Ferrero Group, a chocolate and confectionary company, was launched in 1946 by Pietro and his son Giovanni Ferrero. Pietro launched the company with a solid piece of “Pasta Gianduja,” chocolate that was made into loaves and then sliced and placed on bread (Hazra & Jain, 2016). It was learned that this product was often eaten without bread, which led to the creation of a spreadable chocolate, named “Supercrema Gianduja” (Hazra & Jain, 2016). Today, this is known as Nutella. Ferrero group has been successful in the creation of many products which include Ferrero Rocher, Kinder Surprise, Raffaello, Kinder Bueno, Mon Cheri, Kinder Chocolate, Kinder Pingui and Tic Tac (Ferrero Group, 2017).
Since Ferrero products’ major ingredients include cocoa, hazelnuts, sugar and palm oil, they have strategically placed their factories near areas where the sourcing for these products is high (Ferrero Group, 2017). Ferrero Group owns 22 factories in Europe, Russia, North America, Australia and South America. Ferrero Group’s popularity with Nutella, has allowed their sales to reach 170 countries and accounts for 20% of their turnover (Ferrero Group, 2017).
The creation of Nutella requires a large amount of hazelnuts as each container of the product requires 97 nuts (Hazra & Jain, 2016). Due to this high demand, Ferrero Group is the largest hazelnut buyer, acquiring 25% of the world’s supply (Ferrero Group, 2017). Oltan, a Turkish company that supplies, processes and sells hazelnuts, supplies 70% of its nuts for Ferrero Group (Hazra & Jain, 2016). In 2016, Oltan Group had a kernel selection plant, hazelnut procurement plant and five cracking plants. Of the worldwide supply, Oltan Group produces about 33% Turkey’s hazelnut exports (Ferrero Group, 2017).
In 2014, Turkey had low temperatures late in spring which caused unexpected heavy frost on the hazelnut crops. Although hazelnuts are tolerant to frost, the late season temperature change destroyed the hazelnut crops, reducing the typical 800,000 tonne supply to 520,000 tonnes (Hazra & Jain, 2016). Due to a change in supply, the price of hazelnuts nearly doubled (Ferrero Group, 2018).
Climactic changes and seasonal variations of Ferrero Group’s raw materials means strong price variations to manufacture their products (Ferrero Group, 2018). The cost of these materials experience volatility (Ferrero Group, 2018). In an effort to help level the price variations, Ferrero Group had to consider options to control the price of their hazelnut supply.
Advantages and Disadvantages of Vertical Integration
The devastation of hazelnut crops in 2014 was not the first time such issue had happened. Ferrero Group considered vertical integration as a means to help their company with price fluctuations of their products as the objective of such strategy is to help reduce or eliminate the buying and selling costs associated when different companies have their hand in the production of the product (Buzzell, 2014). Such considerations were the advantages and disadvantages of this strategy.
As vertical integration is a means to help reduce production costs, this was one advantage of this strategy. By owning multiple stages of the production cycle, elimination or reduction of transaction costs was a great advantage. The elimination of most sales force, advertising, sales promotion and market research add to the reduction of transaction costs as Ferrero Group would manufacture their materials as well as produce the finished product (Buzzell, 2014).
The guarantee of supply is an essential piece to Ferrero Groups sales. These critical materials are needed, and vertical integration could ensure the company maintains its needed supplies. As Ferrero Group has faced this dilemma in the past with the devastation of the hazelnut crops, this strategy would help eliminate or greatly reduce the fluctuation of their supplies.
Vertical integration could also help improve coordination (Buzzell, 2014). Although the supplies are guaranteed, you may also experience a cost reduction by way of improved coordination between inventory scheduling during production. When dealing with independent suppliers, you do not have the downstream manufacturing which can help schedule production more efficiently (Buzzell, 2014).
Another advantage of vertical integration is gaining economies of scale (Amadeo, 2018). By having the ability to buy in bulk, this can help lower their per unit cost (Amadeo, 2018). This is an important advantage Ferrero must consider as one of their weaknesses is lack scale (Ferrero Group, 2018). Although their revenues come in across the world, their competitors far surpass the revenue of Ferrero Group, therefore having accesses to better financial resources (Ferrero Group, 2018). By building scale, it gives them brand power to recreate popular products being sold by their competitors. A vertically integrated company can take those products and make them cheaper, rebrand it and sell it as their own (Barney & Clark, 2007).
Although there are many advantages of vertical integration, there are also disadvantages. The biggest disadvantage of vertical integration is the cost of doing so. A great deal of capital must be invested to vertically integrate (Buzzell, 2014). Consideration must take place on the possibility of each stage of production having varying degrees of operations to function efficiently (Barney & Clark, 2007).
Each stage of production has its particular capability, which means when one vertically integrates, they must go through the long and sometimes difficult process of learning those capabilities (Barney & Clark, 2007). Oftentimes, this learning process cannot be ‘short circuited’ therefore, decisions that take place before this learning curve takes place, can have major negative impacts to the company’s success (Amadeo, 2018). This also reduces flexibility and loss of speculation (Amadeo, 2018).
Criteria for Decision Making: ‘Vertical Integration’ vs. ‘No Vertical Integration’
When deciding whether or not to integrate, specific criteria must be considered. First, the up-front costs associated with integrating must be evaluated. Up-front costs can include capital, training, systems development etc. (Stuckey & White, 1993). Transaction costs are another consideration. Transaction costs include the legal fees, sales and purchasing and information collection and processing (Stuckey & White, 1993). With transaction costs are transaction risks. Transaction risks are risks associated with the possibility of price changes, insulation from market and supply or outlet foreclosure (Stuckey & White, 1993). Last, coordination effectiveness which looks at capacity utilization, quality, inventory levels and delivery performance are important to consider.
Other criteria Ferrero Group must consider is opportunism, capabilities and flexibility (Singer, 2018). After considering all of the above criteria, Ferrero has to have the opportunity to vertically integrate, the capability to complete the process and the flexibility to ensure it remains successful. Without all of these considerations, vertical integration is impossible.
Final Assessment of ‘Vertical Integration’ vs. ‘No Vertical Integration’
To determine if vertical integration would be beneficial to Ferrero Group, a SWOT analysis is appropriate. First, Ferrero Group’s strengths include diversified business operations as well as a strong brand portfolio (Ferrero Group, 2017). Also, they have initiatives to help make their position in the hazelnut industry stronger (Ferrero Group, 2017). A large weakness for Ferrero is their lack of scale (Ferrero Group, 2017). Some opportunities are strategic acquisitions, a growing market for chocolate and health trends which help drive the demand for dark chocolate (Ferrero Group, 2017). Threats to Ferrero Group are increasing labor costs in Europe, fluctuating prices for the needed raw materials and competition from private labels (Ferrero Group, 2017). Based on the above information, it appears as though Ferrero Group would benefit from vertically integrating with the Oltan Group. They have the initiatives to strengthen their position as well as a strong brand portfolio. This would help increase their lack of scale and turn their weakness into a strength. There are several opportunities to make more money due to the growing trends and chocolate market. If they do not vertically integrate, they may continue to face fluctuating costs, not grow their economies of scale and not take advantage of the growing health and chocolate trends. Overall, it can help control costs, which means their customers will appreciate the stable price of their products, therefore, maintaining their customer base.
Other Strategies to Gain Better Control over Upstream Supply
Although Ferrero Group used vertical integration as it best suited their needs, there are a few other strategies a firm can use to gain better control over their upstream supply. These are the many suppliers’ strategy, few suppliers’ strategy, joint ventures strategy, Keiretsu networks strategy and virtual companies’ strategy (Heizer, Render & Munson, 2017).
The many suppliers strategy is used when a firm has a “request for quotation” when the demands are high (Heizer, et. al, 2017). The suppliers bid against each other in an effort to win the buyers business. As there is no loyalty to a supplier when using this strategy, there is no partnership with the supplier (Heizer, et. al, 2017). The few suppliers’ strategy is the opposite of the many suppliers strategy. The few suppliers’ strategy is used to create relationships with only a couple suppliers and the relationship built helps to bridge gaps and bring a better partnership between the two (Heizer, et. al, 2017).
The joint ventures strategy is used when vertical integration is too much of a risk, therefore, the creation of a formal collaboration between the firm and the supplier takes place (Heizer, et. al, 2017). This can be difficult if one side is not as cooperative as the other. The Keiretsu networks strategy was created in Japan. This strategy integrates few suppliers, collaboration and vertical integration (Heizer, et. al, 2017). Lastly, virtual companies’ strategy is when a supplier provides other services, such as payroll, designing, consulting and hiring (Heizer, et. al, 2017).
When a company needs to control its supply, these methods should be considered. In this case, Ferrero Group has been successful with vertically integrating with the Oltan Group. This is a successful example of how vertical integration can help a company grow and become even more successful.