Vertical integration is the integration of firms engaged in successive stages in the production of goods. Andrew Carnegie introduced the idea of vertical integration.
There are three varieties of vertical integration: backward (upstream) vertical integration, forward (downstream) vertical integration, and balanced Vertical and Horizontal Integration.
Vertical integration is the degree to which a firm owns its upstream suppliers and its downstream buyers. Vertically integrated companies are united through a hierarchy with a common owner. Each member of the hierarchy produces a different product or service, and the products combine to satisfy a common need. Vertical integration is one method of avoiding the hold-up problem.
A monopoly produced through vertical integration is called a vertical monopoly, although it might be more appropriate to speak of this as some form of cartel. Lateral Integration is an alternative term for Horizontal Integration, defining an enterprise pursuing a diversification strategy under a uniform management in the economy.
Here, the company sets up subsidiaries that produce some of the inputs used in the production of its products. For example, an automobile company may own a tire company and a metal company. Control of these subsidiaries is intended to create a stable supply of inputs and ensure a consistent quality in their final product.
Here, the company sets up subsidiaries that distribute or market products to customers or use the products themselves. An example of this is a movie studio that also owns a chain of theaters.
Balanced vertical integration
Here, the company sets up subsidiaries that both supply them with inputs and distribute their outputs. For example, a restaurant chain owns the farms where they produce agricultural products as well as the factories that processes these agricultural products is practising backwards vertical integration. Forwards vertical integration would mean that they would own the regional distribution centers and shops or fast food restaurants where the hamburgers are sold. Balanced vertical integration would mean that they own all of these components.