Retailing

“Importance of
Vertical integration
in Retailing”
Submitted by:

Nelum Shehzade
Maryam Choudhary
Vertical Integration:

The degree to which a firm owns its upstream suppliers and its downstream buyers is
referred to as vertical integration. It is also referred to as an approach for increasing or
decreasing the level of control which a firm has over its inputs and distribution of
outputs. [1]
Vertical integration is of two types: backward integration and forward integration. A
firm’s control of its inputs or supplies is known as: backward integration. A firm’s control
of its distribution is known as: forward integration.
The strategic reasons for opting for a vertical integration strategy have changed over the
years. During the 19th century, firms used vertical integration to achieve economies of
scale. During the middle of the 20th century, vertical integration was used to assure a
steady supply of vital inputs. In some cases, the theory of transaction cost economics was
applied to backward integration or forward integration, as a means to total cost reduction.
That is, it was cheaper for a firm to perform the role of suppliers and distributors than to
spend time and money to interact with such parties. Subsequently, in the late 20th
century, competition intensified in most industries. Corporate restructuring resulted in
vertical disintegration by reducing the levels of vertical integration in large corporations.

Drivers of Vertical Integration:

Multiple factors contribute to the establishment and continued existence of large
integrated firms despite inherent inefficiencies. These can be described in terms of
reduced costs, weak supply networks, increased market power, and government policy.
These factors are important during the early stages of an industry.

Cost reductions:
Integrated firms have a cost advantage over smaller firms by avoiding transaction costs in
imperfect markets, particularly during early stages of market development. Transaction
cost includes ‘the cost of measuring output in all of its dimensions and the consequence
of not measuring it perfectly’. Costs like writing, monitoring and enforcing contracts with
supply chain and other partners. Such costs further intensify under conditions of
specialized assets, complexity, uncertainty, and information asymmetry and these costs
are applied to the transactions with suppliers and customers. This is the reason why larger
firms can become suppliers to global firms.
Integrated firms avoid the high transaction costs often linked with the activities that
require highly specialized assets. Specialized assets make each party vulnerable and costs
like writing, monitoring and enforcing contracts take place. And when a company decides
to outsource then a supplier would be reluctant to invest in the equipment that cannot be
used for any other purpose or for any other customer and highly asset specific in that
conditions firms become there own suppliers.
Vertically integrated firms also benefits from reduced costs through economies of scale,
improved capacity utilization, decreased labor costs, lower raw material procurement
costs etc. the highly integrated Ford motor company utilized economies of scale to
provide better value at lower prices to achieve market dominance. And large integrated
textile firms in America in 1800’s were better able to obtain stable supplies of reliable
yarn then smaller scattered firms.
Offensive Market Power:
Since large integrated firms have increased access to resources like finances, human and
technology and they have more bargaining power, therefore, they are better positioned to
develop markets for the new products
Highly integrated firm Bird’s Eye pioneered the frozen food industry by developing a raw
material supply network, introducing new harvesting and freezing technologies, building
product awareness and establishing specialized warehousing, transportation and retail
equipments for handling frozen foods.

Government policy:
Large integrated firms influence and benefits from government policies. In the early
stages of industrial development capital, labor and product markets as well as regulatory
environment are poorly developed and hence governments have greater control over the
allocation of resources. Larger firms in such emerging markets benefits from government
policies and gradually become more vertically integrated and horizontally diversified.
Large vertically integrated firms are likely to emerge in high scale economy industries, in
situations where premium products are being pioneered.

Because it can have a significant impact on a business unit’s position in its industry with
respect to cost, differentiation, and other strategic issues, the vertical scope of the firm is
an important consideration in corporate strategy.

LITERATURE REVIEW AND THEORETICAL FRAMEWORK:

Vertical integration is a corporate strategy that has been misunderstood. [2] .It has long
been a key force in the development of high productivity and managerial sophistication in
U.S. business (Chandler, 1977). Vertically integrated corporations have been key engines
of change in the past and have enhanced shareholder wealth (Lubatkin, 1982). Oftentimes
researchers did not recognize that vertical integration could be an effective strategy,
provided it was used prudently, because they often took an overly aggregated view of it.
Vertical integration can offer temporary state-of the-art advantages that must be weighed
against the advantages of being flexible to exploit the next technological innovation.
Firms that commit early to vertical integration, linking themselves in a highly inflexible
fashion to a particular technology, risk being wrong, and the cost could be substantial.
But if these pioneers are right, vertical integration can be a rationalizing device that form
order in disordered environments, establishes industry standards, or lowers operating
costs significantly. Then the harm of late entry can be substantial. Thus, firms should
build pilot plants early to learn about suppliers and distributors before competitors can
match these intelligence gains with their own experience.

An over view of the economy shows that industries operating in

relatively stable environments with large capital investments continue
to remain integrated, while firms with volatile markets in rapidly
changing technological thresholds have moved away from it. [3].Mining
and oil exploration are two industries which continue to operate on a
highly integrated level.

A vertically integrated firm controls a number of different operations in the production

and/or marketing of similar commodities on successive levels; and its management
pursues a unified profit policy. Werner Z. Hirsch (1950). It should be pointed out,
however, that vertical integration may take place in the direction to the ultimate
consumer, to the major raw materials, or in both directions simultaneously. Backward
vertical integration exists if the unit which initiated the vertical integration is closer to the
ultimate consumer than any other unit. On the other hand, forward vertical integration
exists, if the unit which initiated the vertical integration is further away from the ultimate
consumer than any other unit.[4]. The fact is that there exist very few examples of such
purely vertical integration. A very important reason for the lack of large purely vertically
integrated firms seems to be the fact that a substantial volume has to be handled by the
firm before vertical integration can be introduced profitably. Large production or
marketing volume is usually associated with multiple plants (horizontal integration), or
multiple commodities (complementarity), or both.
The process in which several steps in the production and/or distribution of a product or
service are controlled by a single company or entity, in order to increase that company's
or entity's power in the marketplace.

By their ‘make or buy’ decisions firms decide their degree of vertical integration.[5]. This
analyze the vertical integration strategy from a long-term profit-maximization
perspective, It arguments for a long-term analysis rest on two premises: (a) strategy, by
definition, relates to the future, which is almost always different from the present; and (b)
strategic decisions imply resource commitments, few of which can be revoked without
incurring some costs. A far-sighted firm, therefore, will base its vertical integration
decision not only on the current technological conditions, but also on the anticipated
changes in these conditions. The focus of the paper is, in short, why certain investments
in the long run would be more attractive to integrated firms than to independent suppliers.
And the result shows that to analyze the vertical integration strategy from a technological
and competitive perspective. Two main results are that:
1. Especially if the degree of competition is high, integration is affected negatively by the
frequency of technological change;
2. The optimal level of integration depends negatively on the degree of competition in the
industry.
The findings suggest that firms should scan outsiders frequently to assess whether some
activities could be done by others more cheaply than in-house. Broad integration will
likely have to give way to narrower breadths of integration as industries mature, lest
vertical integration strategies create exit barriers and cash traps instead of guaranteed
sources of resources and markets. Vertical integration is not a costless strategy.[6]
Although it apparently can provide benefits through pioneering, industry rationalization
and the creation of entry barriers, results suggest vertical integration should be adjusted to
changing conditions.

Theoretical studies show that firms’ propensity to vertically integrate might be affected
by transaction costs; imperfect competition and imperfect information [7].(Perry (1989)
& Stigler (1951) provides very early work on vertical integration, deliberated on the
theory using arguments rooted in his interpretation of Adam Smith’s theorem that ‘the
division of labor is limited by the extent of the market’. In the same study, Stigler also
provides several testable implications and evidence of the theory. Notably, however,
Stigler makes no direct reference to the transaction cost motive for vertical integration.
Levy (1984) re-examines Stigler’s work and clearly links Stigler’s hypotheses to the
transaction cost theory. Since then, the transaction costs hypothesis has become the
subject of many (if not most) empirical tests on the theory of vertical integration where it
appears to have received strong support (e.g. Kirkvliet, 1991; Lieberman, 1991; Caves
and Bradburd, 1988). Unfortunately, empirical tests on this subject have relied primarily
on firm and industry data from the developed countries. To the authors’ knowledge no
empirical evidence on this subject has been published using data from developing
economies. This is the case despite a strong possibility that part of the measurement
methodology adopted by previous empirical studies might not be applicable in a
developing country like Malaysia. The empirical test results appear to lend support to the
general hypothesis that transaction costs can increase the propensity for vertical
integration. The test was conducted by running both the fixed-effects and random-effects
Regression models using data from Malaysian manufacturing.

An advantage of the vertically integrated organisational marketing

system is that it forces senior managers to embrace cultural
differences and produce a culturally sensitive leadership style.[8]. This
should result in best practice being achieved that ultimately results in
products and services that meet customer expectations. Staff in the
collectivist oriented vertically integrated organisational marketing
system will be able to formulate and implement marketing strategies,
and can develop a hybrid organisational culture that draws on the best
characteristics from staff in partnership member organisations.

The plant level studies has pointed to a variety of factors being related to integration,
including asset specificity, supply uncertainty, market power, incomplete contracting,
transaction costs, and regulation.[9]. Despite this, there is little systematic micro-level
evidence on the ways production in vertically integrated firms differs from that of
unintegrated producers in the same (narrowly defined) industries. This applies not only to
differences in hard-to-measure attributes like capital specificity, contracting
environments, and transaction costs, but even to more basic features like scale, factor
intensity, and productivity.

Thornton’s strategy of vertical integration provides a number of differentiating

characteristics while at the same time avoiding the consequences of market power and
value appropriation in product and supply markets.[10] The company under review in the
article gains benefits from the integration of activities and is able to access customer
feedback to assist the processes of product and service innovation. Overall the company’s
in-house strategy is consistent with the competitive, technological and supple context in
which it operates. Within retailing more choice is apparent, however the occasional loss
of franchised outlets and questions of sustainability and quality have determined the
decision to follow a retail strategy largely based on shop ownership.
The problems of focus and investment may present particular difficulties for the
vertically integrated organization when seeking to address the longer term changes that
occur in competitive environments.

Partnership arrangements such as vertically integrated organizational marketing systems

provide staff in a retailing organization with a means for working closely with staff in
supplier organizations and the manufacturer. This type of partnership arrangement, which
is common practice in Japan and South Korea, provides organizations with a marketing
oriented focus; a commitment to customer relationship management; and places decision-
making within a strategic marketing framework. It also embraces developments in
technology utilization such as the internet and supports the development of joint project
units.

As the rivalry among retailing companies increases, it is likely that staff in retailing
organizations will both embrace and adopt the strategic marketing approach, and use
scenario planning to aid the decision-making process.[11]. By working closely with
marketing strategists based in the manufacturer and linking with staff in the suppler
organizations, it is vertically integrated organizational marketing systems possible to
utilize the organizational learning approach that ensures that all staff in the partnership
arrangement are marketing oriented and that the marketing intelligence activity becomes
more research focused. The advantage of staff adopting a pro-active approach to research
is that it will allow marketing trends to be identified and training support systems to be
put in place. This will ensure that the right level of managerial skills and technical
marketing skills are available when required. An advantage of the vertically integrated
organizational marketing system is that it forces senior managers to embrace cultural
differences and produce a culturally sensitive leadership style.

The case of Bread Markets, is a pioneering study of changes in the market structure of
grocery retailing, Mueller and Garoian compared the earnings of grocery chains from
1950 to 1958 with those of three supplier industries, baking, dairy, and meat packing and
found a gradual deterioration in the latter industries' earnings relative to those of grocery chains
to examine some of the consequences of oligopolistic competition and vertical integration
in bread markets.[12]
Empirical evidence is drawn from a recent study of the baking industry. Attention is
focused on the changing market structure and the associated changes in market conduct
and behavior. The central objective is to determine whether changes in selling costs and
prices support the hypothesis stated earlier-that increased vertical integration by chains
has increased competition and improved performance in the food industry.

Fashion apparel makers have used vertical integration to their advantage in this volatile
and highly competitive environment. It gives them superior capability to respond quickly
to competitors and to disrupt the status quo. More specifically, these firms have used
vertical integration to escalate competition within the arena of timing and know-
how.[13].And in so doing, they have been able to achieve superior customer satisfaction.
By linking design and production closely to retailing through integration, they are better
able to manage flexible production to meet emand volatility. The operational flexibility of
the integrated firms matches the flexibility required by their competitive environment
(Volberda 1996). Integration of manufacturing and retailing provides the controllability
that is needed to achieve the overall operational flexibility of quick response.

E. Avenel & S. Caprice , analyze product line differentiation between retailers competing
on a vertically differentiated market. It include the analysis the vertical relations between
retailers and manufacturers.[14] This feature proves to be crucial for the determination of
product line differentiation. In particular, it find an equilibrium in which product lines are
partially differentiated, which is a new result. Analysis suggests that exclusive dealing
should be banned per se, while a rule of reason approach should be adopted toward
vertical integration. This is related to the fact that integration doesn’t necessarily imply
foreclosure.

Most of the firms dislike to rely on there competitors for supplies therefore recent
corporate restructuring indicates that this reluctance can make vertical integration
unprofitable.[15]. For instance the desire to sell to competing downstream firms
motivated AT&T’s separation from lucent technologies, Pepsi Co; spin-off of the Tricon
restaurants in addition to these spin-offs, firm’s reluctance to purchase from competitors
may be one of the reason that some business-to-business are jointly owned by parties
most likely to use the exchange.
Incomplete contracts explain how vertically integrated firm could favor its own
downstream unit over competing downstream unit however profit maximizing firms do
not have an incentive to do anything including exploit contractual incompleteness that
reduce profits. Thus contractual incompleteness cannot explain why a vertically
integrated supplier would favor its own downstream unit when such favoritism reduces
the integrated firm’s profits.

We’ll see a case of a person named Carlos he had dreamed about vertically integrating his
mango and pineapple fruit plantation and export business into further processing of pre-
cut fruit. His business sold fresh fruit to brokers in various Caribbean countries and the
United States. Moving into the pre-cut fruit market would require all of the company’s
capital and management expertise. It offered a great deal of potential because of the
added value but there were risks involved in such a venture. As CEO of Telesignos, he
was constantly looking for new business opportunities. Vertical integration into
production of pre-cut fruit would permit Telesignos to capitalize on its potential growth
opportunities. [16].However, forward vertical integration required high capital
investment, fruit processing skills, a favorable image, and access to new markets. The
shareholders of Telesignos could provide the money to build a fresh fruit processing
facility. Carlos had gathered a great deal of information about the fresh pineapple (fruit)
industry. There were many things to consider before becoming vertically integrated like
Production and Technology, Market Environment and Opportunities, etc

The variables identified by Casson are used to project the extent of backward and forward
VI at the manufacturer level and the extent of backward integration at the retail level.[17]
Backward VI by retailers into the wholesaling function is significant.
Retailer Vertical Integration: Backward VI by retailers will decrease slightly. Factors that
will discourage vertical integration include the increasing number of products included in
retail stores, The minimum number of stores required to enter a new market, the
increasing size of food retailing firms, and the future growth of retail food sales. These
factors will interact with the increasing concentration of food retailers, the importance of
quality control among generic brands, and the existence of past VI by retailers. The
management expertise required for undertaking VI will be fully employed when
managing new superstores that have more products and which may also be involved with
managing the firm as it merges horizontally with other retailers. The net effect will be a
slight decrease in VI.

In Agricultural production: (backward integration).Vertical integration will increase

slightly in the crop portion of agriculture. Causes of VI increases in the crop category
include the perish ability of vegetables, the concentration and capital intensity of
processed manufacturers and the discontent among farmers with respect to prices
received (Marion, p. 169), the concentration at the manufacturer (processor) level,
continuous flow economies, and the variability in supply due to weather.

The economic forces which led to massive vertical integration in the commercial broiler
industry describes the importance of vertical integration. [18].There are some of the long-
run social, political and economic implications of this particular example of vertical
integration in agriculture. vertical integration means any arrangement by which a
decision-maker in one stage of production acquires control of inputs, processes, or output
levels in a vertically separated stage. Vertical integration embraces control by acquisition
of facilities used in the separate stage, by contracting these facilities, or by an informal
understanding kept effective by mutual benefits.[19]. Decision-integration is much more
important than ownership integration in agriculture. In the decisions type of integration,
ownership is not necessarily passed from one decision-making firm to another. The
essential element is that decisions (especially output decisions) of two or more units are
coordinated through contracts or agreements. [20].

To study the Forces Leading to Vertical Integration assumption of a hypothetical broiler

industry without vertical integration, and subject this industry to realistic conditions, and
isolate some economic forces leading to vertical integration. The development partially
follows suggestions by other authors and particularly by Collins, Kohls, and Trif0n. His
findings are that Vertical integration and horizontal amalgamation may eliminate the
traditional social-political role of “farmer” in the broiler industry. Vertical structuring
does not eliminate an important social problem associated with periodic over-expansion
of the broiler industry. Vertically integrated broiler firms may extend their activities into
other sectors of animal agriculture, but none of the sectors inherently have advantages of
vertical integration comparable to those in the broiler industry.

Economedies shows that the vertically integrated firm will always have an incentive to
impose costs on its down stream rivals throught non price dis-crimination[21]

The dangers of vertical integration in the presence of environmental instability have

recently been the subject of much attention in the policy literature (Hayes and Abernathy,
1980; Porter, 1980: 309-315; Marrigan, 1983a,b). The argument made by these
researchers is essentially that irreversible investments are vulnerable, if there is
uncertainty about their future value.[22]
In order to clarify this some careful theoretical reasoning is necessary. According to the
standard analysis of Williamson (1975), uncertainty will, in general, lead to more vertical
integration. The basic argument is that an independent supplier will demand a reasonably
complete long-term contract before committing to investments in an idiosyncratic asset.
As the number of contingencies in the contract goes up, it becomes more expensive to
write, monitor and enforce so that vertical integration becomes more attractive. The
predicted positive relationship between general uncertainty and vertical integration has
been demonstrated conclusively by h'lasten . For a particular type of uncertainty, the
possibility of technological obsolescence, the relationship does, however, reverse. In this
case more uncertainty does not increase the number of contingencies in a hypothetical
contract with an independent supplier; it only makes the single contingency more likely.
Furthermore, as the likelihood of obsolescence goes up, the expected profitability of the
investment goes down, and with it the incentive to bargain and hence the gains from
vertical integration.

In particular instances, it is obvious that vertical integration does contribute to functional

efficiency. A unified control over a sequence of operations may promote efficiency of
physical processes by eliminating unnecessary handling, by making the flow of goods
more regular,or by adapting quality more closely to use.[23]. Unity of control may
promote efficiency in business operations by eliminating unnecessary sales effort or may
facilitate more exact planning which can reduce inventories and minimize idle time.

The vertical integration in general does not entail a reduction in output and an increase in
price in the product market if the assumed condition is met.[24].The condition is that
vertical integration does not affect the production function of the firm in question, so that
vertical integration neither causes economies nor diseconomies of scale. Economies of
scale following vertical integration favor an increase in output and a reduction in price in
the product market. Diseconomies of scale following vertical integration, on the other
hand, have an opposite effect on output and price in the product market.
Firms vertically integrate to create specific investment between stages
of the value chain, to internally exploit their pool of knowledge and
capacities, and to guarantee quality of inputs and services employed.
On the other hand, firms avoid high levels of vertical integration in the
presence of high demand changes in order to stay flexible. Finally,
providers or clients with market power do not seem to affect vertical
boundaries in any consistent way.[25].

A New Look at Vertical Integration

The old concept of vertical integration as being 100 percent owned operations that are
physically interconnected to supply 100percent of a firm's needs is outmoded. Under
appropriate circumstances, quality control and access to stable supplies can be obtained
through quasi-integration arrangements. Firms could contract for R&D services, for
example, to utilize the technology of genetic engineering in product development, or they
could form joint ventures to obtain this capability. Firms could have components
engineered to their tight and highly specific instructions by outsiders, as do Japanese
automobile manufacturers, for example. And if their bargaining power is sufficient, firms
can use a kanban or "just in time" system of inventory controls that shifts the burden of
holding costs to their suppliers.
If firms prefer not to use outsiders as extensions of their corporate entity, a variety of
other vertical arrangements are possible. Some firms may conclude that they need not
undertake certain activities at all. In other situations, firms may find that they can enjoy
the integration economies, uncertainty reduction, competitive intelligence, and other
benefits that internal vertical linkages may provide through outsiders. The key in using
vertical integration is recognizing which activities to perform in-house, how to relate
these activities to each other, how much of its needs the firm should satisfy in-house, how
much ownership equity needs to be risked in doing so, and when these dimensions should
be adjusted to accommodate new competitive conditions. Briefly, the concept of vertical
integration should be expanded to include a variety of arrangements by which the firm
can use outsiders, as well as its own business units to counterfeit an optimal vertical
system for supplying goods, services, and capabilities.

VERTICAL INTEGRATION AND LOCAL VIEWPOINT:

Chenab Ltd:
Chenab Ltd., Faisalabad, Pakistan is a US$83 Million textile company with annual sales
in excess of US$85 Million and a market presence of over 28 years. With vertically
integrated manufacturing facilities of Ginning, spinning, weaving and processing they are
by all means, the largest textile company in the region with a capacity to process 4.5 to 5
million meters per month of finished fabric. 12 years ago, was established a dedicated
apparel garment division. This division has now grown exponentially and in the process
of becoming one of the major backbones of the company. Why do companies like
Tommy Hilfiger, JC Penny, Wal Mart, Sears, Kellwood, QVC, Federate, Ikea, GDC, L.A
Intimate, VF, Roman’s Lerner, and Lane Bryant prefer to buy from Chenab Ltd. The
fashion industry in the world is very dynamic and highly competitive. At Chenab, they
keep a constant watch on the pulse of the global fashion industry. This proactive approach
germinates commitment towards innovation and continuous product development. This
exceptional team consists of a unique mix of individuals from different fields such as
textiles, designing and marketing. Chenab combine these expertise to produce a creative
value chain, whereby an idea generated by technical personal. This value is further
enhanced by marketing personal that creates technical viability into fashion and so the
journey of thought to fabric is completed and today’s idea becomes tomorrow’s fashion.
This value addition is finally materialized edge in the fashion world by providing them
with unique products to work with.

Their Technical Assets have a state of the art processing & Dying. All dyes and chemicals
are European origin. They have in house quality control and assurance lab which is fully
equipped with latest testing machines and tools. This lab is comparable to any other
textile lab in the world. Made up divisions have been equipped with all the required
modern machinery i.e. quilting, embroidery, e-cording, Stitching, Pleating, Button
Holing, Button Fixing, Safety over lock, Steam press, Cutting and Packing machines.
Some of products are Comforters, Quilt Cover, Flat Sheet, Fitted Sheet, Curtain, Shower
curtain, Valance, Pouf Valance, Bed Skirts, Sofa cover, Table Cloth, Cot Bumper, Pillow
Cover, Sham, Napkin, Oven Gloves, Bed Spread and a lot more.

Usually, textiles manufacturing companies consider themselves to be in the business of

selling fabric. But the basic business policy of Chenab Ltd is to develop long-term
business relationships with customer and the only way to achieve this is to ensure
customer satisfaction. Hence they provide unmatched customer service along with timely
deliveries. ChenOne (Changing lifestyles) the fashion brand of Chenab Ltd was launched
in 1997 in Pakistan & Middle East. ChenOne has established itself for ladies, gents &
kids garment as well as home linen. In few years the brand has taken the market by storm
and is already a preferred choice of the fashion conscious people. The total number of
outlets has gradually grown. And they are performing all these activities because they are
highly integrated to provide consistent products to the customers.

Being a vertically integrated manufacturing facility gives Chenab an edge unparalleled by

any other company in this region. Being a proactive company, they continuously invest in
the development of new products and new ideas. Their own Ginning, Spinning &
weaving plants allow them to create an array of weaves with different types of
yarn/fibers. They own there own outlets around the country by the name of ChenOne as
mentioned above as well therefore they are doing both backward and forward integration
at the same time and benefiting from them.

Case about Two Large Integrated Players of Foot Wear Industry in

Pakistan:
(And how they decided to de-integrate certain activities)
Pakistan has the footwear market of more then 150 million pair/year. There are three
different classes of suppliers to this market i.e. the informal sector, the small
manufacturers and the large integrated units. The informal sector consists of over 17000
units, each with an average of two employees. These firms generally pay no taxes, and
mainly sell non-branded shoes through cobbler shops. In addition there are about 500
small manufacturers who distribute through wholesalers or their own outlets. And there
are two large integrated manufacturers, with almost 20% market share and sell through
there own national distribution network. But recently they have started outsourcing there
certain activities we’ll further see why this is happening to the two large integrated
players.

Early vertical integration:

Bata (Pakistan) was established in Batapur (near Lahore) in 1942 as a branch of Bata of
British India in Batanagar, as a part of Bata international headquartered in Toronto,
Canada. Bata Pakistan becomes an independent firm after partition. Service Industries
was established in Gujarat in 1954. Bata is twice the size than Servis with the share like
10% versus 6% respectively. Both were vertically integrated firms, with company owned
leather tanneries, shoe manufacturing, and retail network. Both made strong brand image
by providing consistent shoe quality at affordable prices and through extensive
advertising.
Smaller non integrated manufacturers were unable to compete with Bata had Servis. To
produce reliable shoes, access to high quality leather is required which involves quality
leather tanning which require imported chemicals, and expensive equipments. There were
only 5 tanneries in Pakistan in 1947, thus small manufacturers does not had any access to
quality leather. Initially Servis followed the strategy to open the outlet right next to Bata’s
therefore in 2002 Servis had 260 stores while Bata had 350 and planned to grow by about
30% in next few years. Small manufacturers without access to such retail networks had to
depend on the wholesalers who often defaulted or delayed payments also low cost capital
and imported technology available were lacking for them.

Gradual de-integration:
In 1980’s leather and footwear industry expanded and markets became more efficient.
Smaller manufacturers who do not had access to quality raw materials, low cost capital,
imported technology and distribution networks gained access to that, and developed
specialized expertise. Therefore Bata and Servis faced who were facing competition from
these smaller firms as well as imported footwear started developing supply networks to
remain competitive.
During 1981 to 1992 the no of tanneries tripled (from 180 to 509), making quality
finished leather widely available to footwear manufacturers.
As a result of the changed economics of vertical integration during the eighties, both Bata
and Servis started a process of de-integration in the late 1990s. Bata diversified out of
leather tanning in 1996 and embarked on a program to increase outsourcing to specialized
vendors and there labor force decreased by 20%. In 1965, the marketing and distribution
division of Servis was formed into a separate company: Service Sales Corporation (SSC).
In 1998, SSC became an autonomous body and by 2002, SSC had increased the value of
products being produced from outside the Servis group to 30%
Outsourcing at Servis & Bata:
In 2002, both Servis and Bata carried about 1500 SKUs each, grouped broadly into 6
categories. Each of these 6 categories is characterized by different production
technologies, and market characteristics. The outsourcing decision for each product
category by Servis and Bata also varies depending on scale economies, transactional
costs and proprietary knowledge. (Shown in the fig below)
The combination of low scale economies, low transaction costs, and minimal proprietary
knowledge has resulted in Women Sandals & Slippers being one of the first choices for
outsourcing by both Bata & Servis. Men Moccasins have production characteristics
similar to Women Sandals & Slippers. However the large lot size allows for assembly
line manufacturing, resulting in higher scale economies. Also the longer product life
cycle of Men Moccasins result in more strict quality requirements thus outsourcing was a
viable option. All others are produced in-house.

Summarising the findings and importance of Vertical

integration in retailing from the literature review:
 • Reduce transportation costs if common ownership results in closer geographic
proximity.1
• Improve supply chain coordination.2 .
• Provide more opportunities to differentiate by means of increased control over
inputs.3 .
• Capture upstream or down stream profit margins.4.
• Increase entry barriers to potential competitors.5.
• Facilitate investment in highly specialised assets in which upstream or down
stream players may be reluctant to invest.6.
• Lead to expansion of core competencies.
• Minimization of risks factors. 7
• Monopoly .8.
• Branding benefits
• Flexibility 9.
• Economies of scale and Economies of scope.10

Vertical integration could be the possible best solution in the emerging economies but in
developed economies it does not always work because of the competition and many other
factors as we have seen in the case of Bata and Servis that they were highly integrated but
when faced competition they also had to outsource some of there activities. The findings
suggest that firms should scan outsiders frequently to assess whether some activities
could be done by others more cheaply than in-house. Broad integration will likely have to
give way to narrower breadths of integration as industries mature, in case vertical
integration strategies create exit barriers and cash traps instead of guaranteed sources of
resources and markets. Vertical integration is not a costless strategy. Although it
apparently can provide benefits through pioneering, industry rationalization and the
creation of entry barriers, results suggest vertical integration should be adjusted to
changing conditions.

Notes
1. Integration in practice-the broiler case (W.R.henryand robertraunikar 1960)
2. Impacts of Vertical Integration on Output Price and Industry Structure J. A. Seagraves; C. E. Bishop
3. Vertical Integration and the Monopoly Problem (Corwin D. Edwards1953)
4. Technical Change, Competition and Vertical Integration (Srinivasan Balakrishnan; Birger Wernerfelt (Jul. -
Aug., 1986)
5. Vertical Integration and Production: Some Plant-Level Evidence . Ali Hortaçsu , Chad Syverson 2007
6. Technical Change, Competition and Vertical Integration (Srinivasan Balakrishnan; Birger Wernerfelt (Jul. -
Aug., 1986)
7. The effects of vertical integration on price and output .S. y. wu’
8. Vertical Integration and the Monopoly Problem (Corwin D. Edwards1953)
9. Vertical Integration and internet strategies in the apparel industry. Robert . H. Gertner & Robert. S . Stillman.
10. Vertical Integration and the Monopoly Problem (Corwin D. Edwards1953)

References
[1] Toward a Definition of Integration , Werner Z. Hirsch

[2] Formulating Vertical Integration strategies: Kathryn Rudie Harrigan

[3] The evolution of vertically integrated organizations: the role of historical context.
Ashay Desai & Ananda Mukherji

[4 ] Technical Change, Competition and Vertical Integration Srinivasan Balakrishnan;

Birger Wernerfelt (Jul. - Aug., 1986)

[ 5] Matching Vertical Integration Strategies to Competitive Conditions:Kathryn Rudie

Harrigan

[6 ] Toward a Definition of Integration , Werner Z. Hirsch

[7 ] Vertical Integration, Foreign Multinationals and Stigler’s Hypotheses: An Empirical

Test Using Malaysian Data*
Nor Ghani Md. Nor, Ahmad Zainuddin Abdullah and Khalil Md. Nor

[8 ] Vertically integrated organisational marketing systems: a partnership approach for

retailing organizations . Peter R.J. Trim

[ 9] Vertical Integration and Production: Some Plant-Level Evidence . Ali Hortaçsu ,

Chad Syverson 2007

[10 ] Thornton’s: the vertically integrated retailer, questioning the strategy (David
Fennings)

[ 11] Vertically integrated organisational marketing systems. Peter R.J. Trim and Yang-Im
Lee

[12 ] Some Consequences of Bilateral Oligopoly and Vertical Integration in Bread

Markets. Richard G. Walsh; Bert M. Evans; Eleanor M. Birch

[13 ] Vertical Integration and Rapid Response in Fashion Apparel

James Richardson

[14 ] Vertical integration, exclusive dealing and product line differentiation in retailing E.
Avenel & S. Caprice
[ 15] Vertical enclosure: vertical integration and the reluctance to purchase from a
competitor .D. Lee Heavner

[16] Vertical Integration in Ecuador: The Case of Fresh-Cut Pineapples

Carlos F. Piana, Allen M. Featherstone, and Michael A. Boland

[17] Vertical Integration in Agricultural and Food Marketing Richard L. Kilmer (Dec.,
1986)

[18 ] Integration in practice-the broiler case: W. R. Henryand Robertraunikar .

[19] Impacts of Vertical Integration on Output Price and Industry Structure

J. A. Seagraves; C. E. Bishop

[20 ] Vertically integrated organisational marketing systems: a partnership approach for

retailing organizations. Peter R.J. Trim, Yang-Im Lee

[21 ] Regulation, Vertical Integration and Sabotage: Randolph Beard,

David.L.Keserman, John .W. Mayo

[22 ] Technical Change, Competition and Vertical Integration Srinivasan Balakrishnan;

Birger Wernerfelt (Jul. - Aug., 1986)

[23 ] Vertical Integration and the Monopoly Problem (Corwin D. Edwards1953)

[24 ] The effects of vertical integration on price and output . S. Y. Wu’

[25 ] Explaining Vertical Integration Strategies: Market Power, Transactional Attributes

and Capabilities . Isabel Díez-Vial