Backward integration refers to the process in which a company purchases or internally produces segments of its supply chain. In other words, it is the acquisition of controlled subsidiaries aimed at the creation or production of certain inputs that could be utilized in the production. This backward movement is initiated to ensure supply along with securing bargaining leverage on vendors.
Backward integration is a well-known competitive strategy. Through the control of more of its supply chain, an organization can bring down the costs as well as guarantee access to key materials. Moreover, it can also manipulate competitors in an indirect manner through affecting how they access their raw materials. In certain cases, a number of companies might join hands for purchasing and controlling a supplier.
Advantages of Backward Integration
Backward integration brings in the following benefits for organizations:
- Increased control: Through the process of integrating backward, companies can control their value chain in a more efficient manner. When retailers take the decision to develop or acquire a manufacturing business, they attain increased control over the production segment of the distribution phase.
- Cost Control: Through backward integration, costs can be considerably controlled all along the distribution process. In the conventional distribution process, each phase of product movement includes mark-ups to enable the reseller to earn profit.
By direct sale to end buyers, manufacturers are able to do away with the middle man through removal of one or more mark-up steps in the course. In other words, a single entity controlling the entire distribution process brings in enhanced capability leading to optimization of resource utilization. Transportation costs are lowered, and other wasted costs can be avoided.
- Competitive Advantages: Some companies adopt backward integration in order to block competitors from gaining any access to important markets or scarce resources. For instance, a retailer might purchase a manufacturing company and have access to proprietary technology as well as resources or patents that are solely available in the local area of the firm.
- Differentiation: Backward integration allows companies to access an increasing number of production inputs and distribution resources. By effectively leveraging these opportunities, the company can stand out from the competition through efficient marketing. A retailer is able to cater to the changing customer needs more rapidly if it owns the production or manufacturing firm that produces its products.
Drawbacks of Backward Integration
Although backward integration has a number of benefits, it also has some drawbacks such as the following:
- It builds up excess upstream capacity to ensure that downstream has an adequate supply even when the demand is heavy. This involves increased investment.
- The process leads to lack of supplier competition that will lead to low efficiency resulting in potentially higher costs.
- In due course, there are high chances that the flexibility will get reduced owing to previous investments upstream and also downstream.
- In case there is a need for substantial in-house requirements, then it will diminish the capability of producing the product variety.
- At certain times, existing competencies need to be sacrificed in order to develop fresh core competencies.