Updated July 21, 2023
Definition of Forward Integration
In layman’s terms, forward integration involves a business expanding forward or vertically to gain control over its manufactured products’ supply or direct distribution.
This business strategy applies some form of vertical integration, where the company takes complete ownership and control of the supply chain and directly distributes its products.
Explanation
Forward distribution involves a business strategy wherein the business takes control or expands its business into the supply and direct distribution of its product to its end customer without depending on any third party. It mainly involves advancing the supply chain. It can also mean cutting down the scope of the middleman who eats away the majority of the profit. On the one hand, where forward integration strengthens the company to maintain a grip or enhanced control of its product or services, it can also dilute its core competencies and business.
Companies, before application of this, should be thoroughly aware of the cost and scope of the process. The company should only engage in such strategies if it identifies a significant cost advantage or an opportunity to maximize its profit. It should also ensure that it does not hamper its core competencies. Companies should sometimes rely on external vendors and their established core competencies rather than expand independently, which would otherwise affect their business. At times calls for many mergers and acquisitions, too, where companies find that M&A deals would prove more profitable than depending on the same company as a vendor.
How Does Forward Integration Work?
The primary focus of this strategy is to cut down on middlemen, implementing an operations-centric approach to gain better control over suppliers, manufacturers, or distributors, to increase market power. To make this work successful, a company must bring other companies that were once its customers under its own ownership. It is different from backward integration because, in backward integration, companies try to gain ownership over companies that were once their suppliers. The modernization of technology and the rise of the internet has made these integrations even more popular and easier. When a company desires to implement a forward integration strategy, it must move along the supply chain without disrupting its control over its current operation.
Example of Forward Integration
Amazon can be considered as one of the crucial examples of this. Amazon has not only maintained control over its own in-house supply and distribution chain by not depending on third-party vendors to handle its logistics. It has its own logistics where it has applied both forward and backward integration. Also, the acquisition of Whole Foods, a different company, has made Amazon utilize its brick-and-mortar outlets, which serves Amazon a scope to serve its customers both online and offline. Here customers can come and collect their products physically or buy new products.
Risks of Forward Integration
The following can the risks:
- The business may lose its core competencies and hold off the core business it is involved.
- May eventually lead to mergers and acquisitions, which, if unsuccessful in the future, lead to a big loss for the business.
- It may, at times, lead to unprofitable outcomes.
- It may lead to unforeseen labor issues.
- At times there is a rise in obsolescence due to the application of newer technologies.
Forward Integration vs Backward Integration
As the name suggests, forward integration means a company has to bring other companies which were once its customers under its own ownership. Backward integration means companies try to gain ownership over companies that were once their suppliers. The main aim of forward integration is to capture a bigger market share, whereas the main purpose of backward integration is to take advantage of economies of scale. An example of this can be a car manufacturer taking ownership or acquiring an already-established car dealer in the market. In contrast, an example of backward integration can be a car manufacturer acquiring a tire production company where the tires required for the cars will be produced in-house. It provides control over the supply chain, whereas backward integration provides control over the purchasing power.
Benefits
The benefits are as follows:
- Lowers the cost due to the elimination of market-related transaction costs.
- It greatly reduces the cost of transportation.
- Helps gain a bigger chunk of market share and thus increases market capitalization.
- It brings about the point of strategic independence for the company.
- Provides better opportunities for the growth of investments.
- It also acts as a barrier to the entry of new competitors or threats to the business.
- Due to better synchronization of demand and supply, there is enhanced coordination of the supply chain.
Limitations
The demerits of backward integration are as follows:
- Leads to a significant rise in cost if new activities are not managed well
- It may impact the quality of the product and reduce efficiency when there is no competition.
- It may give rise to a monopoly in the market.
- The organizational structure may become more rigid due to the drawbacks of such implementation.
- It brings about the inability to change the product due to the requirement for in-house efficiency.
- It makes the company less flexible due to increased bureaucracy.
Conclusion
If managed well, forward integration is a great strategy that can serve as a boon to the business and help increase the market share and gain market hold. On the other hand, it requires proper implementation as if it is wrongly applied. It can cause huge losses to the business.
Recommended Articles
This is a guide to Forward Integration. We also discuss the introduction to forward integration and the working, benefits, and demerits. You may also have a look at the following articles to learn more –
