How does backward integration work?
Backward integration is a type of vertical integration that occurs when a corporation extends its reach to take on duties that were previously carried out by companies farther up the supply chain. Put differently, backward integration refers to the process wherein an organization purchases another firm that provides the goods or services required for manufacturing. For instance, an organization could purchase raw materials or goods from its supplier. Companies can create their own subsidiary to perform backward integration, but they can also acquire or merge with these other companies. A corporation has achieved complete vertical integration by owning all production process phases, from raw materials to final goods or services.
Recognizing Reverse Integration
Businesses frequently utilize integration to seize control of a supply chain segment. The network of people, companies, assets, processes, and technology used in producing and distributing a good is known as a supply chain. The sale of a finished product to a final customer completes the supply chain, which begins with transferring raw materials from a supplier to a manufacturer.
A tactic called “backward integration” uses vertical integration to increase productivity. A vertically integrated corporation aims to manage part or all of its manufacturing process by including many supply chain parts. In the case of backward integration, a company’s suppliers of inventories and raw materials may come under management, while distributors that distribute its product and retail outlets that sell it are under the control of the vertical integration process. Put, backward integration happens when a business starts a vertical integration by going backward in its sector’s supply chain.
A bakery that buys a wheat processor or a wheat farm is an example of backward integration. In this case, a retail supplier buys out one of its producers, eliminating the middleman and impeding the market.
Forward Integration as opposed to Backward Integration
Vertical integration also includes forward integration, which entails buying out or taking control of a business’s distributors. As an illustration of forward integration, consider a garment company that opens its retail storefronts rather than selling its products to department stores. On the other hand, a garment manufacturer that practices backward integration can purchase a textile firm that makes the fabric for their clothes.
To put it briefly, purchasing a portion of the supply chain before the company’s manufacturing process constitutes backward integration, whereas purchasing a portion of the process after the company’s manufacturing process constitutes forward integration.
Initially operating as a DVD rental service for TV and movie material, Netflix Inc. leveraged backward integration to grow its business model by producing original content.
Benefits of Retrograde Integration
Businesses promote backward integration when it is anticipated to increase productivity and save costs. Backward integration, for instance, may reduce the cost of transportation, increase profit margins, and boost the firm’s competitiveness. Costs can be significantly reduced from the point of manufacturing to the point of distribution. Additionally, businesses may increase efficiency by obtaining direct access to the required commodities and establishing more control over their value chain. They can also fend off rivals by accessing specific markets and resources, such as patents or technology.
Backward Integration’s Drawbacks
Capital-intensive backward integration sometimes necessitates substantial sums to buy a portion of the supply chain. To achieve backward integration, a business could have to take on a lot of debt if it wants to buy a supplier or a production site. Even if the business could save money, any savings might be offset by the expense of the new debt. Furthermore, the extra debt on the company’s balance sheet may make it more difficult for them to receive future bank approval for new credit facilities.
Relying on independent distributors and suppliers might occasionally be more economical and efficient for businesses. If a supplier realizes increased economies of scale or reduced prices with increased quantities supplied, backward integration would be desired. If it were both the supplier and the producer, the supplier may occasionally be able to offer input items for less money than the manufacturer.
Backward integration companies risk growing too big and becoming challenging to run. As a result, businesses may diverge from what makes them successful or their core competencies.
A Practical Illustration of Backward Integration
Amazon.com Inc. is one of several prominent businesses that engage in backward integration. Amazon bought books directly from publishers when it launched as an online bookstore in 1995. It acquired new and old work rights when establishing its specialized publishing section in 2009. Now, many impressions are on it.
Its publishing operations have increased earnings by drawing customers to its goods, helping control distribution on its Kindle platform, and giving it influence over rival publishing houses—even though it still sells books written by others. To put it briefly, backward integration allowed Amazon to grow and become a publisher as well as a retailer of books.
Conclusion
- Expanding a business’s position to take on responsibilities formerly performed by companies farther up the supply chain is known as backward integration.
- A common form of backward integration is purchasing or merging with a business that supplies its products.
- Businesses promote backward integration when it is anticipated to increase productivity and save costs.
- Capital-intensive backward integration sometimes necessitates substantial sums to buy a portion of the supply chain.
