Backward Integration: Definition and How it Works

Once companies achieve a specific level, they will aim to expand their operations. However, the process is not as straightforward. Usually, companies must use a market entry strategy to ensure their success in new markets. There are several strategies that companies may use to do so. These categories fall into three classifications, which dictate when companies can use them.

There are two aspects in which companies can expand, including markets and products. Usually, companies choose one or the other. However, companies may also use both. This process is known as diversification, which allows companies to expand into new markets with new products. One strategy that companies may use within this category is vertical integration.

What is Vertical Integration?

Vertical integration involves expanding through acquisitions, mergers, or takeovers of different supply chain participants. This strategy allows companies to streamline their operations through direct ownership of various stages of their production processes. It also reduces their reliance on external contractors or suppliers. In this process, companies become their own manufacturers or distributors.

With vertical integration, a company integrates its supply chain within itself. Usually, each member of the supply chain produces a unique product or service. These products or services go through this chain to satisfy consumer needs. By acquiring processes within the supply chain, companies gain higher control over the overall process.

The vertical integration strategy goes against the horizontal integration strategy. With horizontal integration, companies produce several that relate to one another. Similarly, it involves acquisitions, mergers, and takeovers within the same supply chain level. However, it does not allow companies to secure supplies needed to produce their products. In contrast, vertical integration helps companies have more control over their supply chain.

Vertical integration allows companies to bring outsourced operations in-house. This process is fully about keeping operations within a supply chain. There are basically two types of vertical integration strategies that companies can utilize. These include backward vertical integration and forward vertical integration. Both of these strategies have advantages and disadvantages.

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What is Backward Integration?

Backward integration involves a company taking over operations for which higher supply chain participants were responsible. In other words, it is when a company acquires or merges with its suppliers. Therefore, with this strategy, companies become their own suppliers. For example, a company buys out a supplier that provides its raw materials.

Backward integration usually involves acquiring, taking over, or merging with a supplier. Sometimes, companies may also form a new venture that competes with their suppliers. However, acquisitions and mergers are more reliable and require lesser resources. Either way, companies can become responsible for providing their own raw materials and supplies.

There are several reasons why companies may want to employ a backward integration strategy. The most critical of these is to have more control over the supply chain. This process can result in cost savings, better efficiency, and increased revenues. Some companies may also use this strategy to overtake suppliers that can impact their competitors’ operations.

Overall, backward integration refers to the process of expanding business operations up the same supply chain. With this strategy, companies take complete control over one or more stages in their production channels. Unlike forward integration, it does not impact a company’s distribution channels. However, it allows companies to expand their operations.

How does Backward Integration work?

Backward integration begins with companies identifying a supplier that they can acquire. Usually, companies need to have the resources to go through with the acquisition. Once they meet the criteria, they can overtake the supplier to get control over its supplies. However, some companies may also establish a subsidiary to carry out the same operations as their suppliers.

The primary purpose of backward integration is to take over a portion of a company’s supply chain. This chain includes individuals, organizations, resources, and technologies that help manufacture and sell a product. Every supply chain begins with the delivery of raw materials from a supplier to a manufacturer. Similarly, it ends when the final product reaches the end customer.

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Backward integration uses vertical integration to improve efficiency. It is when a company acquires multiple segments of the supply chain to control its production process better. Therefore, companies can manage their raw materials and inventories better. The process of backward integration involves moving backward in a company’s supply chain.

Since raw materials represent a scarce resource for companies, they always aim to increase their control. Not having access to these resources can significantly hinder a company’s growth. With backward integration, companies can get that control. However, that comes with the cost of additional financial requirements.

What are the advantages of Backward Integration?

Backward integration can have several advantages for companies. The process can result in more profits for companies and strengthen their operations. However, there are more specific advantages of backward integration, some of which are as below.

Control production

The primary advantage of backward integration is the better control it provides over the production process. By managing raw materials and inventories better, companies can get more value from this process. Similarly, they gain control over the quality of raw materials that go into producing the end product. Companies also can get goods on time, which can help with quality control.

Reduce costs

When suppliers deliver goods to a company, they charge a percentage of profit. However, when these goods come from within the company’s operations, these profits will not be a part of the price. Similarly, companies can cut any intermediaries from the process, decreasing the costs associated with it. Controlling the supplies also allows companies to reduce holding and delivery costs.

Gain competitive advantage

Another primary reason why companies use backward integration is to gain a competitive advantage. Companies can prevent competitors from using suppliers by acquiring them. Similarly, better control also allows them to manage the quality better. Since this quality translates into a better end-product, it can significantly help provide more value to customers.

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What are the disadvantages of Backward Integration?

Backward integration can have several disadvantages apart from its benefits. These disadvantages may come from it being a vertical integration strategy. However, they may also relate to this specific strategy. Some of the disadvantages of backward integration are as follows.

Requires investment

Backward integration requires companies to buy out or take over their suppliers. For larger supply chains, the suppliers will also be large companies. Therefore, acquiring these companies will require a substantial investment. For smaller companies, therefore, backward integration may not be possible. This disadvantage relates to vertical integration as a general.

Increase inefficiencies

Backward integration can also result in inefficiencies for companies. When companies acquire their suppliers, they will become dependent on in-house production. Similarly, the process will limit competition in the market. Therefore, it can lead to inefficiencies in the industry as a whole. These issues will also translate into the final product, which can impact a company’s operations.

Difficult to manage

Backward integration can become difficult to manage. As companies acquire more supply chain participants, keeping them together can be challenging. Although these companies may operate as separate subsidiaries, it may still be difficult to manage them. The larger these companies become, the higher the financial burden also gets.

Conclusion

Vertical integration is a process in which companies expand into the supply chain vertically. Backward integration involves acquiring or merging with a supplier. This process allows companies more control over their production process. However, it can also create some issues. Some of the advantages and disadvantages of backward integration are available above.

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