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What does backward integration mean in simple terms?
How does it work?
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What Is Backward Integration
In business, backward integration refers to the situation when a company starts performing tasks and functions that were previously performed by its suppliers within its supply chain.
For example, a company that normally purchases its inventory from a supplier buys the supplier or starts engaging in a business similar to that of its supplier so it can internally manage its inventory.
Typically, companies who expand their business operations using backward integration strategies will acquire or merge with the companies within their supply chain allowing them to internally manage more aspects of their production.
Backward integration is essentially vertical integration but the company’s focus is to move back or up in the supply chain (as opposed to going down).
Vertical integration is the process where a company is looking to control different aspects, or even all, of its supply chain.
A company that controls the portion of accessing raw material, manufacturing the goods, distributing the goods, and selling to customers is said to have complete vertical integration as it controls all aspects of its production process.
Backward integration is when a company “goes up” in its supply chain to control the processes such as all the steps leading to the production of the finished goods (but not its distribution, retailing, and sales to customers).
Backward Integration Definition
How do you define backward integration?
According to Investopedia, backward integration is defined as:
Backward integration is a form of vertical integration in which a company expands its role to fulfill tasks formerly completed by businesses up the supply chain.
How Does Backward Integration Work
Now that you have an overall understanding of what “backward integration” means, let’s now look at how it works.
Company Supply Chain
Companies that manufacture products or produce goods rely on other companies to provide them with the raw material, technologies, equipment, and others in their supply chain allowing them to produce their goods.
A complete supply chain starts from the supply of raw material all the way to the sale of the goods to customers.
For instance, a company may purchase raw material, then work with a manufacturer to produce the goods, and work with transportation companies to deliver the goods to retailers, who then sell to consumers.
Backward Vertical Integration
Backward integration strategy is essentially vertical integration where a company merges or acquires other companies within its supply chain to have more control over its production, to be more efficient, and increase profitability.
Backward Integration Example
Let’s look at examples of backward integration to better understand how it works.
There are many examples of companies that used backward integration to control a larger portion of their supply chain or even dominate the entire thing.
For example, Amazon was originally founded as a book retailer and over the years it took over different portions of its supply chain such as the publishing process, printing process, acquiring rights to titles, and so on.
You have Netflix which started out as a DVD rental company that over the years got into producing its own original films and series.
Apple is a company that is backward integrated as it controls all aspects of its supply chain including the production process (it handles hardware, software, retail, and services).
Heinz Ketchup is another example where it purchases its own tomato farms to produce its tomatoes instead of buying them from farmers.
Backward Integration Advantages
There are many reasons why a company may choose to adopt backward integration strategies to better control its supply chain and production process.
The most notable reasons why companies integrate backward are as follows:
- Increase their profitability
- Improve their production efficiency
- Reduce production costs
- Acquire additional skills and knowledge
- Gain direct access to materials
- Gain access to some patents and technologies
- Have a competitive advantage in the market
- Helps secure raw material costs
Backward Integration Disadvantages
Integrating with companies up the supply chain has its advantages but also has different drawbacks.
Here are some disadvantages of backward integration:
- It can cost a lot of money to integrate up the supply chain
- Handling certain aspects of the supply chain may not result in greater efficiency
- Suppliers may have certain technologies or methods allowing them to produce at lower costs
- Acquiring up the supply chain may lead to challenges in integrating the processes internal
- The acquiring company may lose its core business focus
- For large companies, it may lead to monopolies and violation of antitrust laws
Backward Integration vs Forward Integration
What is the difference between backward integration and forward integration?
The phrase “backward” integration refers to when a company is looking to integrate within its business operations the steps that used to be handled before the production of its finished goods and products.
The company is essentially integrating backward or integrating with companies up its supply chain.
For instance, a bakery that needs a significant supply of wheat may acquire a wheat processor in an integration moving up its supply chain.
On the other hand, forward integration is when a company moves down its supply chain to integrate with companies that are involved after its goods are produced but before its distribution to end customers.
For example, a beverage manufacturer may acquire specific shipping companies to ship its beverages to retailers or open its own stores to sell directly to end customers.
Backward Integration Meaning Takeaways
So there you have it folks!
What is backward integration?
What are some backward integration examples?
In a nutshell, backward integration happens when a business decides to internally handle or fulfill the roles previously handled by its suppliers.
An example of backward integration is a coffee shop acquires coffee producers.
The objective is to control the supply chain with the ultimate goal of being more competitive in the market, more efficient in producing goods, cutting costs, producing faster, and increasing profit margins.
Every company relying on suppliers to produce their goods can consider backward integration strategies to the extent such a move will result in greater efficiency operationally and financially.
Now that you know what backward integration means, if you are looking to integrate backward in your supply chain, be sure to properly evaluate the strategy and do your due diligence.
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