What Are the Real Benefits of Vertical Integration in a Retail Supply Chain?

This year I was invited to SCOPE East, a peer led conference focusing on supply chain issues from strategic, tactical, and operational points of views. At this conference, I was able to attend multiple educational tracks ranging from retail to consumer goods. One of the tracks that got my attention was about vertical integration in the retail supply chain presented by luxury goods retailer and manufacture Tiffany & Co.   Organizations with vertical integration strategies control the input and output of the supply chain, meaning it owns the supply of the raw material and has the ability to distribute its finished product. By having vertical integration, companies are able to have full visibility into their operations at every level of the business, be it growing or finding raw material, manufacturing, transporting, marketing, or retailing. Every one of these processes is managed by the organization when a vertical strategy is used. It is critical for a retail business to have a vertically integrated strategy with competitive pricing.

Vertical integration is not a new concept or strategy. Surely many companies are thinking about it from economical and competitive points, but in the presentation I attended few key benefits were discussed with reference to cost and customer service by Joe Shearn, VP of distribution at Tiffany & Co.

  1. Cost benefits for Tiffany & Co. were in the following areas:

    • Ability to have control on a selection of diamonds being exploited from the mines.

    • Direct fulfillment of raw diamonds from the source (a “middle man” isn’t needed).

    • Understanding what the demand is versus the capacity available to fulfill the demand based on the manufacturing and distribution infrastructure.

    • Capable of selling off any excess of non-Tiffany & Co. quality stones to other organizations in the luxury goods industry.

  2. Customer service benefits seen by Tiffany & Co. by using vertical integration:

    • Able to provide a quality product that has a tight margin at a competitive price to the consumer without jeopardizing the product or service quality.

    • Knowledge of the product from origin to destination. This means that in order to ensure a long lasting product, the customer will be able to get history on the diamond (e.g. where it came from, where it was manufactured, how it made its way to the final stage, and which distribution facility fulfilled the delivery).

    • Tiffany & Co. can offer its customer a wide range of assortments of diamonds due to the ability to handpick and select right from the source of the raw material.

    • Capable of handling any upside in demand. Tiffany & Co. is able to see what is in the pipeline and what is being exploited within the mines.

All the above reasons are great for cost and customer service benefits, but does it make sense for organizations to move away from their core competencies of designing and manufacturing quality luxury goods products?

In my opinion, there is no such thing as a completely integrated organization. The issue is not a choice of being vertically or horizontally integrated, rather it is a matter of selecting the optimal degree of vertical integration. Furthermore organizations needs to be cautious about  keeping a balance between load and capacity—even though everything is under one organization, this will not eliminate all the pains and headaches  caused by changes in demand, regulation and unforeseen events (war, mine explosion, etc.) .

When an organization is in the process of deciding if they should vertically integrated and to what extent it should be done, the following should be considered:

  • Is it going to be cheaper in the long run if we control the inputs and outputs?

  • Is it going to make the organization’s operations efficient by controlling the inputs and outputs?

  • Does an organization gain a competitive advantage over its competition by being vertically integrated?

I’m interested in what kind of integration strategy your company has opted for: vertical, horizontal, or do you think it’s a hybrid of both. Let me know your thoughts.
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