What Is Backward Integration?
Let me explain backward integration directly to you: it's a type of vertical integration where a company takes on roles that were previously handled by suppliers in the supply chain. Essentially, this means buying or merging with a company that provides the products or services you need for your production. For instance, you might acquire your raw materials supplier. Companies achieve this through acquisitions, mergers, or even setting up their own subsidiaries. When a company controls every step from raw materials to finished products, that's full vertical integration.
Key Takeaways
- Backward integration expands a company's role to handle tasks from upstream in the supply chain.
- It typically involves buying or merging with a supplier of products or materials.
- Companies use it to achieve better efficiency and cost reductions.
- This strategy can demand substantial capital to acquire supply chain elements.
Understanding Backward Integration
You should know that companies use integration to control parts of their supply chain, which includes everyone and everything from raw material delivery to selling the final product to consumers. Backward integration boosts efficiency through vertical integration, where you control multiple supply chain segments to manage production. This could mean overseeing distributors, retail outlets, or, in backward integration, your suppliers of inventory and raw materials. Simply put, it's moving backward in the industry's supply chain.
Consider this example: if you're running a bakery, backward integration might mean buying a wheat processor or farm. Here, you're eliminating the middleman by acquiring a manufacturer, which reduces competition and streamlines operations.
Backward Integration vs. Forward Integration
Now, let's compare it to forward integration, another vertical integration type that focuses on controlling distributors. For example, a clothing manufacturer might open its own stores instead of selling to department stores. In contrast, backward integration could see that same manufacturer buying a textile company for fabric production.
To clarify, backward integration targets the supply chain before manufacturing, while forward integration handles what comes after.
Fast Fact
Here's a quick note: Netflix, starting as a DVD rental service, applied backward integration by producing original content to grow its model.
Advantages of Backward Integration
You pursue backward integration expecting efficiency gains and cost savings. It can lower transportation costs, boost profit margins, and increase competitiveness. You'll control more of your value chain, access needed materials directly, and block competitors from certain markets or resources like technology and patents.
Disadvantages of Backward Integration
Be aware that backward integration is capital-intensive, often requiring large investments or debt to buy suppliers or facilities. This debt might offset any savings and limit future borrowing. Sometimes, sticking with independent suppliers is more efficient if they offer better economies of scale. Also, growing too large through this can make management tough, pulling you away from your core strengths.
A Real-World Example of Backward Integration
Look at Amazon: it started as an online bookseller in 1995, buying from publishers. By 2009, it launched its own publishing division, securing rights to titles and creating imprints. While still selling others' books, this backward integration increased profits, controlled Kindle distribution, and gave leverage over publishers, turning Amazon into both retailer and publisher.
