Vertical Versus Horizontal Integration: What To Consider When Building A Product (2024)

As a growing company building a new product, you’ll be faced with an important decision.

You can build the majority of the product on your own, which is known as vertical integration. Or, you can order most of the components from vendors, and then assemble them into your final product — otherwise known as horizontal integration.

While this applies readily to hardware, it also applies to software products.

One of the best examples of vertical integration is Apple.

They create premium products by tightly controlling their supply chain, setting strict requirements for the few vendors they rely on.

They build a lot of the components themselves, so their products feel high-quality and are well put together. The hardware and software operate seamlessly because they were designed specifically for each other.

On the other end of the spectrum is horizontal integration.

This includes products such as Android phones made by LG and Xiaomi, or PCs made by HP or Dell. These products don’t have the same look or feel as Apple products, but they’re much less expensive. The components are more standardized, and they typically come from a large number of vendors.

These products get the job done, but it would be rare to see any Android fanatics spending days in line waiting for a new phone.

There are significant differences in the products, target customers, and correspondingly requirements for both vertically and horizontally integrated products, so it’s a good idea to carefully consider what you’ll need before you make a decision.

Here’s how each strategy stacks up when it comes to building a product:

The difference between vertical and horizontal integration comes down to how much you can do yourself.

Vertical integration requires you to build nearly everything on your own.

You may use a few generic components, but your company will need to put a lot of resources into finding vendors who can create the custom and specialized components your team has designed.

This can be risky because you have to build many components yourself, and you may not always find a good vendor. As a result, you’re out of luck if one of your vendors can’t fulfill an order.

Are you financially, organizationally and operationally setup for that? Apple is — but they’re a trillion-dollar company.

Since you have all the specializations needed to build a premium product, it becomes harder to build products at scale. Your volumes will be lower. Just look at how Tesla has struggled to mass produce its vehicles and compete with less-specialized auto manufacturers.

Avoiding manufacturing issues is part of the allure of a horizontally-integrated business.

Using existing components from outside vendors means your primary goal is assembling the components to create your final product. There’s little risk if a vendor goes out of business or can’t deliver the necessary components, because many others can offer a similar part or service.

Building a product this way also has an advantage when it comes to getting issues fixed. You have less control over your vendors and the quality, but you have more options to choose from if something goes wrong.

With a horizontally-integrated product, your goal is to get the components at the best price possible. This allows you to focus only on what you’re really good at and what gives you the highest return. While you may develop some of your own secret sauce, it’s typically not enough, so it’s harder to differentiate your product.

A vertically-integrated product has more custom components and interfaces. Since you want to build a tightly-coupled machine that works perfectly, know you will spend money on custom interfaces within components. For example, Apple makes its own custom CPUs, GPUs, and displays.

On the other hand, if you’re a horizontally-integrated product you will strive for standardized interfaces. That enables you to use different vendors, take on less risk in your project plan, and scale very quickly. But understand you’ll be in the volume game and will have lower margins.

A horizontally-integrated company will generally focus more of their resources on operations, procurement, and supply chain organization.

Their aim is to minimize risks and costs while ensuring the right components are procured. Those are more important than the product R&D process inherent in a vertically-integrated company where you want to produce or procure the best component that works for you.

You’ll also need to carefully consider the cost of your product and how that will affect your pricing.

Vertical integration generally leads to a more expensive product. The costs required to develop and build custom components are incredibly high, so they have to be passed along to the consumer. That’s why the latest iPhone is upwards of $1,000. You will retain higher margins to compensate the company for all the work you did.

Focusing on the best working product does give a vertically-integrated company a competitive advantage, however. The business develops its own unique, dedicated market segment.

For instance, there really is no competitor for the MacBook because many people don’t want to purchase a $2,000 Dell laptop.

While a low price point can be seen as a disadvantage for horizontally-integrated products, the advantage is being able to tap into the wide network of vendors.

Your company can negotiate with vendors to get the lowest possible prices for components, which allows you to assemble a much less expensive product. The focus isn’t on building the highest-quality product available — it’s about keeping costs down by using standardized components and interfaces.

Your product is also not that differentiated so you will have more competitors, lower margins, the value-conscious customers.

It should be no surprise that with these differences in pricing come differences in the customer base, as well.

When it comes to laptops, there’s a market segment for $500–700 PCs. But there’s also a market for $2,000 MacBook Pros.

Both segments exist and have a large customer base. Some people are willing to pay more for brand and quality, while others want an affordable product that gets the job done.

With vertical integration, you control the overall customer experience by optimizing for a specific selection of components. Your goal is to create a product that gives customers an above-and-beyond experience.

Horizontal integration requires trade offs in customer experience.

You’re aiming to produce a general-purpose product, so the components may not be perfectly optimized for each other. This can negatively impact the overall experience and cause pushback from customers. However, this product works for value-conscious customers who have different expectations from the product.

In the case of vertically-integrated products, it’s just one company creating products.

The potential for scaling is limited because you’re restricted by how much the vendors can produce. With horizontally-integrated products, your company and your competitors can scale production very quickly, which is why there are so many Android and PC laptop vendors.

Since there multiple vendors selling horizontally-integrated products, the overall ecosystem is much larger. In case of vertically-integrated products, there’s a limit to the amount of products one company can sell, so the ecosystem is smaller.

While deciding what customers you want to attract, keep in mind that it’s tough to move from a vertically-integrated strategy to a horizontal one — and vice versa.

A horizontally-integrated company can’t simply raise their prices to compete with higher-end products because their brand is perceived as a value brand.

For instance, Toyota wouldn’t be successful if they offered sedans that are twice the price of a Camry. People don’t associate the brand with luxury vehicles. In fact, Toyota had to create an entirely new brand and product line, Lexus, in order to compete.

But it’s relatively easier for a vertically-integrated company, such as Tesla, to create a lower-priced offering like their Model 3. Customers still associate the brand with the cohesiveness of design and quality of experience their higher-end models are known for.

Just know, this move doesn’t always work.

Apple tried targeting value customers with the iPhone 5C — a cheaper phone with a plastic body instead of metal. However, it was a failure since customers in that market segment prefer Android phones.

Ultimately, the question of which route to take for the product you plan on building really comes down to your individual company. No matter which you choose, understanding the tradeoffs and what makes you attractive to customers will help you best position your product.

For diving deeper into the nuances of this conversation, I suggest listening to this A16Z podcast, which inspired many of my thoughts.