Concept and types of vertical integration. Examples of vertical integration

Vertical integration- production and organizational association, merger, cooperation, interaction of enterprises connected by common participation in the production, sale, consumption of a single final product: suppliers of materials, manufacturers of components and parts, assemblers of the final product, sellers and consumers of the final product.

Vertical integration refers to that part of the added value that is produced under joint ownership. The price of the product sold will likely include the costs of materials, components and systems. The high purchase price of these investments means a low level of integration. If the majority of total sales value is generated within a single organization, the level of integration will be high. The concept of horizontal integration is used much less frequently these days and refers to the use of a wide range of products in order to maximize customer satisfaction.

Vertical integration is the process of replacing market transactions with intra-corporate transactions, which leads to a planned economy in which suppliers enjoy a monopoly position and consumers simply have no other choice. Vertical integration, like diversification, was once very popular in the management of commercial organizations, but the peak of this popularity passed several decades ago. A classic example is Singer, the American manufacturing company sewing machines, which at one point integrated all of its operations from primary sources of raw materials (forests and iron mines) to finished sewing machines.

Vertical integration in a company is closely related to outsourcing and make-versus-buy analysis, and touches on philosophical questions such as "did Ronald Coase get Nobel Prize in 1992? or “where does the company begin and end and why?”

Experience shows that a low level of competition leads to a high level of integration, that is, diversification. Those countries of the world where competition was at a low level were too strongly influenced by the planned economy to be competitive in the modern world with its globalization. This led to a thorough review of the entire business chain and, as a result, consideration of outsourcing opportunities. As a result, traditional value chains were broken and new companies were created. At the same time, the productivity of older companies was declining. The production of components and the supply of auxiliary systems in the telecommunications industry was left to specialized companies whose main activity was the production of electronics.

Most industries are now in a phase of reduced integration where they produce fewer end products themselves and source more components from third party suppliers.

In theory, all functions can be performed by separate companies. We can highlight the computer department, factory, sales company and other parts of the management apparatus. The decision to vertically integrate essentially involves a choice between producing goods and/or services in-house and purchasing them from someone else.

Gradually, the disadvantages of advanced vertical integration emerged. The high level of vertical integration became a problem and an object of struggle for Mikhail Gorbachev in the Soviet Union, a similar problem faced by all traditional airlines. The largest European companies have always been relatively free from the stress of competition, and accordingly they have been characterized by a high level of vertical integration. In the competitive battle with newcomers such as Ryanair and Easy.Jet, older companies have faced challenges not only with their cost structures, but also with advanced vertical integration. These companies handled their own engine maintenance, cleaned their own aircraft, ran their own ground support and cargo handling operations, etc., which of course led to a whole series of intermediary deals.

Centralized organizations are characterized by excessive faith in their own abilities, which is expressed in the desire to do everything on their own. Organizations that are more entrepreneurial, on the other hand, have a different tendency: they make the entire chain more efficient by purchasing the goods and services they need from other companies. The following are the negative features of advanced vertical integration:

1. It eliminates market forces, and with them the possibility of correcting unnecessary transactions.
2. It makes the provision of subsidies attractive, which distorts the picture of competition and distorts the question of the meaning of the company's existence.
3. It creates a misleading sense of power that does not correspond to the realities of the free market.
4. It creates interdependence that can lead to the collapse of any of the functions involved if one of them finds itself in a difficult situation.
5. The closed market it organizes (guaranteed sales channels) lulls the company’s vigilance and creates a false sense of security.
6. A false sense of security dulls an organization's desire and ability to compete.

Many examples of vertical integration are based on misconceptions and self-deception. The most common misconception is the belief in the possibility of eliminating competition in a single link of the production chain through its control. Some of the illusions prevalent in the world of vertical integration are listed below:

Illusion 1: a strong market position at one stage of production can be transformed into a strong position at another.

This assumption often led to poor investment decisions in the activities of the Swedish Consumers Cooperative* and other conglomerates, which were subsequently exposed to the above-mentioned shortcomings.

Illusion 2: commercial transactions that do not go beyond the boundaries of one company exclude the participation of sales agents, simplify the management process and thus make transactions cheaper.

This is nothing more than the classic credo of all adherents of a planned economy, who consider centralized control the only true path and the free market anathema.

Illusion 3: We can resurrect a strategically weak unit by buying out the unit next to it in the production chain, or the unit preceding it.

This is possible in rare cases. The logic of each industry must be judged by its own metrics. This rule applies here too, with the exception of situations of diversification for the purpose of spreading risks.

Illusion 4: Industry knowledge can be used to achieve competitive advantage in both upstream and downstream operations.

It is worth taking a closer look at the potential benefits and making sure that this logic is not misleading.

There are many examples of stunning improvements in profitability achieved by breaking down vertically integrated structures. Perhaps it is for this reason commercial organizations generally moving towards less integration. Automobile manufacturers with their own supply chains do not supply their vehicles to export markets at a lower price than those using independent supply companies. They also make their own transmissions no less expensive than transmission companies.

One of the reasons why vertical integration was so popular in the technocratic era was the obvious economies of scale that were tangible and measurable, as opposed to the advantages of small scale, such as entrepreneurial spirit and competitive energy, which cannot be expressed in numbers.

In certain specific situations, vertical integration also has a positive side, especially when control of key resources allows achieving competitive advantages.

Some are listed below:

- higher level of coordination of operations with better control capabilities
- closer contact with end users thanks to vertical integration
- creating stable relationships
- access to technical know-how relevant to the industry
- confidence in the supply of necessary goods and services.

The integration of the travel company VingrevSor into the hotel business through the creation of holiday villages in tourist resorts is an example of growth from the sale of holiday packages to holiday accommodation, a move that was seen as a likely strategic advantage.

SAS has also invested in hotels, and IKEA, with its backward integration from furniture sales to furniture design and production planning, is balanced by forward integration, leaving the final stage of production (furniture assembly) to consumers themselves.

Vertical integration is often based on narcissism or excessive pride, so it is worth carefully considering your own internal motives.

Tired of the look of the kitchen? Do you want to change something? Order kitchens to order for individual orders.

This strategy means that the company is expanding in areas of activity related to the promotion of a product to the market, its sale to the end customer (direct vertical integration) and related to the supply of raw materials or services (reverse).

Direct vertical integration protects customers or the distribution network and guarantees the purchase of products. Reverse vertical integration aims to secure suppliers who provide products at lower prices than competitors. Vertical integration also has a number of advantages and disadvantages, some of which are given below.

Advantages:

New savings opportunities arise that can be realized. These include better coordination and management, reduced handling and transportation costs, better utilization of space, capacity, easier collection of market intelligence, reduced negotiations with suppliers, lower transaction costs and benefits from stable relationships.

Vertical integration should ensure that the organization delivers within tighter deadlines and, conversely, sells its products during periods of low demand.

It can provide a company with greater scope to engage in differentiation strategy. This is because it controls more of the value chain, which can provide more opportunities for differentiation.

This path allows you to counter the significant market power of suppliers and buyers.

Vertical integration may allow a company to increase its overall return on investment if the proposed option offers a return greater than the company's opportunity cost of capital.

Vertical integration can have technological advantages due to the fact that the acquiring organization will gain a better understanding of technology, which can be fundamental to the success of the operation and competitive advantage.

Flaws:

Vertical integration tends to increase the proportion of fixed costs. This is due to the fact that the company must cover the fixed costs associated with backward or forward integration. The consequence of this increased operational dependence is that the risk of the enterprise will be higher.

Vertical integration may lead to less flexibility in decision making due to change external environment. This arises because competitive advantage company is associated with the competitiveness of suppliers or buyers included in the integration process.

It can also create significant barriers to exit because it increases the tie-up of the company's assets. They will be much harder to sell in a downturn.

There is a need to maintain balance between the initial and final stages of the main

The activities of modern companies take place in a rapidly changing competitive environment, which is caused by globalization processes, market liberalization, as well as technological progress. The success of a company in such a situation largely depends on the effectiveness of interaction with other companies at various stages of creating and promoting the final product or service to the final consumer, in other words, on the effectiveness of vertical integration.

The main purpose of this article is to consider the concept of vertical integration, a comprehensive analysis of theoretical approaches to explaining this phenomenon, which has not received significant attention in the literature previously, as well as the creation of a theoretical basis for explaining the processes of vertical integration in the automotive industry. The main source of information when writing the article were the works of R. Coase, O. WilliamsonM. AdelmanK. R. Harrigan, J. Stigler, V. Abernasie, K. Arrow, R. Blair, R. Basel, devoted to the consideration of issues of vertical integration, as well as a number of articles in scientific journals.

The object of study in this article is economic theories that are used to explain the vertical integration of a company. At the same time, the object of analysis, the arguments given in defense of vertical integration, the contribution to the theoretical justification of vertical integration, as well as their limitations are considered.

Vertical integration is the process of incorporating into the structure of a company firms that are connected to it by a single technological chain, or merging the production stages of a single technological chain and establishing control of one company over them. At the same time, the production stage is understood as a process as a result of which added value is added to the initial cost of the product, and the product itself moves along the chain to the final consumer.

The main difference in scholars' definitions of vertical integration is the degree of control one firm has over another that results from the integration of different stages of the value chain.

So, professor at Massachusetts Institute of Technology M. Adelman believes that a company is vertically integrated when goods and services that could be sold on the market without further processing occur within it from one division to another. This definition reflects the opinion of most scientists that vertical integration implies 100% control of the company over several stages of production. This definition excludes the firm's flexibility in choosing the degree of vertical integration, as well as the possibility of implementing quasi-integration strategies.

Harvard University professor K.R. Harrigan gives a broader definition of vertical integration as a way of increasing added value in creating a product or service and promoting it to the end consumer. This point of view assumes a variety of forms and degrees of control over the relationships between different stages of production, including their disintegration. The latter phenomenon is observed in many industries, for example in the automotive industry.

Depending on the direction of vertical integration, there are:

-- “forward” integration, or direct integration, which involves combining one of the stages of the value chain with subsequent stages of production and sales. An example of such integration could be the integration of the stages of car assembly and distribution;
-- “backwards” integration, or reverse integration, in which one of the stages of the value added chain is combined with previous links in the technological process. For example, a company that assembles a car vertically integrates with a supplier of assembly materials.

Depending on the degree of integration, the following are considered:

-- full integration;
-- quasi-integration, requiring less capital investment and allowing companies to remain freer.

Quasi-integration can exist in the form of:

-- long-term contracts;
-- joint ventures and strategic alliances. In this form, firms pool certain resources to achieve overall result while remaining independent in resolving other issues;
-- licenses for the right to use technologies. In this case we're talking about about vertical integration, in which one of the integrated stages is technology development and R&D. Full vertical integration can be replaced by a licensing agreement if the developed technology is difficult to copy and additional assets, such as marketing specialists, are not required to sell such technologies;
-- ownership of assets. The firm has ownership rights to certain assets at various stages of the process chain, and the management of such assets is carried out by external contractors. For example, automobile manufacturers own specialized tools, fixtures, templates, stamping and casting molds, without which the production of components is impossible. They enter into contracts with contractors for the production of such components, while remaining the owners of the means of production, thereby preventing the possibility of breach of contracts by contractors and guaranteeing supplies;
-- franchising. The franchisor is the owner of intangible assets (for example, a trademark), controls prices, product quality, and level of service, while minimizing financial and managerial resources.

On at the moment in economics there is no general theory of vertical integration and its existence is explained using various theories and approaches.

For a long time in neoclassical direction of economic theory Taking into account one of the assumptions about the existence of competitive markets through which efficient allocation of resources occurs, the only justified case of vertical integration was the existence of a continuous technological interconnection of the various stages of production. It is assumed that in order to achieve efficiency in sequential processes that coincide in time and space, as in steel production, for example, common ownership is necessary. According to this approach, vertical integration in the automotive industry as a discrete manufacturing business does not make sense.

This approach is unjustified because, as various scientists subsequently proved, the market is not an ideal mechanism for allocating resources; in addition, in the history of the automotive industry there are many examples of successful vertical integration.

In economic theory there is the concept of integration. Integration is the process of developing stable relationships between neighboring states, leading to their gradual economic merger, based on the implementation by these countries of a coordinated interstate economy and policy. There are horizontal and vertical integration.

Horizontal integration involves the acquisition by one firm of others engaged in the same business. A type of horizontal integration is diversification, which means the combination of firms whose technological processes are not related in any way (for example, the production of chemical fibers and aircraft).

Vertical integration is a method by which a company creates (integrates) its own input or output stages of the technological chain. Integration can be complete (combining all inputs or outputs) or narrow (a company purchasing only part of the input elements and producing the rest in-house).

A company using vertical integration is usually motivated by the desire to strengthen the competitive position of its key source business, which should be facilitated by: cost savings; departure from market value in integrated production; increasing quality control of production and management processes; protection of own technology.

However, vertical integration also has negative sides: increased costs; inevitable financial losses with rapid changes in technology and unpredictability of demand.

Vertical integration can increase costs if a company uses its own input production when external low-cost sources of supply are available. This may also occur due to the lack of competition within the company, which does not encourage its suppliers to reduce production costs. When technology changes, there is a risk that the company may become overly tied to outdated technology. With constant demand, a higher degree of integration allows for more secure and coordinated production of products. When demand is unstable and unpredictable, such coordination under vertical integration is difficult, increasing the cost of management. In these circumstances, narrow integration may be less risky than full integration because it reduces costs compared to full integration and, under certain conditions, allows the company to expand vertical integration. Although narrow integration can reduce management costs, it cannot eliminate them completely, and this effectively limits the expansion of the limits of vertical integration.

It is all of the above that emphasizes the relevance of the chosen topic of the course work.

The purpose of this course work is to study vertical integration. The objectives of this work are to find a definition of vertical integration, study the causes of vertical integration, consider vertical restrictions and mergers, and study this topic at the present stage.

To produce any type of product, it is necessary to carry out a series of stages, each of which includes a sequence of technological stages. For example, it is necessary to explore raw materials, extract raw materials, deliver them to the processing site, process them into intermediate and then final products, distribute them and deliver them to the consumer.

Vertical integration is the combination of two or more such stages of production. Theoretically, it can include all stages - for example, from the extraction of raw materials to the distribution of the final product between manufacturers. In this case, all transformations of the product at each stage must be internal within the company. In Fig. 1 presents elements and options for vertical integration. The sequence of technological operations T 1 - T Q characterizes the completed production cycle, which includes the sequence of production stages E 1 - Um, the growth of added value goes from the initial to the final operation, and it increases towards the product output of the production process. If at each stage the product is produced by a single firm, then there is no vertical integration, and each subsequent stage is implemented through a transaction on the open market.

In reality, almost every company has several intermediate stages of integration, i.e. carries out a certain sequence of technological redistributions, combining them with the purchase of initial resources from other companies. In the product flow, they can integrate upstream (lagging) or downstream (advanced).

In non-integrated firms, products move from one stage to another through market transactions based on free market prices. In integrated firms, the internal transfer of products from stage to stage is carried out at internal (conditional) transfer prices, which do not require equivalence to market prices and are completely dependent on the internal interests and behavioral strategy of the company. In this regard, it is necessary to note the reasons for choosing the integration of stages, since:

Market transactions can provide close, efficient and controlled contacts and strict ownership;

Highly representative control in integration can be effective, authoritative and relatively inexpensive.

The question of the scope of vertical integration and its very feasibility is a complex issue of theory and practice, which is still largely debatable. In particular, the core of the debate remains the connection between integration and monopoly forces.

Economists at the UCLA Chicago School tend to argue that integration cannot transform monopoly forces from one level to another and cannot create greater market forces than exist at horizontal levels. Other opinions boil down to the fact that integration, on the contrary, generates a transaction, eliminates the market and therefore can eliminate competition among sellers for access to resources. In this regard, it is important to note the actualization of the problem of the possibility of both determining and measuring the level (magnitude) of integration, as well as the reasons for firms using this process.

From the standpoint of measuring the level of vertical integration, intuitive simplicity rests on the measurement methodology itself. It is possible to count the number of stages with broad integration, but uncertainty arises in the definition of the very concept of “stage” - it can include many individual, relatively independent stages. For example, in the electronics industry, the processes of preparing integrated circuits include 2.5-3 thousand technological stages (transitions), which are sometimes quite difficult to separate into separate stages. Alternatively, a firm's value added to its final sales revenue can be used as an index of the degree of integration of these firms. An integrated manufacturer adds value through many stages, so its rate will be high. For example, the value added of a retailer will be low. At the same time, there are examples of other polarities - brick production is single-stage and has a high added value, while multi-stage industries have a low added value. The value added indicator may be lower for industries that are ahead in the production chain (raw materials, processing).

Thus, to date there are no perfect (reliable) measures of the level of integration; conceptual approaches require clarification and improvement.

Ensuring efficiency includes the use of technical specifications and cost savings in the transaction.

Some of the technical efficiencies are physical - for example, in metallurgical production, thermal resources can be saved when smelting iron and making ingots and processing them while maintaining the heated state. (The heat can be used to heat water, heat greenhouses and farmsteads, etc.).

Savings and efficiency can also be achieved by increasing the level of organization, more precise coordination and interpenetration of technological processes, eliminating additional costs and risk, as well as compliance with clear schedules and regulatory procedures.

Reducing transaction costs can also be a significant source of efficiency gains. By directly controlling their operations, integrated firms can avoid the risks and additional costs of finding better and cheaper resources, stipulated delivery terms and conditions, control of supply flows, etc. Transactions are always associated with limited knowledge about the processes occurring in the markets, which determines the “bounded rationality” of the transaction. Integration significantly reduces costs and reduces risks. “Supply opportunism” is associated with certain supply trends - misleading, disinformation, weak overall activity. An integrated firm also minimizes these weaknesses by directly controlling its resources.

Evasion of government restrictions involves, first of all, minimizing taxation. When taxes are taken on raw materials and intermediate products, there is a natural incentive to integrate since internal transformations are not taxed. For this reason, integrated firms have lower costs than non-integrated firms that act as competitors. If the tax rate varies depending on the stage of production of the product, this stimulates the emergence of a special tax; the firm seeks to increase the level of integration in order to minimize the overall tax. This is necessary, for example, in the oil industry, where oil production is taxed less than its refining. As the literature points out, through integration and clever use of pass-through prices, big oil firms reduce their taxes and, in some cases, bring them to zero.

Income regulation in natural monopolies (for example, in public services) is carried out by establishing restrictions on their rate of profit. Firms are allowed to earn an adequate rate of return on their investment funds after covering all expenses, which is an indirect compensation to the firm for the lag in integration and provision of output, including the provision of capital. Integrated utility industries set entry prices for their products as high as regulators allow. If regulators allow an unincentivized increase in prices for output, a monopoly firm is able to use its characteristics and status of a natural monopoly to the same extent as if prices were unregulated.

Price controls are often used by governments (for example, for oil). Slow integration frees input consumers from open market transactions and price controls. If integration becomes universal, price controls may be completely eliminated.

The reasons associated with the monopolistic conditions of integration are quite serious and varied. Each of them increases the possibility of setting a monopoly price or strengthens the ability to avoid monopoly prices for inputs.

Consider strengthening entry barriers. If market collateral comes from integrated entities, independent and newly formed firms may find it necessary to have production capabilities at both levels for fear that they may not be able to obtain an accurate and reasonable price for the collateral. The need for a two-tier structure may require increased costs as barriers to entry increase. Thus, large capital requires the establishment of new production capabilities at both levels. Capital market imperfections may increase barriers.

The increase in barriers is facilitated by the control of critical input resources, which provide either limited supply or differentiation of products by quality. Examples include the specific location of resources, mining rights, or copyrights that provide advantages or eliminate competitors altogether.

Vertical integration can eliminate competition at lagging levels, especially as firms may take strategic actions that increase competitors' costs. The effects associated with monopoly under integration assume that the market is imperfect. Vertical pressure is the cause of chronic dissatisfaction among firms with integrated structures. When an integrated firm sells to itself and to outside buyers, it gains the ability to manipulate prices due to its monopoly, and it is this, not integration, that makes pressure possible. Thus, market imperfections make some stages of pressure possible, connecting them with integration. Integration prevents the growth of monopsony, which can neutralize market forces in the early stages of production.

Neutralization of an advanced monopoly can be manifested in the attraction by firm B, which has some monopoly, of some resources from level A. Slow neutralization can increase the income of firm B through guaranteed supply at lower prices. Thus, firm B threatens the supply of other firms and increases their production costs. In this case, firm B will invest specific supplies in its production capacity, reducing its choice among alternative supplies. Competition from other supply firms will be more costly and difficult.

To avoid conflicts due to price increases, firm B at level A introduces slow integration, which does not pursue the goal of increasing efficiency, but of diversifying the monopoly. However, the result may be more significant for a two-level monopoly, since the possibilities for increasing prices may be higher than before. Integration can increase monopoly power and achieve efficiency.

In accordance with a number of theoretical provisions that have been confirmed in practice, in a perfect market system integration can be carried out when the technical scale of production allows it. Integration cannot serve as an indisputable lever for increasing the power of a monopoly from one level to another; a monopoly can exist at one or more levels and have the usual effects.

At each level, the product range and profit margins expand, regardless of the existence of integration. Each price charged by an integrated firm must include total costs and not too much total profit.

Vertical factors can control price setting. For example, US steel prices after 1955 were designed to maintain a vertical oligopoly price structure. When imported steel prices fell by 40%, US firms did not accept the prices. They reviewed a wide range of products at various vertical stages of production, which led to the risk of breaking down oligopoly pricing at various levels.

Speaking about the consequences of vertical integration, it should be noted that there are such concepts as vertical mergers and restrictions.

Merging for integration requires the emergence of a structure that has the utmost clarity, which, however, is very difficult in practice. This is one way to achieve the benefits of vertical integration. The firm's own internal growth can provide a fairly long evolutionary path of integration, involving the addition of new production capabilities (for example, based on new technologies) and new aspects of competition. Long-term contracts can eliminate risk and secure the firm's operating conditions as fully as integration.

The effects of a vertical merger can be purely profitable, being a balance of two provisions:

These are profitable farms obtained through a merger that cannot be obtained by direct growth of long-term contracts;

Anti-competitive effects such as increased barriers to entry into the market are possible.

Typically, anticompetitive effects are not very large; There are also not too many purely profitable firms as a result of mergers, since other paths (such as direct growth and contracts) are not excluded. However, in some cases, vertical merger costs and/or profits can also be quite large. In particular, large costs arise if, for example, the two merging firms are highly dominant at their levels and capital barriers are high.

According to the UCLA School of Chicago, vertical containment is more profitable than it is unprofitable. It is useful to consider the following aspects:

A. Territorial restrictions.

b. Resale price restrictions.

Territorial restrictions are associated with the establishment of certain boundaries of areas within which goods (for example, fizzy drinks) can be sold. Any distribution outside the designated area may terminate the manufacturer's privilege to operate in that area. Thus, with the help of territorial restrictions, competition between sellers and the level of resale is prevented. Attempts to establish sales privileges in expanded areas lead to the development conflict situations, since rivals may launch a counter-invasion. Thus, distributors and traders are convinced of the need for strict territorial division within the market, opposing the multitude of many local traders who also seek privileges to operate. Public provision normally involves maximum competition at mass sales levels, as this increases sales volume at a profit-maximizing price. When sales privileges are limited, the level of monopoly reduces competition and sales.

The literature has identified two classes of vertical constraints that shape the creation of market power and efficiency gains. Market power (constraints) eliminates competition through fixed prices through special contracts. Efficiency considerations are achieved through transaction costs (contracts) or the consolidation of high-quality trading networks. Typically, supply contracts impose high costs on good traders (with high reputations) and guarantee their participation in increasing influence.

Vertical integration or intersectoral integration, according to most researchers, is assessed as a higher form of integration, which uniquely and successfully leads to the formation of competitive industrial structures at the present stage. Despite the particular relevance of building this form of production organization at the present stage, most textbooks are limited to only defining vertical integration, while increased interest in this type of integration requires its more complete description.

An example of vertical integration of enterprises is the largest holding structure in Russia, OJSC Lukoil, reflected before the reorganization in 2003 - in Figure 1, and - after the reorganization - in Figure 2. An example of vertical integration of credit institutions is the merger on September 20, 2005 of five banks "Avtobank- NIKoil", IBG "NIKoil", Bryansk People's Bank, Kuzbassugolbank and OJSC "UralSib" into the financial corporation "UralSib" (Fig. 3 - 5).

Rice. 3. Lukoil Group before reorganization (480 companies)

Rice. 4. Lukoil Group after reorganization (274 companies)

Rice. 5. Vertical integration of credit institutions using the example of the URALSIB financial corporation

A number of researchers identify types of vertical integration presented in Table 1.

Table 1.

Classification of vertical integration of enterprises

Typological feature	Types of vertical integration	Characteristic
			1. Depending on the integration of stages of the technological chain	"back" or "down"	Merging with enterprises of previous technological operations
"forward" or "up"	Integration with downstream enterprises
2. Depending on the volume of integration		All stages of the technological chain are combined
		Combining only part of the incoming elements of the technological chain and producing the rest in-house
3. depending on the initiator of integration	Progressive	An association initiated by a supplier company seeking to bring its consumers under control
	regressive	An association initiated by a consumer company seeking to bring its suppliers under control

Countries that have taken the path of developing vertically integrated structures are naturally included in the leading group; they have the highest level of productivity and labor efficiency, household incomes and quality of life, macroeconomic competitiveness, and scientific and technological development. This result is ensured by the advantages that vertical integration provides.

The main advantages include:

1. Increased savings opportunities such as: better coordination and management, reduced handling and transportation costs, better utilization of space, capacity, easier collection of market and demand information, reduced negotiations with suppliers, reduced transaction and receipt costs benefits from stable connections.

2. The ability to guarantee the organization of delivery within tighter deadlines and, conversely, the sale of its products during periods of low demand.

3. The ability to provide the company with greater scope to engage in differentiation strategy by controlling more of the value chain.

4. Allows you to counter the significant market power of suppliers and buyers.

5. The ability to create your own sales network, which has an impact on accelerating the entire cycle of product distribution, capital turnover, cost recovery and information exchange between enterprises.

6. Concentration and acceleration of the reproduction of industrial, financial and intellectual capital.

7. Reducing transaction costs.

8. Allows a company to increase its overall return on investment if the proposed option offers a return greater than the company's opportunity cost of capital.

9. The possibility of obtaining technological advantages due to the fact that the acquiring organization will gain a better understanding of technology, which can be fundamental to the success of the operation and competitive advantage.

However, despite the described advantages, vertically integrated companies have features that, under certain circumstances, can reduce their efficiency.

Let us determine the main disadvantages of vertical integration:

1. There is a tendency towards an increase in the proportion of fixed costs.

This is due to the fact that the company must cover the fixed costs of maintaining production capacity throughout the vertical chain, managing interactions between integrated enterprises, transferring information up and down the hierarchy, duplicating functions in separate production structures, as well as monitoring and coordination of activities. The consequence of this increased operational dependence is that the risk of the enterprise will be higher.

2. Increased costs in case of expensive internal sources supplies.

May lead to greater inflexibility due to the fact that. A company's competitive advantage is associated with the competence of suppliers or buyers.

3. Loss of flexibility when technology and demand change.

It can create significant obstacles to “exit”, as it increases the degree of attachment of the company’s assets. They will be much more difficult to sell in the event of a downturn, i.e. makes it difficult to get rid of uncompetitive industries in a timely manner.

For the socio-economic well-being of the state, vertical integration accompanies increased competition in the market for products with high added value, a reduction in the cost of production of the final product with a possible reduction in its price, and an increase in the sustainability of the country's economic development.

The disadvantages of the development of vertically integrated structures for the country's economy include the likelihood of suppressing competition, the danger of large vertically integrated structures imposing their will on the state, and a decrease in the volume of tax deductions.

Disadvantages of vertical integration for enterprises and organizations also exist, and these include the likelihood of a decrease in strategic maneuverability, the possibility of revaluation of the assets of the acquired enterprise (bank), damage to shareholders due to the use of free funds for the acquisition of other enterprises (banks), increased management costs and control and more. At the macroeconomic level, the negative consequences of vertical integration may be the suppression of competition, the danger of large integrated structures imposing their will on the state, and a decrease in the volume of tax contributions.

In the modern economy, along with clusters, such forms of intersectoral integration as strategic alliances and vertically integrated concerns (VIC) have become widespread.

Strategic alliances as a form of targeted cooperation between competing or technologically related enterprises are created for a certain period for the implementation of a specific investment and innovation project on the basis of an agreement on cooperation between scientific, technological and/or financial units, most often without creating a joint venture (JV) as a legal entity. Thus, Cisco Systems, Microsoft and EMC (USA) corporations created an alliance in 2007 to develop technology for the exchange and protection of classified information. The newly formed alliance for the development of a hydrogen engine included a number of automobile concerns. Strategic alliance as a form of integration is of great interest for theory and practice, but by its very nature it is temporary and therefore not widespread.

VIC has become much more widespread. A successful definition of VIC can be found in I.P. Boyko, who defined this type of integration as an association of legally independent enterprises that form successive links in the technological chain of production and sale of the finished product (as opposed to a conglomerate, which unites enterprises that are not technologically connected to each other). The organizational and legal form of a VIC often becomes a holding company - a company whose purpose is to manage not production, but the capital of other enterprises. The assets of such a company consist, first of all, not of fixed and current assets, but of controlling stakes (shares in the capital) of other enterprises, which makes it possible to manage them.

There are two main reasons for the creation and widespread dissemination of VIC. The first of them is the desire to protect oneself from the dictates of suppliers of raw materials and other intermediate products, as well as consumers of finished products, i.e. limit the effect of competition, replace the market transaction mechanism with an internal corporate, organizational and planned one. The second reason is the achievement of a synergistic effect as a result of pursuing a unified economic policy within the entire intersectoral technological cycle while maintaining the operational and economic independence of subsidiaries and their interest in improving their commercial results.

FIV occurs in three in various ways:

1) separation of individual production facilities from the parent enterprise and their acquisition of legal independence (I.P. Boyko calls this emergence from within);

2) establishment of regional branches and branches of the parent company;

3) takeover of small and medium-sized companies.

The integrator that organizes and finances the creation of a concern is an industrial company, a trading company (they organized the majority of associations in the Russian agro-industrial complex), an innovative structure (this happened extremely rarely in Russia) or a financial organization. In recent years, private investment funds (private equity) have increasingly acted in this capacity, but they do this, as a rule, not for the sake of production development, but for profitable resale assets.
The initiator of the merger is private capital or the state. In modern Russia, the creation of state concerns in high-tech and depressed sectors is necessary for their restructuring. In 2007, state aircraft manufacturing, shipbuilding, shipping, titanium and nuclear corporations were formed.

To the center Khrunichev in 2007–2008. a number of federal rocket and space enterprises join (Voronezh Mechanical Plant, Omsk Polet association, etc.), which increases the company’s staff to 35 thousand people, and annual income to $1 billion. Currently the process is underway privatization of the Technopromexport company - VIC, which carries out the entire range of work (from surveys, design and development of feasibility studies to commissioning, comprehensive maintenance and supply of spare parts) for the construction of hydraulic, thermal and geothermal power plants, power lines and substations. All these associations in 2008–2009. held an IPO.

Government support large associations are also carried out in countries with developed market economy. A Cato Institute study showed that in 2006 the American government spent $92 billion on subsidies to American businesses - 11% more than in 2001. Among the recipients of government assistance are the largest US corporations: Boeing, Xerox, IBM, Motorola, Dow Chemical, General Electric, Ford, Chevron, etc. The Cato Institute emphasizes that its estimates are based on the calculation of not only direct, but also indirect subsidies.

The second most popular recipient of grants is the high technology sector. According to an analysis by the Cato Institute, large companies that have sufficient internal funds to conduct scientific research(it was assumed that public funds should be received by small businesses engaged in innovation). The third area of government subsidies is support for American exporters. And in this case, the largest contributions from the budget pie were received by the largest American corporations.
In Russia, which needs a radical change in the structure of the economy, the role of state industrial policy is especially great. However, in most industries, state-owned companies, having completed their functions, can be privatized. The reform of RAO UES can be cited as an example. Its capitalization in 2005–2007 increased 6 times, although the price of a megawatt of energy in Russia ($540) is much lower than in developing ($1300) and developed markets ($2000).

2007 was a significant year in terms of financial results achieved and the implementation of new large-scale projects. According to the main production and financial indicators The company has surpassed the 2006 level. The company continued to develop in accordance with its long-term strategy and strengthen its competitive position in the global energy market. For example, LUKOIL began gas production in Uzbekistan, continued active modernization of oil refineries, and completed the acquisition of a network of gas stations in European countries.

The Company's net profit in the reporting year increased by 27.1%, to a record $9.5 billion. The return on invested capital was 22.2%. Operating cash flow significantly exceeded the 2006 figure and reached $10.9 billion. This allowed the Group to finance capital investments in the amount of $9.1 billion. It should also be noted that in the structure of capital expenditures of the LUKOIL group, about 40% are expenses for new projects, the purpose of which is to intensively expand the scope of the Company’s activities.

Record financial results in 2007 allowed the company to recommend that our shareholders approve dividends in the amount of 42 rubles. ($1.80) per share, which is 10.5% higher than the dividends for 2006. The dividend yield will be the highest in the last three years and amount to 2.1%. It should be noted that in the reporting year, for the first time since 2000, the share price of OAO LUKOIL decreased slightly (by 1.1%). This was due to a number of internal Russian political factors and the instability of the global financial system. For our part, the Joint Stock Company is doing everything possible to maintain the income of our shareholders at a high level. For example, the Company continued to repurchase its own shares: in 2007, $712 million was spent for these purposes.

The main factor in the growth of the financial results of the LUKOIL group in 2007 was the favorable price environment - high oil prices and high refining margins. The growth in financial results was also ensured by the expansion of the scope of the Company’s activities. First of all, it should be noted a significant increase in oil refining volumes. Thus, refining volumes at Russian refineries increased by almost 8%, and the level of capacity utilization in Russia reached a record value in the entire history of the Company - more than 96%. In addition, unlike most competitors, LUKOIL continued to increase hydrocarbon production. At the end of 2007, the Group's production increased to 2.18 million barrels. n. e./day Particularly noteworthy is the high organic growth in production from international projects.

Positive influence The Company's financial results were also influenced by work to improve the efficiency of operating and financial activities in all areas. The company continued to maintain strict financial discipline. Taking into account high inflation and significant dollar devaluation, LUKOIL effectively controlled production costs. An important role in this was played by centralized work with contractors and suppliers, the use of tender procedures, energy saving, and increased labor productivity.

In the Geological Exploration and Production business segment, LUKOIL clearly adhered to its strategic goals - increasing production volumes and efficiency, expanding the resource base for stable long-term growth.

The company is continuously expanding its resource base and for eight years in a row has been fully replenishing hydrocarbon production with an increase in proven reserves. The Company's largest discovery in 2007 was the Bayandy oil field in the Komi Republic, which was put into operation in 2008. In general, in 2007 the Company discovered 7 and put into operation 13 new fields.

In 2007, the average daily production of commercial hydrocarbons increased by 1.5%. The slowdown in production growth rates compared to previous years was due to the sale of a 50% stake in Caspian Investments Resources Ltd. and a decrease in purchases natural gas by the Gazprom company, as well as interruptions in the energy supply to the fields of Western Siberia. Significant resource potential, the start of production at new major projects and the accelerated implementation of the gas program allow us to confidently assert that the Company will achieve its strategic goals to ensure growth in hydrocarbon production in the medium term.

The most significant event of 2007 in the Exploration and Production business segment was the start of gas production in Uzbekistan. For the first time as an operator, the company commissioned a gas condensate field abroad. High production growth potential and market conditions for gas sales make the Uzbek Kandym-Khauzak-Shady project the most effective in the Company’s gas block. It is also the Company’s largest international project, taking into account its share of participation: maximum level Production for the project as a whole will be about 12 billion m 3 /year of gas.

It is also necessary to note the completion of the construction of the Varandey terminal in the north of the European part of Russia - the world's first shipping terminal capable of operating year-round in Arctic conditions. The terminal will be used primarily for exporting oil from the Yuzhno-Khylchuyu field, which will be put into operation in mid-2008, and in the future - from other fields of Timan-Pechora.

In 2007, LUKOIL continued to actively develop the international sector of the Geological Exploration and Production business segment. The company has achieved significant success in implementing existing international projects. For example, commercial oil reserves were discovered in Colombia through the Condor project - this became the first ever discovery made by a Russian oil company in the Western Hemisphere. In addition, the LUKOIL group became a participant in three new geological exploration projects in Cote d'Ivoire and Ghana.

Separately, it is necessary to note the development of partnerships with state corporations around the world. In an environment where fewer and fewer resources are available to private oil companies, such collaboration is essential for successful and sustainable long-term operations. Of particular importance is the partnership with OAO Gazprom and its subsidiaries. The company has signed a number of agreements that open the way to cooperation in the field of geological exploration and production, production of petrochemical products, and sales of hydrocarbons and fuel. In the reporting year, LUKOIL began cooperation with state-owned companies in China, Indonesia and Qatar. This will help ensure growth resource potential, production and, accordingly, the shareholder value of the Company.

In 2007, the efficiency of hydrocarbon sales increased significantly as a result of improved pricing formulas and optimization of supply routes. Thus, the net profit of the gas sector doubled, including due to an increase in direct sales to end consumers, although the volume of gas supplies to the Company remained virtually unchanged compared to 2006. In addition, due to the high level of Russian oil refining margins, LUKOIL increased oil supplies to the domestic market by 7%.

In the “Refining and Distribution” business segment, the Company paid primary attention to increasing processing capacity and volumes, improving the quality of products, as well as developing the sales network.

Oil refining volumes at the Group’s own refineries increased by almost 7% and reached a record 52 million tons.

Thanks to the ongoing modernization of plants, the share of high-octane gasoline in the total output of this type of product has approached 90%, and the share of environmentally friendly diesel fuel has reached 70%. In 2007, a number of installations were introduced that will significantly increase the production of motor fuels that meet European environmental standards.

Thanks to a successful marketing policy, improving product quality and expanding the network of gas stations, retail sales of petroleum products increased by 14%, to 12.8 million tons. In 2007, the Company acquired more than 500 gas stations and entered the retail market of Western Europe for the first time. As a result of increasing the efficiency of sales activities and optimizing the gas station network, the average sales volume per gas station reached 7.9 tons/day, an increase of almost 10% compared to 2006.

In its activities, LUKOIL is guided by the highest security standards environment and industrial safety and pursues an active social policy. The Company strives to continuously increase the transparency of social policy and continue a constructive dialogue between the Company and the public. To this end, in 2007, OAO LUKOIL issued its second Report on activities in the field of sustainable development.

Based on the results of the work done, the following conclusion can be made.

Measuring vertical integration (VI) in many cases, especially in technology industries, is a rather complex problem, so sufficiently reliable meters do not yet exist. The driving reasons for VI are the potential opportunities to achieve efficiency both through the use of technical conditions and cost savings in the transaction, and through evading government restrictions by minimizing taxation; regulation in natural monopolies and price control, as well as benefits from monopoly conditions - increasing entry barriers, vertical pressure and neutralizing advanced monopolies.

Large VICs should actively promote the creation of regional clusters by forming supply chains. Foreign experience should be used here. Articles in the Harvard Business Review summarize the experiences of Chrysler, Caterpillar and other companies. For clusters, the experience of corporations in modular design, establishing partnerships with clients and chain participants, organizing marketing and lean manufacturing is important.

In general, foreign capital contributes to the development of the country. This has been proven by the experience of the tobacco and brewing industries, which are almost entirely owned by foreigners and use mainly imported raw materials. However, for the fishing industry, which has strategic importance for food security and large raw material resources, this option is unacceptable. As can be generally seen, many territorial and sectoral aspects of the functioning of the VIC have very ambiguous consequences for public welfare.

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Last year, one of the largest technology deals in history was announced - the largest US telecom operator AT&T decided to buy Time Warner for $85 billion. Operators around the world are suffering from slowing growth and are beginning to actively look for new opportunities in related segments. Considering that the popularity of video content on the Internet is growing at a tremendous pace and is already creating a serious load on the infrastructure of any mobile operator (Netflix alone generates up to a third of all American traffic during peak hours), the purchase of Time Warner with its brands CNN, HBO, Warner Bros and DC Comics would seem to make complete sense. But is this really so? What is the economic essence of buying a completely different business? What is behind similar deals between Verizon and Yahoo or Megafon and Mail.Ru?

In the business world, we often hear about a vertically integrated approach. Retailers are launching their own brands, oil companies are developing their networks of gas stations, and telecom operators in many countries, including Russia, are still building their own networks and managing infrastructure. The vertical approach is especially noticeable in large companies, when, as the growth of their core business slows down, they begin to look for new sources of income.

The main idea of vertical integration is to gain greater control over the value creation process. By capturing various segments of the notorious “value chain,” companies can manage their margins and distance from the end consumer. Obviously, consumer brands are receiving the most attention — companies that have been able to secure customer ownership (though this alone does not guarantee high margins). It was there, closer to the client, that the most successful startups of the Internet era began, and the very pattern of development of such businesses is similar everywhere:

Startups start from a relatively small niche and quickly begin to dominate it.
The next stage is horizontal integration, when companies add new services and products, expanding their reach (an example of horizontal integration would be the purchase of direct competitors)
After this, the stage of vertical integration begins, when startups (if you can still call them that at this point) go down the value chain and begin to control suppliers of services and goods

Examples of a vertically integrated approach among Internet companies

Amazon

Amazon did something similar, starting with books, then becoming the Everything Store, and then switching to producing some product categories in-house. And we're not talking about drills or clothing produced under the retailer's own brands, such as AmazonBasics or Mama Bear. Over the past 10 years, Amazon has built the largest cloud business in the world—Amazon Web Services. First, the company went “down”, building computing power for its own needs, and then went “up”, creating a huge line of products for end consumers based on the infrastructure it built for itself. As a result, the created structure is a bizarre mixture of vertical and horizontal integration, and the AWS service itself allowed the eternally unprofitable Amazon to finally begin to show profit, now generating half of the company's operating profit. And the company’s unique approach — creating a closed ecosystem and “burning out” competition — allows analysts to suggest that Amazon could become the world’s first company with a trillion-dollar capitalization.

Facebook

Facebook followed a similar pattern, launching with a focus on college campuses and now covering most of the world's Internet users. But the position of the largest social network in itself never suited Zuckerberg. Seeing how quickly innovation can break patterns that once seemed indestructible, Zuckerberg has time and again made bold moves toward horizontal integration. Here is the purchase of Instagram for what seemed then an incredible price of $1 billion (now this deal can be called visionary, like Google’s purchase of the start-up YouTube or Android), and the takeover of WhatsApp for 20 times a large amount. In recent years, the company has begun to actively strengthen its “verticals” - this includes the purchase of Oculus and the subsequent foray into virtual reality, tests of payment services, and programs of free Internet access for developing countries. You could say that Facebook is still at the very beginning of finding the right model to integrate its business, but it is clear that Zuckerberg is looking much further than the current advertising model.

Uber

And of course, we can’t help but say about Uber, which started from the niche of expensive “black” taxis, and then, in a rush of horizontal integration, captured all related segments — from ride sharing to delivery of everything. And now the time has come for vertical integration — two years ago Uber began developing its own self-driving car technologies, hiring several hundred engineers and roboticists. And in September 2016, the company acquired a 10-month-old startup, Otto, for $680mm, which develops technologies for creating self-driving trucks.

In general, vertical integration is not something new. At the beginning of the 20th century, many entrepreneurs saw no other way to gain competitive advantage. Companies bought suppliers (upstream integration) and distributors/sellers (downstream integration) en masse. In his book, Henry Ford wrote that vertical integration was the key to the success of his business. And what an integration it was — at that time, Ford owned coal fields, mined iron ore, operated sawmills, made rubber, built railroads, made glass, had a fleet of ships, and did many other things in-house. But since then, supply chains have improved significantly, the economy has globalized, competition between suppliers and other parties has increased, and much of the company has begun to look for specialization. The focus has shifted to developing key competencies.

The IT industry has also undergone transformation. With the advent of independent producers software in the 80s, the industry began a massive separation of hardware and software production. By the end of the decade, many technology giants went from being leaders to catching up. The hero of that time was certainly Microsoft, which became the most valuable company in the world thanks to what seemed at that time a narrow focus on the operating systems niche. Seeing the overwhelming success of Bill Gates, many technology companies followed suit and tried to get rid of a significant part of non-core businesses. For example, for IBM, those years were spent trying to maintain a business that was destroyed by Windows at the OS level and by Intel at the chip level. By the way, the WinTel pair still dominates on desktops (although both companies missed the mobile era).

In 1996, Gates published his famous essay “Content is King” on the Microsoft website. The expression was not invented by Gates himself, but it was from his suggestion that it became firmly established in the everyday life of any modern marketer. The essay began with the words “Content is the area where I expect to create the most money on the Internet.” True, Microsoft itself, in the era of Steve Ballmer, who replaced Gates as CEO in 2000, completely missed the online content revolution. The company took its first serious step in this direction only 20 years later with the purchase of LinkedIn this year for $26 billion. Before that, Microsoft tried many times to build certain verticals. But the only truly successful project in this direction is the Xbox, which does little to help the company's core business (which is Microsoft Office). True, with the arrival of Sati Nadella as CEO, the company seems to be back on track and is now ready for vertical integration with new energy. Here is the first ever serious professional competitor to the iMac — Microsoft Surface Studio PC, and the somewhat truly breakthrough augmented reality glasses HoloLens.

Many modern IT giants have been moving toward vertical integration for years, if not decades, but there is one company that has never changed its approach. And what at one time nearly led Apple to bankruptcy, by the early 2000s, helped the company return to the Olympus of the technology world. It found that users are willing to pay a premium for well-integrated products, ease of use outweighs the complexity of customization for many, and greater control over the production chain means better product quality.

Chips made by Apple

But vertical integration makes economic sense as long as the business continues to be innovative and ahead of the competition. In the late 80s, Apple suffered from the rise in popularity of Windows and cheap PCs. It took the company 15 years and the return of Steve Jobs to become relevant again. For now, Apple is more likely to adopt a hybrid model, finding a balance between vertical integration and outsourcing. It is no secret that the main contractor of the company is Taiwanese Foxconn, where 1.3 million people work, and the contractor itself is the third largest IT company in the world in terms of revenue. Ironically, right after Apple and Samsung themselves.

It is the late Jobs-style Apple that can be thanked for bringing vertical integration back into fashion after a long period of oblivion. Here is the only technological Tesla among automakers with its gigafactory (even if it is still running at 5%). And the aforementioned Amazon with its fleet of aircraft and robotic loaders (and an even larger set of cloud services, advertising networks, consumer electronic devices, a film studio, etc.).

We can’t forget about Netflix, which plans to spend most of its revenue on content production in 2017—$6 billion. And, of course, Google, which is launching a mobile operator, producing its own phones and at the same time trying to solve the problems of the world.

Tim Cook, who replaced Jobs, continued to do what he had done throughout his 13 years at Apple as COO — increase efficiency, maintain incredibly high margins, and manage sales. But the company completely forgot about innovation under Cook. And now Apple is forced to catch up with its sworn competitors from Google, and soon Microsoft. Vertical integration requires not only smooth operations, but also a clear long-term vision. And if you look at it, the most successful vertically integrated businesses of our time — Apple, Amazon and Tesla — were built by such leaders. Just look at last year's disputes between Tesla shareholders, after Elon Musk proposed a merger between Tesla and SolarCity, where he was also a co-founder and chairman of the board of directors. The merger of an electric car manufacturer and a solar energy generating company might have seemed like something out of science fiction just a few years ago. Even now, after Musk agreed on a $2 billion deal with other shareholders, I still can’t believe that he succeeded. Just as Bezos managed before him at Amazon when he launched cloud services, and how Jobs’s visionary vision once helped Apple become the most valuable company in the world.

But if for an established business vertical integration is often a logical step, among startups this approach has long been something of a taboo. An attempt to control the entire value chain in conditions of limited resources seemed utopian, and investors preferred to see narrowly targeted products and services of startups. But the achievements of large technology companies have made this strategy popular again. At the same time, until now greatest successes vertically integrated startups showed in online commerce. Typically, such companies produce and sell their products themselves. Here are Warby Parker, Bonobos, Casper, Shoedazzle and many others.

But perhaps the apogee of vertical integration of startups was the purchase of Harry’s (an analogue of Dollar Shave Club, acquired in 2016 by Unilever for $1 billion) of a German razor factory. Everything would be fine, but the startup, which sells razors by subscription, was only 10 months old at the time of the purchase, which cost $100 million, while the plant has been successfully producing razors for more than 90 years.

What vertically integrated fashion startups are doing in the world of online commerce was done long ago by the founder of Zara, Amancio Ortega. Full control over the chain of production and distribution of goods allowed the parent company Zara — Inditex — to grow into the largest clothing retailer in the world. Considering that online penetration in clothing already exceeds 25% in the states, young companies dream of repeating Zara's success in low-performing segments. Ironically, startups are best able to fight against the same vertically integrated businesses that once used the advantages of this model to squeeze all competitors out of the market. Consider the monopoly on the eyeglasses market or the oligopoly on the mattress market in the United States. In the world of eyewear, Luxottica produces in the same factory (and sometimes line) eyewear brands Prada, Chanel, Dolce & Gabbana, Versace, Burberry, Ralph Lauren, as well as Rayban, Oakley and many others. If you need an online metric, then this is 500 million audience wearing glasses of one company. Or 80% of the major brands segment. But to further control the value chain, Luxottica bought a significant share of eyewear retailers in the United States. Which ultimately provides the company with almost complete freedom in pricing its products (Luxottica’s gross margin reaches 70%).

It is clear that this situation could not help but attract the attention of entrepreneurs who are now all over the world trying to repeat the success of vertically integrated Warby Parker, which began selling its own glasses online, and is now opening dozens of offline stores a year (despite the fact that the level of sales in flagship stores stores per square meter is rumored to surpass the indicators of former leaders — Apple and Tiffany).

However, despite the possible advantages, it is worth remembering that vertical integration is usually extremely difficult to implement. The cost of a mistake when integrating different business segments in one company is high, and it is extremely difficult to deploy unfinished integration. Moreover, complex companies are often worth less together than they would be worth individually. One can recall at least the TripAdvisor spinoff from Expedia, when the travel giant's transactional content business surpassed its parent company in capitalization within a year and a half after its IPO in 2011.

It is generally believed that vertical integration has makes the most sense in poorly commoditized markets, in those segments where the share of unique developments is high. Therefore, the vertical approach is more often used in innovative industries, especially those where their own standards have not yet been formed. A recent example is largely the virtual reality industry. Key players — such as Oculus, NextVR, Jaunt, as well as their Russian counterparts Prosense and Fibrum — are partly forced to be in several segments at once.

The opposite is also true - the combination of businesses, albeit complementary, but without pronounced competitive advantages, does not always lead to success. Just remember the deal between AOL and Time Warner in the early 2000s. As is now the case with AT&T's purchase of Time Warner, the main theme of that deal was access to content. Today it seems incredible that an Internet provider with revenues of less than $8 billion bought one of the world's largest media companies for $164 billion. That deal was considered the worst in corporate history, and the idea of a merger was criticized many times.

But the lessons of the past are quickly forgotten and here again history repeats itself — just as AOL (which was recently bought by Verizon, AT&T’s main competitor) decided that the Internet alone was not enough for it and needed content in order to fill its channels, so now AT&T believes that vertical integration into content will allow them to gain significant competitive advantages. Megafon also seems to believe it - but frankly speaking, there is much more logic in the purchase of Mail.Ru - which controls almost all social traffic in Russia - than in the attempts of American telecoms to build their content vertical at the expense of stagnating businesses.

Vertical integration is when a company controls more than one stage of the supply chain. It is a process that businesses use to turn raw materials into a product and bring it to the consumer. There are four stages of the supply chain: commodities, manufacturing, distribution and retail.

There are two types of vertical integration.

Forward integration is when the company at the beginning of the supply chain controls the steps further down. Examples include iron mining companies that own downstream activities such as smelters. Backward integration is when the business at the end of the supply chain carries out activities "upstream". For example, when a movie distributor such as Netflix also produces content.

An example of vertical integration is a store such as Target that has its own store brands. It owns production, controls distribution and is a retailer. Because it cuts out the middleman, it can offer a product similar to the brand name product at a much lower price.

Manufacturers can also integrate vertically. Many shoe and apparel companies have a flagship store that sells a wider variety of products than you can get from a regular retailer. Many also have stores that sell last season's items at a discount.

Five advantages

Any of the five benefits of vertical integration gives a company a competitive advantage over non-integrated companies. Consumers are more likely to choose their products or services. Either the costs are lower, the quality is better, or the product adapts directly to them.

The first advantage is that the company does not have to rely on suppliers.

They are less likely to experience abuse from those who do not work. They can avoid frequent strikes and labor disputes from companies located in socialist countries.

Second, companies take advantage of vertical integration when its suppliers have great market power and can dictate terms. This is important if one of the suppliers is a monopolist. If a company can bypass these suppliers, it will bring many benefits. It can reduce internal costs and improve delivery necessary items. It is less likely that it will not have critical elements.

Third, vertical integration provides the company with economies of scale. This is when the size of the business allows you to reduce costs. For example, he can reduce the cost per unit by buying in bulk. Another way is to make the production process more efficient. Vertically integrated companies eliminate overhead costs by consolidating management.

Fourth, a vertically integrated retailer knows what sells well. It can knock off the most popular branded products. That's when it copies the ingredients or production process. He creates similar, yet branded, marketing messages and packaging. Only powerful retailers can do this. This is because brand manufacturers cannot claim copyright infringement.

They don't want to risk losing distribution through the retailer.

The fifth advantage is the most obvious to consumers. These are low prices. A vertically integrated company can reduce costs. He can pass on these savings to the consumer as more low prices. Examples include Best Buy, Walmart and most national grocery store brands.

Four Disadvantages

The biggest disadvantage of vertical integration is expense. Companies need to invest a lot of capital to set up or buy factories. They must then keep the plant running to maintain efficiency and profit.

This reduces flexibility. Vertically integrated companies cannot follow consumer trends that take them away from their factories. They also cannot change factories to countries with lower exchange rates.

The third problem is loss of focus.

For example, a successful retail business requires a different set of skills than a profitable factory. It's hard to find a CEO who is good for both.

It is also unlikely that any company will have a culture that supports both retail stores and factories. A successful retailer involves marketing and sales. This culture does not meet the needs of factories. Clash of cultures can lead to misunderstandings, conflicts and lost productivity. A non-integrated company may even use cultural diversity in the workplace to compete with a vertically integrated one.

The present stage of development of the world economy is characterized by the entry into a qualitatively new stage of its development. Qualitative changes are taking place in the structure and management system of large companies, which allow them to adapt to constantly changing conditions and increased competition.

In modern conditions, the market model, in which each enterprise is a separate and independent production unit, is not economically feasible for some industries. For many enterprises, the creation of vertically integrated companies is the most promising way out of the crisis. World experience confirms the feasibility of creating powerful vertically integrated holding-type structures.

The potential of integration processes in Russian economy was laid down by the chosen privatization strategy, during which an enterprise was considered as an object outside the system of its traditional, established economic relations, the significance of which is obvious.

The prerequisites for intensifying integration processes arose in 1998, after the August financial crisis, which increased the investment attractiveness of many sectors of the Russian economy.

At the present stage of the formation of market relations, the logical conclusion of the restructuring of large industrial enterprises in Russia according to the production principle is the creation of so-called vertically integrated companies - new and extremely important structural elements of the Russian economy and industry.

There is a need for research organizational structure, principles of corporate governance and financial and economic activities of vertically integrated companies, making it an atypical object of assessment.

The peculiarities of a vertically integrated company as an assessment object require improvement of the assessment process in order to increase the reliability of the final value.

A vertically integrated company as a special object of assessment

In the literature there are different, sometimes not entirely accurate, interpretations of a vertically integrated company (hereinafter referred to as VIC).

An integrated company is a company that combines several enterprises or production facilities. Various ways and forms of integration are known: horizontal integration, conglomerate-type integration, contractual relations, the creation of financial and industrial groups, etc. Vertical integration is a special form of association different from others, which has its own characteristic features.

Goldstein G. Ya. gives the following definition of vertical integration:

“The method by which a company creates (integrates) its own input stages of a technological chain (backward integration) or its output stages (forward integration).”

Stages of the technological chain and directions of vertical integration.

Integration can be complete or narrow. When full, all inputs or outputs are combined. An example of a narrow one is a company purchasing only part of the input elements and producing the rest in-house.

The main feature of the VIC is that it unites manufacturers operating at subsequent stages of the same production vertical.

Vertical integration takes place in following cases:

The lower division of the company (downstream) supplies 100% of the products (raw materials) for processing to the higher division (upstream) of the company in the form of intra-company supplies.
The upstream division of the company, which produces final products, purchases 100% of the raw materials supplied from the downstream division. The missing part of the raw materials can be purchased on the external market (outsourcing).
The division of the company that produces raw materials is obliged to supply it for processing within the company and cannot sell it outside the company, and the processing enterprise within the holding can purchase raw materials only within the company. Thus, with vertical integration, an alternative to the market is one of the company’s divisions, the creation of which is due to cost savings compared to market transactions.

VIC is a holding company, and not all holding companies are vertically integrated.

VIC is the most common form of integration in the Russian oil industry. Recently, integration processes have intensified in many sectors of the Russian economy: metallurgy, mechanical engineering, communications, energy, agro-industrial and financial sectors, and high-tech industries.

Analyzing the organizational and structural features of Russian VECs, we can highlight their common characteristic features:

1. The organizational and legal basis of vertically integrated companies is an open joint stock company of a holding type.

2. The core of the VIC is a set of enterprises that are successive stages of one production cycle and are interconnected by technologically necessary production connections.

3. One of the main natural elements of the system are natural resources.

4. The structure includes auxiliary and service industries that ensure the development of specialization industries and partly their own needs.

5. Production and cash flow management is carried out by the parent company.

Vertically integrated company- a complex organizational and production structure of a holding type with a single management center and a closed production cycle, uniting enterprises that are consistently involved in the production, sale and consumption of the finished product at subsequent stages of a single technological process, thus interconnected with each other by commodity and cash flows.

The study of the organizational and legal structure of the VIC and the specifics of the functioning of the VIC of Russia made it possible to identify the main features of the VIC as an object of assessment:

1. VIC is an investment holding company. In accordance with Guideline No. 6 of the ICSC Standards, the asset-based method should be considered when valuing controlling interests in investment or holding companies. Therefore, when evaluating VIC shareholdings, the result obtained by the net asset method should be considered as one of the main ones when calculating the final market value.

2. VIC, as a holding company, prepares consolidated and unconsolidated financial statements. A consolidated balance sheet prepared according to Russian standards is suitable for accounting purposes, but is not suitable for the purpose of assessing the market value of VIC.

Summary (consolidated) statements are understood as financial statements compiled taking into account the indicators of subsidiaries and dependent companies, but excluding a number of costs in the form of mutual settlements, etc. When preparing consolidated statements, the property of an enterprise in which the parent company has a participation share of 51% or more , is included in the consolidated statements in full (100%) composition. These statements combine all assets and liabilities, income and expenses of the parent organization and subsidiaries, and also take into account participation in affiliated companies. Consolidated statements compiled in this way are more suitable for accounting purposes, but are not suitable for assessing the market value of vertically integrated oil companies.

To assess the market value of VIC using a cost approach, it is better to use unconsolidated statements with subsequent adjustment of the value of assets.

3. VIC combines the structural links of one production and technological chain, the stages of which are controlled to one degree or another by one company.

4. The share of participation of VIC in the equity capital of dependent and subsidiary enterprises can range from a blocking to a controlling stake. VIC is the parent company in relation to the enterprises that are part of it. VIC manages the entire production process, product sales and cash flows through control over the financial and economic activities of the enterprises that are part of it.

5. VIC receives income from the functioning of the divisions and enterprises that are part of it. Thus, long-term financial investments in the form of investments in subsidiaries and dependent companies are the main income-generating assets.

6. One of the main elements of a vertically integrated system is natural resources. For companies in whose technological chain the initial product is natural resources, the rights associated with their use (for example, intangible assets in the form of licenses for the right to develop subsoil and extract minerals) are also the main income-generating assets.

7. The share of fixed assets in the VIC balance sheet is relatively small.

8. A large share of inventories may be presented in the form of finished products and goods for resale, the market value of which may differ significantly from the book value, which necessitates its adjustment when calculating using the net asset method.

9. The formation and accumulation of profits from the entire production and technological process of VIC is carried out by the parent company.

10. Within the VIC, the transfer pricing mechanism is widely used to optimize taxation. When forecasting the cash flow of VIC and its subsidiaries, products/services are taken into account not at market prices, but at transfer (domestic) prices.

11. Most of the enterprises that are part of VIC work on customer-provided raw materials. Payment for products/services of each individual production unit of VIC is carried out by the parent company. Thus, when forecasting VIC cash flow, the revenue/operating profit of each link in the VIC production chain is a cost to the parent company.

12. According to its organizational and legal form, VIC is a joint-stock company. The shares of most VICs in Russia are traded on the stock market and are liquid securities.

13. The main return on investment in minority stakes in VIC is generated by the increase in market value.

14. Subsidiaries and dependent enterprises are de jure open, but de facto closed joint stock companies. Therefore, to calculate the value of long-term financial investments in subsidiaries and dependent companies within the framework of the comparative approach, the peer company method can be used.

15. As part of the comparative approach, methods of correlation and regression analysis can be used.

Main factors influencing the market value of a vertically integrated company

We can distinguish two groups of factors influencing the market value of blocks of shares in a vertically integrated company, external and internal. Let's take a closer look at them.

1. External factors

1.1. Macroeconomic

This group of factors influences the market value of any valuation object. The main factors are the rate of change in GDP, the volume and dynamics of industrial production and investment, the volume of budget items and its execution, the refinancing rate, the inflation rate, and the ruble exchange rate against other currencies.

1.2. Industry

1.2.1. The conditions of the global and domestic market for the initial and final product (for example, oil and refined petroleum products) are one of the main industry factors influencing market value.

1.2.2. The market model influences the level of demand, supply and, accordingly, prices.

For example, the oil and petroleum products market is a standardized oligopoly. Oligopoly can be local, national or international. The pricing policy of producers in oligopolistic industries differs from the strategy of enterprises characteristic of a purely competitive market model. Oligopolistic prices are inflexible and “rigid”. When prices change in the market, firms change their prices together.

In localized markets, oligopolistic suppliers of standardized products set the same price level. When setting a price for an oligopolist, the most important data are costs and demand, but to this must be added the reaction of competitors. The firm's inability to predict with certainty the responses of its competitors makes it virtually impossible to estimate the demand and marginal revenue faced by the oligopolist. Without such data, a company cannot even theoretically determine the price and production volume that increase its profits.

Anti-dumping policy of importing countries; relationships with international organizations (for example, Russia’s obligations to OPEC member countries to limit oil exports).

1.2.3. Legislative and regulatory regulation of the activities of companies in the industry.

The state can indirectly influence the market and prices by setting taxes, excise taxes and export duties. For example, with a reduction in taxes on the development of unprofitable fields, we can expect an increase in oil production and supply on the market. And with an increase in export duties on oil and petroleum products, the attractiveness of operations in the domestic market may increase.

In order to ensure the normal functioning of the population and the functioning of economic sectors Russian Federation, creating conditions for the energy security of the state The Russian government regulates the oil and petroleum products market. Government measures include:

adoption of so-called “balance targets” for the supply of petroleum products;
artificial restrictions on exports;
mandatory sale of part of export proceeds;
requirement to pay the budget in cash.

1.3. General condition and stock market conditions influence stock prices.

2. Internal factors

2.1. The size of the block of shares and the set of rights arising from the shareholder.

The number of links in the production and technological cycle combined into a VIC and the direction of integration affect the value of VIC assets, the level of costs and the amount of income of the VIC, and therefore the amount of cash flows.

2.3. Market value of intangible assets in the form of licenses

Rights to use raw materials, which are often one of the main elements of mineral resources, are secured by licenses for the right to use subsoil; for the right to extract minerals. Many analysts view reserves as the most important component of VIC's corporate value.

Despite the fact that often the rights holder of licenses for the use of raw materials are the input elements of the VIC (for example, oil production enterprises), in world practice, raw material reserves are considered as the main asset of the VIC. This is due to the fact that VIC owns controlling stakes in enterprises engaged in the extraction of mineral resources, the main income from the use of which is received by the parent company.

2.4. The volume of long-term financial investments in enterprises that are the input stages of the production and technological process, and the share of participation in them.

Because VIC receives income from the operation of subsidiaries and affiliates; long-term financial investments in these facilities are the main income-generating assets and influence production volume, market share, the amount of VIC's income, and the formation of Goodwill.

2.5. Amount of investment in the production process.

Economically feasible investments of the parent company for new construction, expansion, reconstruction, technical re-equipment of subsidiaries reduce current cash flows, but are a factor in the growth of future income of VIC.

2.6. Production potential and efficiency of the initial link, for example, the volume of mineral reserves, as well as the volume of production of main types of products, services, starting from the initial product, including intermediate ones and ending finished products. These indicators influence the market value of long-term financial investments and VIC cash flows.

2.7. The value of intra-corporate and transfer prices, principles of intra-corporate management.

2.8. The issuer's relationship with small investors and dividend policy affect the value of minority stakes.

Improving methods for assessing vertically integrated companies

Under the cost approach, licenses are one of the main assets. Despite the fact that the rights holder of the licenses is often the mining divisions, the licenses can be considered as the main asset of the VIC. This is due to the fact that VIC owns controlling stakes in mining enterprises. The parent company receives the main income from the use of licenses.

The book value of licenses is an implementation of one of the methods for valuing intangible assets - the value creation method. Licenses have a certain utility. The usefulness of a license is that during its validity period it provides the opportunity to earn income from the extraction and subsequent use of certain natural resources.

Therefore, the cost of licenses (reserves at specific fields) should be analyzed from the point of view of projected income. The income approach may use the royalty exemption method. Before you begin evaluating licenses, you should familiarize yourself with licensing agreements, where the royalty rate and other stipulated payments under the license are indicated.

According to the Miller&Lents company, the royalty rate, for example, oil fields may be 10%.

Many analysts view reserves as the most important component of oil companies' corporate value. Therefore, the proven reserves method is of particular relevance.

The proven reserves method is one of the modern methods of the income approach, which allows one to calculate the present value of future income from the exploitation of mineral deposits. It is used to assess the market value of a controlling stake in VIC, in production cycle the basic element of which is natural resources.

Source of information - reserve assessment report.

The following categories of reserves are included in the calculations:

1. Proved Reserves

1.1. Proved Developed Producing

1.2. Proved Developed Nonproducing

1.3. Proved Undeveloped

2. Probable

3. Possible

Currently, investors are interested in total proven reserves. The assumption of the method is a constant price case, i.e., no significant changes in raw material prices, cost increases, capital changes or taxes relative to the date of the forecasts.

Future net income is projected as follows:

Total income (inventory volume * price - transport costs - export and customs duties - port taxes - VAT and excise taxes - special taxes)

royalty (10% of total income)
total costs:
operating costs (may be average annual operating costs for the previous period)
wear
restoration costs, resource renewal
commercial and administrative costs
interest paid on short-term loans
and other costs (eg taxes).

If information exists on field production volumes for each year of the forecast period, cash flows can be forecast for each year of the forecast period. The forecast period is the life of the deposits.

One of the modern areas of assessment is the use of regression analysis methods in the process of cost calculations equity. The need for a significant amount of information explains the possibility of using and the significance of the method specifically for assessing VIC.

We can distinguish the main stages of calculations based on the regression model:

1. Collection of primary information.

2. Conducting correlation analysis.

3. Selecting a model and assessing its parameters.

4. Analysis of the quality of the resulting model.

5. Calculation of the variable value based on the constructed model.

When estimating using the DCF method, peculiarities arise in the calculation of VIC cash flow.

1. VIC income is generated through the sale of products of the mining or processing unit on the market at market prices.

2. Most of the enterprises that are part of VIC work on customer-supplied raw materials.

3. Payment for products/services of parts of the production and technological process is carried out above cost, but below market prices - at transfer (domestic) prices.

4. Payment for products/services of each individual production unit of VIC is carried out by the parent company. Thus, when forecasting VIC cash flow, the revenue/operating profit of each link in the VIC production chain is a cost to the parent company.