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The food industry was hit hard by myriad challenges last year, like the rising cost of energy, labor shortages, and squeezed supply chains resulting from the war in Ukraine and shortages from Asia. The German consumer association recorded a food price rise of more than 21% in the past year up to November 2022. The complex reasons for this increase can be traced throughout the entire food value chain that includes the producers of consumer packaged goods (CPGs) and the food retailers themselves. As a result, retailers and food and beverage CPGs have been forced to react and put a brake on prices charged to increasingly cost-conscious customers, and address recent supply shortages.
One response has been to extend vertical value chains by establishing closer relationships with suppliers, clients, or both. While a growing number of companies are entering into or strengthening such arrangements, some of the most successful companies in the marketplace have been right at the forefront of this development.
By looking at recent examples of vertical integration in the food and beverage industry, this report breaks down the underlying strategic rationale behind these moves. At the same time, it explains why retailers should consider vertical integration as an astute response to current market instability.
Vertical integration can span the upstream activities performed by suppliers (backward integration), or downstream activities such as e-commerce and direct-to-consumer (forward integration). In terms of execution, this can involve anything from strengthening a long-term relationship to fully-fledged mergers and acquisitions.
Whatever the selected course of verticalization, the associated risks might be significant and need to be considered upfront. This is especially the case when it comes to an acquisition, which not only places a heavy financial burden on the purchasing company, but often also demands capabilities beyond a company’s core competencies. Moreover, even a long-term supply agreement can limit the flexibility of a CPG or retailer, and even restrict their ability to take advantage of better prices if market conditions change.
There are five major strategic rationales to answer the question how companies can justify taking these risks, especially in strained economic times:
The rising costs of sourcing and production have placed pressure on retailers and on food and beverage companies. By strengthening vertical integration and eliminating players along the value chain, companies can cut supplier margins and realize efficiencies through supply centralization, overhead cost reduction, and the resulting economies of scale.
Supply bottlenecks were rife during the pandemic years. Vertical integration can be used as a means to strengthen supply security and resilience. Put simply, partnerships with suppliers, or even owning them, can significantly reduce the risk of stock-outs.
Sustainable products and environment-friendly value chains are a must in order to satisfy the demands of stakeholders and customers alike. Vertical integration gives companies more control in this respect. It also makes the origin and footprint of sourced goods more transparent, a benefit much valued by health-conscious and environmentally-aware consumers.
Rapidly evolving customer needs and technological developments demand much shorter innovation cycles. By controlling the various steps in their supply chain, food companies and retailers can acquire the necessary agility and speed to react to emerging trends.
Forward integration can make it easier for companies to get closer to consumers and glean invaluable insights. The consumer access and data afforded by forward integration allow companies to forge direct sales and create a much more tailored offering.
When implemented well, vertical integration can be a powerful tool for strengthening the business model of retailers and CPGs. However, before rushing to incorporate vertical integration within a company’s strategy, three key issues need to be addressed.
The skills needed will vary depending on the chosen form of vertical integration. Some of the most crucial capabilities include negotiation skills and partner management, managing the organizational aspects of the integration, or the business skills specific to the nature of the companies being acquired or partnered with. Companies will need to be fully persuaded that the time, money and effort spent on building up the skills will be amply repaid by the expected benefits.
Full acquisition/
greenfield
Acquiring/ building companies active along the value chain
Joint
venture
Collaborate with suppliers and other industry partners
Minority equity
share
Investing into equity deal based upon a green- or brownfield approach
Non-equity
partnership
Entering into strategic partnerships without equity commitment
Long-term contract
manufacturing
Tailoring the supplier's products to the retailer's specific requirements
Long-term supply
agreements
Establishing long-term relationships to develop supplier capabilities
Due to tough market conditions and intensifying competition, vertical integration will certainly attract an increasing amount of interest from retailers and CPGs in the upcoming year. By pursuing such integration in a considered way, these companies are expected to outperform rivals by reducing costs, safeguarding supply, boosting innovation, improving sustainability and transparency, and building closer links with the consumer. To fully benefit from its advantages, companies need to be open to the various forms it can take. Only then, they will be ready to adopt bold and assertive strategies and thereby seize the initiative in the marketplace.
Sebastian Weber and Hannah Ableidinger co-authored this report.