now, no signup required!
A supply chain starts with a manufacturer. Then it extends to a supplier who delivers raw materials to the manufacturer. It ends with the sale of the final product to an end-consumer.
Integration of the supply chain refers to mobilizing resources and delivering changes required to move a business forward. There are two types of integration—vertical and horizontal. When an organization takes up the same type of products at the same level of production in a merger, it’s termed as horizontal integration. Vertical integration is a business strategy used by organizations to gain ownership of another organization operating in the production process of the same industry. Vertical integration is a risky, complicated and expensive strategy. Hence, organizations don’t integrate vertically unless it’s absolutely necessary to create or protect value.
Vertical integration is of two kinds—forward and backward Integration.
Backward Integration Meaning
Backward integration occurs when an organization enters into an alliance with a manufacturer or supplier through an acquisition or merger. Sometimes organizations can establish their own subsidiary and complete backward integration. A backward integration example could be a bakery purchasing a grain processor. Another backward integration example could be an automobile organization owning a tire organization, a glass organization and a metal organization. This strategy attempts to move organizations backward in the supply chain so that they have control over the raw materials. Organizations typically use backward integration to gain control over their supply chains. Some organizations use a backward integration strategy when they feel a supplier has too much power over them. Backward integration isn’t just limited to the manufacturing sector but has also been used in other industries, too.
Advantages Of Backward Integration
The benefits of backward integration are understood if we look closely at the production levels and technologies behind them. The production process is divided into three stages—assembly, sub-assembly and component stage.
The following are the advantages of backward integration:
- Better control: An advantage of backward integration is that by integrating with suppliers, organizations can control their supply chain from the production stage. They can control the quality of raw materials supplied to them and can have a constant supply of materials whenever required.
- Cost advantage: Supply chains consist of middlemen. So, by the time a product reaches the organization’s warehouse, prices would have increased. This makes the final product more expensive for the consumer. With backward integration, organizations remove the middlemen and save on transportation, mark-up and other costs.
- Differentiation: Organizations integrate backward to get a differentiation-based competitive advantage. An organization can gain access to production units and distribution chains and can thus market itself differently from its competitors.
- Innovation: Businesses and organizations that are vertically integrated, especially backward, are best equipped to innovate because they participate in many of the production and distribution activities in which change can occur.
- Competitive advantage: The final advantage of background integration is that organizations use backward integration for gaining an edge over their competitors. For example, a technology organization can integrate backwards and gain access to patents, trademarks and so on, which are owned by its competitors. A raw materials manufacturer who also sells a final product may create an entry barrier for businesses trying to sell their final product.
The advantages of backward integration greatly outweigh its disadvantages. However, there are some limitations that you need to be aware of:
- Inefficiency: When an organization acquires a supplier of raw materials, the organization will limit competition, resulting in a lack of innovation. Because they’ve spent a good amount on the acquisition or merger, they wouldn’t have enough funds for research and development activities. Thus, it may affect the quality of the organization’s products.
- Large investment: Acquiring another organization requires a huge investment. Backward integration builds up excess upstream capacity to ensure that downstream has adequate supply during heavy demand.
Let us understand backward integration meaning with the help of some real examples.
Examples Of Backward Integration
There are many examples of backward integration, and some of the ones listed here are now household names:
- Peloton is American exercise equipment and media organization. Peloton integrated backward in 2012 into organization-owned hardware manufacturing after initially relying on contract manufacturers. Peloton acquired Tonic Fitness Technology, a Taiwanese manufacturing organization, in October 2019. In December 2020, Peloton acquired Precor, a workout machine manufacturer.
- Netflix was a platform to distribute films and TV shows created by others. It then decided to make original content. This strategy has helped boost Netflix’s continuing success. Netflix streams more original content reducing their dependency on film studios and their licensing.
- Another backward integration example is the Swedish furniture and home accessories giant IKEA. The organization purchased 83,000 hectares of forests in Romania to supply its timber requirements. This is the first time that a furniture organization is managing an entire forest. IKEA has sealed the deal for managing wood sustainably at affordable prices.
- Ferrero Group is a confectionery manufacturing organization that makes chocolates and chocolate spreads with hazelnut as the main ingredient. It acquired Otlan group, a global leader in supplying hazelnuts, for $500 million. By this acquisition, Ferrero improved the quality of its hazelnuts that form the main ingredient for its popular products such as Nutella, Ferrero Rocher and Kinder.
- One more backward integration example is the Ford Motor Company. During its beginning in the 1920s, Ford Motor Company created subsidiaries that provided key inputs in the form of rubber, gas and metals to vehicles. With this, Ford wanted to be sure that the business wasn’t hurt by suppliers charging high prices or providing inferior quality raw materials.
- Continental, an international automotive supplier and tire manufacturer, acquired Veyance Technologies, a manufacturer of rubber products for industrial organizations. With this acquisition, Continental was able to expand its global position in rubber and plastics technologies. It was also able to increase the proportion of industrial and end-customer sales.
If used properly, a backward Integration strategy can help cut transportation costs, improve profit margins and make organizations more competitive.
With this strategy, organizations can take control of the stages in their production channels. A backward integration strategy doesn’t impact an organization’s distribution channels, unlike forward integration. It seamlessly allows organizations to expand their operations.
Harappa’s Select A Strategy pathway will train learners to effortlessly take a solution from idea to execution. Learn how to manage expectations, navigate roadblocks and respond to crises calmly with the help of frameworks that stress on minding cost, quality and timing. Get ready to impress your bosses, peers and team. Sign up today!
