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Every organization aiming to earn revenue provides a product or service that caters to a particular need of the customer. The technical word for such a product or service is a ‘vertical.’
Take the case of a rubber-producing organization. They may produce car tires, surgical gloves and even seals. As you can imagine, each vertical/product is a world unto itself and comes with its set of varying complications, such as manufacturing processes, suppliers, marketers, and so on. The fundamental truth about each vertical is that they aim to improve cost/operational efficiency by either lowering costs or increasing sales.
Therein lies the crux of all business.
On the face of it, this line of reasoning might seem fairly reductive, but that’s the core principle that every business is based on. Be it the humble restaurant around the corner or a Silicon Valley giant.
So how do they do it? By integrating or bringing many moving parts under one roof that formerly existed outside the scope of the business. The more variables under an organization’s control, the more efficiently an organization can operate and potentially generate more profits.
This integration is of two types – forward integration and backward integration. The concepts of forward integration and backward integration are inherently different from each other and are expected to achieve very different objectives.
Forward integration and backward integration are both essential for the success of any business. Here’s all you need to know about forward and backward integration:
- Forward integration: This approach deals with the streamlining of primarily the sales and marketing channels. This is the aspect of the business that’s involved with getting the product out into the hands of the consumers.
- Backward integration: This approach involves the assimilation or acquisition of raw products or suppliers that the organization intends to process and sell on. The raw material might be tangible or, in some cases, intangible.
These are the basics of forward and backward integration. Let’s dive in and see how forward and backward integration differ and what effect they have on an organization.
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FORWARD INTEGRATION
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BACKWARD INTEGRATION
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Difference Between Forward Integration And Backward Integration
FORWARD INTEGRATION
What if a business you owned had to no longer depend on third parties to buy and distribute your finished product? This means that you could take your product to market directly at a scale of your choosing.
A robust supply chain and customer-facing exposure could fine-tune every interaction you have with a prospective buyer.
That’s the ultimate dream for most businesses. That’s exactly what Amazon accomplished with many of their verticals, most prominently their Web Services and Grocery verticals. Amazon develops and maintains its own cloud computing services (AWS), which allows them unfettered access to the average internet-based customer. Apart from this, in-house management allows for customization like no other. In addition to its benefits to Amazon, the AWS component turned into its own revenue stream when it was made available to other retailers.
Amazon was already in the organic food business with its Go Grocery stores. Still, when it acquired Whole Foods and gained access to nearly 500 nationwide stores, it gained an advantage that knocked every competitor out of the park.
The inherent risk with a forward integration is that it may not translate into reality from what it looked like on paper.
BACKWARD INTEGRATION
A backward integration looks to reduce dependency on outside elements for the procurement of raw materials or vital components that an organization needs to produce its goods.
The most recent example would be Apple. They recently started producing their own processor chips, called the M1, for its line of computers.
The development of the chip eliminated the need for third-party chips from Intel entirely. It also freed up Apple to design its hardware around market spec hardware and gave them more creative control over what features they could implement in their devices.
This potentially has several ripple effects on how the organization sets up and develops software as well as hardware.
This type of integration nearly always comes at a huge cost and is only done when an organization or vertical is mature and can afford to take a bold leap in terms of operations and/or finances.
Sometimes, it can take years to recoup the costs or for the acquisition to turn viable.
Difference Between Forward Integration And Backward Integration
Both approaches-forward and backward integration rely on market conditions as well as the foresight of the management running the show, but both need to feature regularly in a business journey.
The main difference between forward integration and backward integration is what they’re expected to achieve for a business, along with other differences that come along.
Forward integration and backward integration are different when it comes to their purpose, target and result. It’s important to understand the difference between backward and forward integration to execute it perfectly.
Here are the key differences between forward integration and backward integration:
Forward Integration vs Backward Integration
| Forward Integration | Backward Integration | |
| Control | The company aims to gain control over activities that are ahead of its product/service in the value chain | The company aims to gain control over activities that are behind the product/service in the value chain |
| Target | The company targets acquisition of a distributor | The company aims to target a supplier or manufacturer |
| Purpose | The purpose is to increase market share | The purpose is to gain economies of scale |
| Result | Gain control over the distribution chain | Gain control over the supply chain |
These are the key differences between backward and forward integration. For a business to succeed, it’s less about forward integration vs backward integration and more about the need of the hour. A business needs to use forward and backward integration as per its business requirements and execute them to gain scale, size and market share.
When a business is debating between forward integration vs backward integration, it must look at its current state, objectives for the medium and long-term and the ecosystem around the business, and take a suitable call. The differences between backward and forward integration should also be taken into account accordingly.
For you to strategize effectively, you must understand concepts such as integration in a more fundamental way. Harappa’s Select a Strategy pathway will help you do all of that. Explore Harappa’s Pathways to Success to improve the skills you need to thrive in a modern workplace.
