Friday, October 20, 2006

What The Hell Does Vertical Integration Mean?

At the end of yesterday's blog, I quoted the Financial Times, saying: "So far, the [media] industry's responses have fallen into three main groups: horizontal integration, vertical integration, and the search for new sources of revenue."

What the hell does that mean?

Fortunately, the university at which I took my undergraduate degree demanded that I take two semesters of Economics--both macroeconomics (the big picture economy) and microeconomics (companies up close and personal). In my micro class, I learned the difference between vertical integration and horizontal integration.

We know that "horizontal" refers to something that occurs on one plane--flat and even. Horizontal integration means expanding one's business by acquiring businesses on the same level. These businesses can be similar (the acquisition of multiple newspapers in different markets) or different (the acquisition of radio stations in addition to the newspapers you already own. Here, both are in the same broad type of business--news distribution--even though they specialize in different mediums).

Horizontal integration can mean increased power in the market (look at the clout that Wal-Mart has as the result of its huge network of stores) as well as economies of scale (look at any company that has regional distribution centers) and of scope (the sharing of resources among similar businesses).

One of the pitfalls that a horizontally integrated company can face is when it so completely dominates a particular market that the government begins to think of it as a monopoly needing to be broken up into its constituent parts (remember the breakup of the phone company?).

According to the Financial Times article I referred to, "the logic behind horizontal integration is this: in a fragmenting market, media companies can no longer reach a mass audience with a single flagship programme or publication. Instead, reach comes from a portfolio of media properties, each targeted at a different group, across a range of platforms."

If you're a regular reader of this blog, you will remember the series I did called "The Long Tail" (see my posts for July 13, 14 and 15). Chris Anderson's new book, The Long Tail, talked about exactly this point. Niche markets across a wide spectrum may prove more valuable to a company over the long haul than a single large market (an example might be selling multiple midlist books rather than seeking the single blockbuster DaVinci Code).

Vertical integration, on the other hand, refers to the expanding of one's business by acquiring businesses at different levels along the industry's chain. Those irritating MBA types refer to these as upstream suppliers or downstream buyers. To complicate things further, they also talk about forward integration and backward integration.

To make it simple, picture a vertical chain with your newspaper (since we're talking media) at the center. Upstream refers to your suppliers (perhaps a paper company). Downstream refers to your distribution network (perhaps newstands). If you integrate upstream (say you buy your own paper company), you're going backwards to your supplier. We, therefore, refer to it as backward integration. If you integrate downstream (perhaps you buy a network of newstands), you're going forward to your distribution network. We, therefore, refer to it as forward integration.

Vertical integration is about cost and control. Companies who vertically integrate are trying to assert greater control over their business. The obvious benefit is that they can capture the profit margins at each step along the chain. They can also make it harder for competitors if they can gain access to a scarce resource. The drawbacks include that the organization now becomes much more complex, and the owners assume more risk by sinking more and more assets into this one industry rather than diversifying.

The Financial Times had this to say about vertical integration: "Vertical integration, the marriage of content with distribution, is an alternative approach . . . the argument for vertical integration is based on market power. Distributors might hope to strike better deals with content providers if they have content of their own to offer in return."

Tomorrow, we'll try to apply this knowledge specifically to the media industry.


lainey bancroft said...

I'd love to comment intelligently, but I'm afraid I'm still stuck at the "What the hell..." part.
That's what happens when you indulge in an education where 'economics' means budgeting so you have weekend entertainment (read cocktail) money left at the end of the week!

I'll most definitely stop back in tomorrow and see if I can have a 'light-bulb' moment :P

Anonymous said...

Another definition of vertical integration is an acquisition that secures either a distribution channel (forward vertical) or a supply chain (backward vertical).

I'm doing economics at a pre-uni level at the moment, can you tell? LOL.

Another thing we could discuss would probably be publishing with regards to monopolistic competition.

Maya said...

Lainey: Sorry I wasn't clear enough. I'll start tomorrow with a post especially for readers who might need a better explanation.

May: Thanks for your help. Appreciate the input.