What is vertical retail?
Vertical retail is the concept of the entire supply chain of a retail organisation being vertically integrated. This means that a single retail organisation controls the entire flow of goods, from design to sale.
Leading retailers in fashion & sporting goods are vertically integrating their supply chains and seeing great results, even amidst difficult trading periods, because of their increased margins and ability to modulate their supply.
Vertical retailers are some of the most resilient and profitable organisations globally. They are also some of the most disruptive and thereby controversial organisations.
Just consider the likes of SHEIN and Inditex Group’s Zara. These companies operate their own design, production, logistics and have nobody coming between them and their end consumer.
Unsurprisingly, Inditex Group is publicly traded at a valuation well above 75 billion euros and SHEIN, in just 10 years since being founded, was recently evaluated at 100 billion euros.
How does vertical integration work?
Vertical integration works by taking over control of additional stages from within your existing supply chain. In doing so, middlemen are cut out and these stages become an incorporated part of the now growing organisation.
Generally speaking, all retailers are vertically integrated to some extent. Consider the designing of goods being combined with the selling of goods to a wholesaler, with manufacturing, distribution and eventual consumer sales being outsourced. This is a partial vertical integration.
Close control of the design and manufacturing process can enable more agile processes catered for quick turnarounds or changes in demand.
The next actions for further vertical integration might involve any of the following:
- Setting up or buying a factory to integrate manufacturing
- Opening retail locations or a webshop to integrate selling to the consumer
- Buying a logistics center along with trucks to integrate the distribution
Benefits of vertical integration
In this way, a company may become increasingly vertically integrated. In turn this creates a greater level of control over the whole supply and distribution process, and this results in benefits for several large areas of impact:
- Keeping the profit margin of each stage
- Controlling costs via control over the process
- Ability to invest in process bottlenecks directly
- Competitive advantage by delivering profit to customer through savings
- Ability to tailor processes to one goal for efficiency and productivity
- Improved quality control and predictability
What is a vertically integrated supply chain?
A vertically integrated supply chain controls all the stages from a product’s design and manufacturing through to selling to the end-consumer.
Companies who get to this level of holistic integration have overcome many challenges along the way. They are often very large organisations in terms of headcount and generate large revenue numbers at relatively high margins.
One of the biggest opportunities for today’s supply chains, when aiming for complete vertical integration, is the prevalence of data throughout their organisation. In turn, it is also one of the biggest challenges.
A smooth flow of information and the translation of this data into coordinated and meaningful actions is absolutely mission critical for vertical integration to succeed.
Good examples of fashion companies with a vertical integration structure
There are numerous examples of vertically integrated businesses. They include some of the highest-valued companies on the equities markets and some of the most successful fashion and sporting goods brands.
H&M and Zara are two excellent examples of vertically integrated fashion brands, which have excelled in good years, and survived the bad ones with an agile and vertical supply chain.
The fact that they do this in different ways to each other shows there is ample room for variation when it comes to vertical expansion.
How does Zara use vertical integration?
As the largest company in the Inditex group, Zara operates a vertically integrated business that controls all design, production, warehousing, logistics, and distribution processes for the 450 million items sold annually in their stores.
How Zara leverages vertically integrated production & distribution
The company leverages nearshored production located close to the distribution HQ in Spain. Using centralised logistics, Zara provides regular small-batch deliveries that arrive at stores on time.
Ownership of the whole process enables the efficient arrival of items at the store, already labelled and priced.
The deeply engrained, regular rhythm of these deliveries ensures other tasks can be planned and managed around them, with positive effects on worker efficiency and profitability.
Zara maintains an agile approach that can be optimised with a vertical structure; designs can turn into trend-dependent items on the store shelf in a matter of weeks.
Some 85% of their factory capacity is reserved for the ability to turn around in-season stock adjustments, meaning the brand can remain flexible regarding frequency, quantity and variety.
The results of Zara’s vertical integration
The ability to respond to demand almost in real-time means Zara has a stunning sell-through rate: 85% of their stock is sold at full price – way above the industry average!
The company is ranked as #41 of the most valuable brands on this 2020 Forbes list (coming just after Ikea), and actually improved its position from 2019, when it was #46.
That was during the pandemic period.
Zara succeeded during this tough year, partly by having a strong online sales segment, and the brand also made plans for closing 1000 stores to focus on expanding their online sales even further.
H&M’s inventory management and vertical integration
Unlike Zara, Swedish fashion brand H&M does not own factories, but outsources their supply processes. This is a good example of a collaboration-powered vertical model. The company keeps close control over the process, using strong links with around 850 independent suppliers.
The power of H&M’s data-driven supply chain
Powered by a rich exchange of information and widespread digitisation, the company maintains overall control and oversight regarding matters like environmental impact and working conditions.
Designers in Sweden have real-time insights into factory capabilities and stock levels of raw materials (which H&M procures throughout the season), meaning orders are sent to the factories best able to efficiently produce those goods.
Their design strategy is more focused on long-term range planning than Zara, but the designers also have an agile strategy for the production of real-time design for latest trends. Items intended for the long-term assortments are produced in Asian factories, and shipped by sea.
By contrast, short-term, trend-driven items are designed and produced with a quick turnaround in smaller batches in European factories, travelling by rail to reduce carbon footprint.
How H&M’s leverages vertically integrated production
H&M leverages a flexible production strategy, with 80% made in advance and 20% produced afterwards based on trend success. All goods arrive at regional replenishment centres, which operate ‘lean’, with minimal buffer stock, using a centralised inventory management.
The whole setup requires extensive coordination and a free flow of information among all stakeholders. For this reason, the company has invested heavily in a powerful centralised IT system that enables overview and control over the whole process.
Why H&M and Zara both benefit from vertical integration
Although H&M’s vertical structure is not ‘fully owned’, the collaboration of partners with fully-aligned objectives (delivering what the customer wants) means the structure operates in concert.
Both H&M and Zara are thriving, thanks to a finely-tuned vertical structure.
Examples of vertical integration structures in other industries
Retailers within fashion & sporting goods industries looking to find opportunities for vertical integration will also find plenty of inspiration in other industries.
We are going to look at two very different companies, IKEA and Netflix, drawing learnings from both examples.
How IKEA tackles their vertical integration challenges
Vertical integration is essential to IKEA’s success. With their innovative supply chain, they have altered the way the furniture industry works, and the way interiors look, forever.
To get to that level of vertical integration, they have had to overcome many challenges along the way. The solutions to these challenges have become integral parts of their supply chain.
In looking at two interesting challenges, we will show you how they solved them:
Logistical challenges of delivering large, heavy goods
They leveraged their business model by turning their points of sale into massive warehouses.
Customers decide on their demands in showrooms and pick up the final product from the actual warehouse shelves right away, allowing IKEA to minimise its handling and transportation costs.
By combining warehousing and retail space the company requires a minimal amount of real estate and associated costs. And, most importantly, it allows IKEA to effectively maintain great throughput of inventory across their supply chain.
Product design challenges of creating durable yet cheap furniture
Through a massive vertical integration strategy, IKEA became one the largest consumers of wood in the world. They built plants capable of pulverising wood into dust and manufacturing many multipurpose boards at once.
The particle board also allowed IKEA to minimise the package dimensions of its furniture, reducing shipping costs, inventory space, and creating a product that IKEA’s healthy and fit millennial customers could bring home in their cars and assemble themselves.
Through strategic integration of its production and distribution processes, IKEA managed to become the king of low-cost quality furniture, while being able to position itself as an environmentally-friendly and innovative brand.
This competitive edge has only grown bigger in the decades since its rise.
Netflix and the vertical integration of content production
Another great example of vertical integration is Netflix. The company started as the first ever DVD rental business through direct mail. Then, when the world’s internet speed was ready for it, they moved into online streaming of films and movies licensed from major studios.
At this point, they looked at their supply chain, which was now largely a digital one. They saw that they could improve their margins by producing their own original content.
Starting with a collaboration with Adam Sandler for his 2014 Happy Madison movie, they began cutting out the middlemen needed for content production.
Instead of continuing to rely on others for the production stage of their supply chain, Netflix vertically integrated to become the world’s largest movie producer in sheer volume of titles released.
How we can help you find opportunities for vertical integration in your retail supply chain
How to win at vertical integration as a retailer
Being more vertically integrated means your company needs to be more collaborative internally. Each department can then operate in close alignment, using a rich exchange of information to achieve common end goals. Digital transformation is an important step in this journey.
This has advantages beyond increasing throughput and profit – the whole organisation becomes much more effective too. With a free flow of information it’s easier to work in alignment.
All stakeholders are then focused on the end goal: targeting the ideal customer. All aspects of the supply chain can be fine-tuned to this end, and this ultimately has better results for all links in the chain.
How we can help you get massive results with vertical integration
There are many possibilities for vertical expansion, such as ‘direct-to-consumer’ offensives, or expansion into omnichannel sales.
A task force needs to examine the whole process with a sharp focus on how they are serving the end consumer. This means you need to conduct an audit of your supply-chain and operation strategy, a retargeting of your operating model, and widespread digitisation.
Bringing all stakeholders into this enterprise helps to clarify to all parties that the conversion of sales does not happen when product is passed to the next link in the chain, but when it actually reaches the end consumer’s hands.
At Retailisation, we can help you establish this task force and get organisational clarity. Using data insights, we make consultative recommendations to help you shorten lead times, increase throughput and maximise Return On Inventory.
As an expert in retail and supply chain management, I can attest to the profound impact that vertical integration has had on the retail industry. The evidence lies in the success stories of major players like Zara, SHEIN, H&M, IKEA, and Netflix, all of which have embraced and leveraged the concept of vertical retail to enhance their operations and gain a competitive edge.
Zara and SHEIN: Pioneers of Vertical Integration in Fashion
Zara and SHEIN stand out as prime examples of vertically integrated fashion retailers. These companies have not only disrupted traditional retail models but have also demonstrated exceptional resilience and profitability. By controlling every stage of the supply chain, from design and production to logistics and distribution, they have achieved remarkable success even during challenging economic periods.
Zara, in particular, has showcased the power of nearshored production and centralized logistics. The company's ability to deliver small-batch, trend-dependent items to stores in a matter of weeks has led to an impressive sell-through rate of 85%, well above the industry average. Zara's vertical integration has contributed to its position as one of the most valuable brands globally, with a market valuation exceeding 75 billion euros.
H&M: Collaborative Vertical Integration Model
H&M provides another fascinating example of vertical integration through collaboration. While not owning factories, H&M has established strong links with around 850 independent suppliers, showcasing a collaboration-powered vertical model. The company's data-driven supply chain, with real-time insights into factory capabilities and stock levels, allows for efficient production planning and order allocation.
H&M's flexible production strategy, with 80% of goods made in advance and 20% produced based on trend success, reflects the agility that vertical integration can bring. The company's emphasis on a powerful centralized IT system demonstrates the importance of information flow in achieving successful vertical integration.
IKEA: Revolutionizing Furniture Retail Through Vertical Integration
In the furniture retail sector, IKEA stands as a testament to the transformative potential of vertical integration. Overcoming logistical challenges associated with delivering large, heavy goods, IKEA turned its points of sale into massive warehouses, minimizing handling and transportation costs. The company's vertical integration strategy also addressed product design challenges by becoming a major consumer of wood, allowing for innovative and cost-effective furniture production.
Netflix: Vertical Integration in Content Production
Moving beyond the realm of traditional retail, Netflix exemplifies vertical integration in the digital age. Initially a DVD rental business, Netflix transitioned to online streaming and, recognizing the potential for higher margins, ventured into original content production. By cutting out middlemen in content production, Netflix became the world's largest movie producer by volume, showcasing the adaptability and profitability of vertical integration in a digital supply chain.
Benefits of Vertical Integration: A Universal Theme
Across these diverse examples, the benefits of vertical integration emerge as a universal theme. Companies that control the entire supply chain enjoy advantages such as maintaining profit margins at each stage, cost control, investment in process bottlenecks, competitive advantage through savings, and the ability to tailor processes for efficiency and productivity. Additionally, improved quality control and predictability contribute to the overall success of vertically integrated organizations.
In conclusion, vertical retail is not merely a trend but a strategic approach that has consistently demonstrated its efficacy in enhancing operational efficiency, profitability, and adaptability in an ever-evolving retail landscape. The success stories of Zara, SHEIN, H&M, IKEA, and Netflix serve as compelling evidence of the transformative power of vertical integration in the retail industry.
