Backward integration is a type of vertical integration when a company buys another company to become its own supplier or manufacturer. The company expands its business and increases its size to make the process of delivering goods or services to the consumer smooth.
Businesses and companies go through backward integration to either benefit the company itself or avoid the risk of loss or production delays, etc. Companies can choose to either buy or establish their own subsidiaries depending on the goals behind a backward integration.
The supply chain of a company starts from the production of raw materials and ends with the finished good that is delivered to the customer. Taking over a portion of a company’s supply chain can also help the company become more competitive.
A real-life example of backward integration is Netflix creating content. Netflix is a streaming service that convinced studios to license content for an online audience. Netflix finally decided to start creating movies and T.V series of its own to capture higher profits.
Backward Integration vs. Forward Integration
The opposite of backward integration is forward integration. Forward integration, as opposed to backward integration, is forward integration is when a company buys its own distribution firms or sets up retail shops for selling products.
Let’s say a manufacturer of jeans establishes retail outlets across the state to sell its own merchandise. This will be forward integration.
In the same example, backward integration will be the jeans manufacturing company deciding to buy the company that manufactures the cloth or becomes the importer of cloth.
Advantages of Disadvantages of Backward Integration
The most common reason for backward integration is to improve efficiency and save costs. It can also help companies become more competitive when the profit margin increases and allows companies to cut down costs.
A company that is backward integrated can reduce costs at more than one step in its supply chain which can significantly improve control and efficiency. All of this can help companies deliver more value to the customers which is crucial to earning customer loyalty to the brand.
The company or business that is backward integrated can also get patents or use technology to access a wider range of resources, penetrate markets and look for new ways to cater to customers.
Backward integration can be very expensive as it may require huge capital investments which can be difficult for small to mid-size businesses to employ on new projects.
Similarly, the company might take on a huge amount of debt to build a factory or operating unit. If it is a public company, more debt can also make investors wary of investing as it increases certain risks associated with debt.
In some cases, relying on distributors or suppliers is much more efficient to keep the costs lower and produce large quantities of products.
Backward integration can prove problematic for some companies as managing a large empire can be complicated. This might stray away from the company from its objective of providing value to the customers and building shareholder wealth.