Consider the case of a manufacturing firm that purchases subassemblies from a supplier, creates a finished product, and then sells that product to a wholesale distributor. What advantages might this firm gain from forward integration? From backward integration? What potential pitfalls of vertical integration might the firm face?

Question

What will be an ideal response?

Answer 1

Forward integration would allow the manufacturing firm to own its distributors, which could enable it to realize higher profits because it will be able to capture the profits that were previously going to the distributor. Also, the vertically integrated firm will be larger and therefore can more easily build barriers to entry, limit competition, and charge higher prices. The firm may also find that it can invest more readily in specialized assets, which protect product quality, enabling differentiation and higher prices. A final benefit would be the increased ease of scheduling and coordination and the increased opportunities for organizational learning.?Backward integration would require the firm to build its own subassemblies. The benefits of backward integration are the same as those found in forward integration. However, whether the firm chooses forward or backward integration, it must consider some potential pitfalls. First, by owning more value creation activities, the firm's complexity is increasing, which will increase bureaucratic costs. Second, the buyer or supplier business units may be less motivated to keep expenses low because they have a guaranteed seller or buyer for their output. Third, ownership of the additional steps in the process locks the firm into technology, capacity, cost, and other choices, whereas the nonintegrated firm is free to choose other suppliers, other technology, other quantities, and so on, through purchasing agreements.