration include the following concerns:

• Vertical integration raises a firm's capital investment in the industry, thereby increasing business risk. 
• Vertically integrated companies are often slow to embrace technological advances or more efficient production methods when they are saddled with older technology or facilities. A company that obtains parts and components from outside suppliers can always shop the market for the newest, best, and cheapest parts, whereas a vertically integrated firm with older plants and technology may choose to continue making suboptimal parts rather than face the high costs of premature abandonment. 
• Vertical integration can result in less flexibility in accommodating shifting buyer preferences. It is one thing to design out a component made by a supplier and another to design out a component being made in-house (which can mean laying off employees and writing off the associated investment in equipment and facilities). Integrating forward or backward locks a firm into relying on its own in-house activities and sources of supply. 
• Vertical integration may not enable a company to realize economies of scale if its production levels are below the minimum efficient scale. Small companies in particular are likely to suffer a cost disadvantage by producing in-house.