The dual strategy of horizontal and vertical integration

The internet has propelled both horizontal and vertical integration on a global scale, driven by customer experience.

The internet and its technology have done many things to many industries and continue to do so. But what really strikes me is the observation of both vertical and horizontal integration at the same time and in the same industries. This dual strategy and its success is probably one of the reasons why Big Tech has become extremely dominant over the past decade.

Let me explain.

  • Vertical integration is the combination of different links in the value chain, from raw materials to the consumer. Companies with a high degree of vertical integration control almost every part of their value chain.
  • Horizontal integration is the expansion on the same level of the value chain. It’s about increasing market share, possibly through mergers and acquisitions. This can lead to oligopolies or monopolies.

Now let’s consider Amazon as a prominent example. Jeff Bezos started as a bookseller; in a relatively small industry and with no vertical integration. Amazon then expanded quickly into almost every category of consumer goods that are fit for mail-order shipping (horizontal integration). It became a marketplace for third-party vendors and sellers. At the same time, the company began its expansion along the value chain: sourcing and developing its own products (e.g. AmazonBasics, a private label) and services (e.g. Amazon Prime, AWS) and expanding its distribution (warehouses, shipping, delivery).

Today, Amazon is a behemoth with high levels of both vertical and horizontal integration that is still expanding in both directions.

Not everyone can become a platform

Vertical integration famously took place in the fashion industry (H&M, Uniqlo, Zara). Netflix started as a distribution platform (horizontal) and moved into content production (vertical). Apple, of course, always maintained a high level of vertical integration. The computing industry went from vertical (mainframe) to horizontal (PC, web) and back to vertical (smartphone). In retail, vertical integration proved to be a successful strategy (e.g. Warby Parker, Casper). Where horizontally integrated platforms dominate the market, vertical is the way forward.

Obviously, not everyone can become a platform. The vertical model can be successful in small niches with well-defined target groups as well as mass markets. The key success factor is the customer experience and the customer relationship that comes with it. Traditional retail owns the customer relationship, while manufacturers of consumer goods traditionally don’t sell directly. Thus, the customer experience gets fragmented. Retailers and manufacturers both own only one part of the experience. The vertical (or direct) model changes that.

While vertical integration for manufacturers means going direct, retailers need to source and develop their own private-label products or services. This is nothing new. For example, German mail-order giant Quelle introduced the trademark Privileg in 1964. Today it belongs to the US household appliance manufacturer Whirlpool, and Quelle went out of business in 2009.

Driven by customer experience and customer relationships

Owning the customer relationship and the value chain gifts you the advantage of speed. Thus, vertical integration allows for a fast, iterative product development cycle. Knowing early on what consumers want makes it easier to get it to them. This is true for both retailers and manufacturers. The trend of going direct has tremendously benefitted Shopify, which provides everyone who wants to sell directly to the consumer with the tools to do just that. Over the past decade, most of the growth in the consumer goods (CPG) market has come from small brands and private-label products.

Like its vertical counterpart, customer experience and customer relationships also drive horizontal integration. Amazon couldn’t have moved into all kinds of consumer goods if its customer experience hadn’t been superior. But the network effects are the main driver here. The internet thrives through the superior network technologies that enable it. This, in turn, enables platforms – or what Ben Thompson calls aggregators – with potentially global reach. Google, Facebook (and ad networks), Amazon, Netflix, Uber and Airbnb are all examples of this kind of horizontal integration.

Platforms, aggregators or simply networks of this size and capabilities just weren’t possible before the advent of the internet. The telephone network was probably the nearest thing, but never came even close. Telcos were always too narrow-minded in their thinking about what they called value-added services.

Going direct is the answer

Another term that’s useful to describe these horizontally integrated platforms is the word marketplace. Since the days of ancient history, people have sold and bought goods and services at the physical spots where sellers and buyers meet. This is true on the local level – I only need to walk a short distance to the next marketplace – as well as on regional, national and international levels. The big trade shows and fairs are all marketplaces. The internet has removed the need to travel and thus enabled global marketplaces where sellers and buyers from all levels can meet. The consumer can buy directly from the manufacturer, at least in principle.

But what sets these marketplaces apart from their traditional counterparts is that they commoditise supply. They reduce sellers or vendors to mere suppliers for the platforms which interact with the consumer. Physical retail has seen the same tendencies through market concentration and the growing prevalence of retail chains. Digital retail drives this to entirely new levels. Furthermore, platforms and the platform model expand into all kinds of industries.

For many companies, going direct (i.e. vertical integration towards the consumer) is the answer to this threat. Now retailers find themselves in a delicate position between their suppliers going direct and new horizontally integrated competitors (i.e. platforms, aggregators, and marketplaces). The old department store model – selling anything to anyone – has expired and been superseded by Amazon. Retailers face a tough choice between vertical and horizontal integration – or indeed both.

Last updated on September 21, 2021. Photo by David Clarke on Unsplash