Updated July 21, 2023
Introduction to Backward Integration
One of the forms of business combinations is vertical integration in which a company reduces its supply chain by taking over a few companies in the same and performing those roles in the house or by bringing the company under its own control when such integration takes place of the supply chain prior to the products that are currently produced by the company, it is known as backward integration.
Explanation
For a garments manufacturer, integrating with a cotton-producing company or one of its raw material suppliers is a form of backward integration. This is done to reduce the inefficiency and dependence on another company and also to reduce costs of acquiring the raw material because this does away with the margin on raw material imposed by the third party suppliers.
At times it is also known as the vendor integration program when the integration is related mostly to vendors. It is not the same as horizontal or lateral integration in which the integration takes place among two or more competitors. It is a form of Vertical integration, which involves integration up the supply chain.
Example of Backward Integration
Below is the example
- This can go as long back as the 1920s when most car manufacturers implemented such an approach by integrating with companies that produced tires and spare parts to become the largest producers in the market.
- One of the more recent examples of the same is Mcdonald’s. Mcdonald’s is said to be one of the most famous players in the backward integration domain. They have their own meat-producing units for the use of meat in their burgers and other products. Apart from this, they own several other ingredients in self-owned factories.
- Apart from this, Mcdonald’s also owns a fleet of trucks to transport the ingredients to the restaurants where they are used as inputs to produce the products offered to consumers. This ownership of transportation is another form of backward integration because it further reduces third party involvement.
Importance of Backward Integration
Below are the importance:
- Positive differentiation: When the company can control all the predecessors in the supply chain, it becomes a differentiated company in the market. The consumers prefer such an organization because they don’t have to wait for a long feedback trail to convey their grievances, the consumers feel attended to with such an organization.
- Better inventory management: As the market’s tastes and preferences keep changing, the production team can quickly impact the movement of raw material as the suppliers are under in house control and therefore prevent capital blocking in unwanted raw material and thereby control the inventory from piling up.
Difference Between Backward Integration & Forward Integration
- Meaning: Forward integration involves the integration of the supply chain after the products produced by a company. While backward integration is the integration of the supply chain before the products produced by the company.
- Goal: The goal of backward integration is to reduce cost and create economies of scale while the goal of forwarding integration is to increase the market share of the products. Therefore if no such benefit is being achieved, then the plan for the integration process is dropped.
Advantages and Disadvantages
Below are the advantages and disadvantages:
Advantages
Below are mentioned some advantages:
- Cost-effective: Margins are reduced when its takes place this leads to lower cost of raw materials and inputs and, therefore, the greater possibility of profitability or reduction of price to favor consumers.
- Control: This provides greater control over the supply chain and therefore it leads to greater efficiency and lower dependence on the third party. This impacts the delivery timing and inventory scheduling as per production requirement.
- Competitiveness: As the company becomes larger post-integration, the competitors have very little chance to enter this market because of the stature of the company. Therefore, the company can gain a greater competitive advantage and higher profitability.
- Technology gain: When the companies integrate they acquire the in house technology of each other and therefore they gain on the same. Later they may create newer lines of businesses by making such technology open to the market.
- Confidentiality: When most of the supply chain is integrated, the chances of the leak of information such as trade secrets and so on are very low. Therefore, a high level of confidentiality is maintained.
Disadvantages
Below are mentioned some disadvantages:
- Higher fixed Investment: The investment required for such integration is huge and therefore it is not always an option for all companies and therefore it is a niche option that can be availed only by companies of big stature.
- Scale issues: At times the scale becomes so large that the companies cannot manage it effectively. This leads to diseconomies of scale and thus it is not always advisable to go into the integration of any kind.
- Complacency: Due to lack of competition among the suppliers, the vendors may become highly complacent to improve the quality of the products they produce due to the level of security they achieve.
- Anti-trust actions: At times the competition laws come into force when such integration takes place, and in order to complete the integration, the company might have to give up on a few assets. This leads to the emergence of a trade-off between whether integration is more beneficial or having the current asset base. Therefore the decision making needs to be highly comprehensive and requires several different perspectives before finally implementing the same.
- Time-consuming: The process is not very fast and therefore a lot of working hours go into implementing integration and bringing it to a level where it runs efficiently and independently. This is a tedious task.
Conclusion
Therefore we now know that backward integration is a form of vertical integration in which we integrate the supply chain elements before the current product of the company. It might have some good effects and some bad ones. It can reduce costs due to the reduction of margins, reduce dependence on outside parties, and create a cocoon of confidentiality.
However, when the scale increases to a very high level, the integration may cause a lot of inefficiencies, therefore increasing the scale is not always a good idea and may not always be advisable.
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