A vertically integrated company is ... The concept of vertical integration, examples

A vertically integrated company is one of the most effective methods of running your own business. The formation of large structures with vertical integration is one of the most significant trends that are present in the modern Russian economy. At the same time, the ambiguity, which is different for any vertically integrated company, is a pretty good reason for considering its main advantages and incentives comprehensively.

Incentives

Modern large integrated organizations constantly dictate the vector of development of the modern economy and represent the basis for maintaining stability in the production of any developed country. A vertically integrated company is quite a popular option for doing business, and in the Russian economy, various integration processes are becoming more and more significant. One of the most important reasons for the establishment of such structures in the active sector of the domestic economy can be called the fact that economic conditions have created favorable conditions, the mutual barriers have been lifted, and it has become possible to strengthen their competitive positions and control the market environment.

The analysis of the market, in which the integrated participants work, provides for active consideration of various specific incentives for different integration options.

What are they like?

There are two types of incentives that distinguish a vertically integrated company - internal and external. The latter represent various requirements that are imposed by some special characteristics of the structure of a particular industry market to potential or already active participants, as well as all kinds of actions performed by firms operating on it.

The concept of vertical integration also provides for the division of external stimuli into two other categories - nonstrategic and strategic. Non-strategic indicators are determined depending on the characteristics of the industry that do not directly depend on the activities of the company. At the same time, strategic incentives are characteristics of the market structure and are combined as a result of the work of the organizations themselves.

Defining non-strategic characteristics of the market is:

• Capacity and saturation;
• Scale effect ;
• The concentration of buyers and sellers that has developed at the moment;
• Elasticity of demand;
• Degree of infrastructure development;
• Foreign competition;
• Administrative barriers;
• General economic conjuncture;
• Transaction costs.

If we talk about the most important strategic characteristics of the market, it already includes:

• Price and other types of discrimination;
• Nature and degree of integration;
• Coordinated actions of companies;
• Presence of potential competitors;
• The actions of companies aimed at limiting entry to the market.

Internal incentives represent any potential and real benefits that a company receives after using a certain type of integration. The internal integration advantages that Gazprom and other organizations with such a structure have received can be the result of effective interaction of several members of the group, and can be expressed in various structural market changes that are favorable for the work of the organization.

Advantages and motives

The Russian economy, which is dominated by such large organizations as OJSC Rosneft and others, is characterized by a tendency to vertical integration, which in fact is one of the most ambiguous forms. Vertically integrated companies differ not only in all the advantages and disadvantages of large enterprises, but also have their own patterns of development.

Due to the merger of enterprises (Lukoil LLC and others), an entirely different level of management is provided, opening up opportunities for using a variety of options for coordinating interests, actions and managerial motivations on the part of various members of the association, thus opening real prospects for an active increase in production efficiency.

In particular, it becomes possible to exchange various strategic information, and the introduction of innovations at any of the sites ultimately leads to a positive result for the entire structure as a whole.

Vertical integration, which is used by Lukoil and other companies, leads to the fact that the company begins to depend much less on distributors or suppliers. The need for constant growth of the organization's independence from its external environment is especially relevant in dynamic markets where there are a large number of sellers and buyers, and also in the presence of a deficit of certain resources.

Such ways to achieve protection from arbitrariness on the part of suppliers, such as increasing stocks, using substitute products, working with a lot of different partners, and others, can not always be called not only cost-effective, but generally realistic in terms of implementation. Different companies that are not integrated with the supplier of the necessary factors of production often face the need to stop their activities always when the demand for such factors exceeds the supply or the supplier is interested in changing the terms of the contract. In this regard, large organizations, including OAO Gazprom, use the structure of vertical integration.

In addition, the decision-making by marketing companies that have not been previously integrated and are not interested in implementing the various products of a certain enterprise, always creates a certain risk of overstocking and active underloading of the used production capacities, as a result of which the production eventually becomes unstable.

The vertical association of organizations that used Rosneft and other companies allows us to use much more efficient schemes of internal trade turnover, as well as to ensure the optimal management of production reserves, which completely overcomes the sales crisis along the technological chain. Accelerated turnover of funds also reduces the need for loans needed to replenish working capital, and also helps to achieve savings on interest paid.

What are the risks?

In comparison with the standard market relations that are formed between independent partners, the concept of vertical integration provides for a reduction in transaction costs, which applies not only to market coordination of companies, but also to the risk of opportunism, asymmetric data and certain specificity of assets.

The risk of the emergence of opportunistic behavior of various counterparties appears in the production process, for which there is no clear definition of the future demand, or when it is not possible in advance to draw up any negative changes in the internal and external economic environment in the process of drafting the contract.

Specific assets

Specific assets are the result of specialized investments: such assets can not be re-profiled for the purpose of further use for other purposes or by some other users, without provoking losses in productive capacity. Their presence contributes to the emergence of two-way dependence, which leads to some complication of contractual relations. At the same time, one must correctly understand that the specificity of assets can have several forms, among which the main features can be identified with different features of location, human capital, technological characteristics and targeted investments.

The specificity of this structure

Specificity of location occurs when the buyer of various factors of production and his supplier are located close enough from each other, thereby significantly reducing the costs necessary for storage and transportation, as a result of this leads to extreme immobility of assets. An example is the steel industry, where the integration of various smelting and rolling operations significantly reduces transportation costs, and eliminates the need for additional heating of steel. Similarly, the location of power plants in close proximity to the coal mining site significantly increases the degree of economy of the enterprise at transportation costs.

The specificity of various technological characteristics is manifested when one or several parties to a transaction invest in tangible assets that have unusual technological and design characteristics. Ultimately, due to such investments, the alternative possibilities of using material assets are significantly reduced.

The specificity of human capital is the result of investing in the active development of personnel. For example, the management of a vertically integrated company may provide for regular training in the specifics of the industry, teamwork skills and understanding of new technologies.

Targeted investments by the supplier are made if it sees a realistic prospect that a significant amount of products will be sold to a certain consumer. In case of prior termination of the contract, accordingly, the supplier will have unused production capacity.

Possible risks

The work of companies that produce or use all kinds of assets in the course of their activities is characterized by certain risks that pertain to the sale of special products, but also has such risks, which are caused by the uncertainty in the supply of this product, as well as by the lack of the possibility of redevelopment of any Production capacities in order that they can be used for some alternative purposes.

Even if there are no risks of asymmetric data and uncertainty, vertically integrated companies in Russia and other developed countries are distinguished by the presence of reduced transaction costs, which is related to the market coordination of organizations. In any competitive market, the buyer of various factors of production and their seller are forced to spend a lot of money looking for each other, as well as the subsequent conclusion and control over the implementation of a number of relevant contracts. Subsequently, the buyer of some factors of production becomes a seller of final products, and now he will need to allocate funds for its implementation. If the companies under consideration are merged, as vertically integrated oil companies do, and many others, ultimately, only transactions remain that are related to the search and maintenance of the contract with respect to the buyer of the final product.

Possible outcome

After the introduction of vertical integration, the total cost of the final product is also significantly reduced, since the costs for intermediate factors are reduced by solving problems associated with so-called double marginalization and a double premium. Savings on costs, which differ in the sale of gasoline and other products in the form of vertical integration, allows the company to significantly expand the form of its own presence in the market. First and foremost, it achieves lower prices for its own products, and also earns greater profits at the already established market price. That is why Rosneft (refueling) and other similar structures are characterized by increased market power compared to what they would differ, only based on their share in this market.

Advantages for companies

The access of competitors to various intermediate products markets is limited because there is no possibility or there are unfavorable conditions for concluding contracts with companies integrated into an integrated structure. In the final product market, Rosneft (refueling) and other structures that use vertical integration differ in the number of advantages that are due to the specific solution to the "double premium" problem, the reduction of transaction costs and many other factors. Lower costs increase the competitive position of this organization, and in parallel, they also raise barriers to entering this industry for any new company.

In addition, specific features of vertical integration make it possible to combine a sufficiently low level of concentration of final products in markets with a fairly high degree of monopolization of power and, accordingly, a reduction in pressure from various executive authorities in the area of antitrust regulation.

Disadvantages for the market

In connection with all this, it can be said that the consequences that vertical integration entails are ambiguous. As an example, the same company, Rosneft, can be taken, which, on the one hand, sets the tendency to reduce production costs and, accordingly, prices, but on the other hand it differs in considerable market power and enhances monopolization.