What is Backward Integration? Definition, Advantages, and Disadvantages

Overview

Backward integration refers to gaining control of the supply-side of a company. It may come through acquisition and merger or arranging in-house production of raw material.

Backward and forward integrations are essential parts of vertical integration. It offers several advantages to the company, including increased control over raw material supply, competitiveness, reduced costs, etc.

Let us discuss the concept of backward integration with the help of a few real-world examples.

What is Backward Integration?

Backward integration is the process of taking control of the supply chain side of a business. It can be achieved by producing the input supplies for production internally or by acquiring the supplier company.

One of the most common ways to achieve backward integration has been through a merger or acquisition. A manufacturing company often acquires or merges with another company, the supplier of raw material.

Backward integration can also take the form of business expansion. For example, if a drinks manufacturing company starts producing fresh fruits by entering the Agri sector, it can be termed backward integration.

Companies consider backward integration for various reasons—the most apparent reason for controlling the supply chain. For many companies, assuring the supply chain is critical.

Backward integration also reduces procurement costs. The company also reduces reliance on third-party agreements. Overall, the process is aimed to smoothen the supply side of a business.

Gaining a larger market share, competitive advantage, and diversification of business activities are other common objectives of backward integration.

Backward Integration Vs. Forward Integration Vs. Vertical Integration

Backward integration and forward integration are both parts of the vertical integration process. We have discussed backward integration. Now let us briefly discuss forward and vertical integrations.

A forward integration happens when a company takes control of its distribution network. It means the manufacturing company also starts distribution and selling its products directly rather than the third-party arrangements.

A typical example of forwarding integration can be a fashion clothing brand. A clothing brand producing apparel and clothing starts selling directly through its retail outlets. Instead of relying on third-party stores, the brand’s products now sell at its very own retail outlets.

Vertical integration happens when a company arranges its supply chain, including raw material and transportation, to the distribution of products itself.

In other words, a vertical integration completes with both the backward and forward integrations taking place simultaneously.

Vertical integration refers to taking control of one or several aspects of the production and supply chain. It also includes control over production, distribution, and selling the products.

In short, backward integration arranges raw material, inventory, and other inputs. Forward integration arranges distribution and sales of products. When both sides are complete, it results in the form of vertical integration.

Real-World Examples of Backward Integration

There are various examples of backward integration in the real world. As we discussed, these integrations can happen for various reasons.

Let us consider a few of these examples.

Apple Inc.

It was one of the most successful examples of backward integration. Apple inc. started manufacturing hardware for its mobile phones internally.

The move resulted in lower costs as well as a competitive advantage for Apple Inc. It resulted in fast production and greater efficiency for the company.

Amazon and Publishing

Amazon is one of the leading digital booksellers in the world. For a long time, it continued to sell the books from other publishers.

Amazon used backward integration and started publishing books through its own dedicated platform. Now, Amazon is a book publisher as well as a bookseller platform.

IKEA buying Forests

In another successful real-world example of backward integration, IKEA bought managing forests in different countries.

IKEA’s most recent forest acquisition has come in the US for 11,000 acres. IKEA is the world’s leading furniture and home accessories producer. The move has paid off in the past as well.

Disney and Pixar

Disney acquired Pixar to consolidate its dominance in the animation movie genre. Pixar was one of the leading animation firms in the world. Disney is the world’s top animated movie producer.

The backward integration move by Disney has seen unparallel success so far. Since the acquisition of Pixar, Disney has produced several animated hit movies.

Advantages of Backward Integration

Backward integration is an essential part of vertical integration. Whether the strategy executes in total vertical integration or only backward integration, it offers several advantages to the company.

Competitive Advantage

Achieving competitive advantage through backward and vertical integration is one of the leading motivations for many companies. For instance, in the case of Disney and Pixar backward integration acquisition, Disney also consolidated its competitive advantage.

A company may acquire its suppliers to take control of the precious raw material to restrict access to its competitors.

Increased Control

Achieving control of the supply chain is one of the most common reasons for backward integration. Backward integration may get control over one or several segments of the supply chain.

For example, Apple Inc. producing its hardware is an excellent example of backward integration.

Operational Efficiency

As a company gains control of its supply chain, it can improve its operational efficiency. Timely procurement and an adequate supply of raw materials mean increased productivity.

Backward integration for a firm following the total quality management philosophy can be an ideal choice to increase operational efficiency.

Cost Efficiency

Taking control of the supply chain means lower input costs. Whether the company produces raw material internally or acquires another company, it costs less to have raw material directly than purchasing it from other companies.

Apple’s in-house production or IKEA’s Forest purchasing moves are good examples of achieving cost efficiency through vertical integration.

Product Differentiation

The manufacturer can concentrate on its product differentiation policy when input material is readily available through increased control over the supply side.

Adapting quickly to the changing consumer preferences is another advantage of backward integration.

Disadvantages of Backward Integration

Despite several advantages, backward integration can offer some limitations as well.

Capital Intensive

Acquiring or in-house arrangements to produce raw material needs a huge initial investment. It means backward integration is a capital-intensive move that may not be feasible for all companies.

Inefficiency

Excessive control over input items may result in a lack of innovation and productivity of a company. It may result in increased operational inefficiency instead of increased efficiency.

Managing the supply side may not be an easier task for the company.

Compromised Quality

Lack of competition for suppliers means compromised quality of the raw material. It also means the company will not look for the better quality input material available in the market.

Lack of Expertise

If an acquiring company does not possess the necessary skills and resources to manage the supply side, it may result in negative synergies. It means the company may find it difficult to reap the rewards of backward integration.

Concluding Remarks

Backward integration offers several advantages to a company. Gaining market control, control over the supply chain, and increased operational efficiency are significant motives behind the strategy.

Backward integration is an essential aspect of total vertical integration. However, the strategy should be adopted and executed carefully as it may come with disadvantages as well.

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