Basics to Backward Integration- Functioning of this Strategy

Backward integration is a type of Vertical Integration in which an organization purchases another organization or creates alliances with other business that supply raw materials needed in the production of the finished product.

In today’s era companies are participating in backwards integration to protect the supply of raw materials. To ensure regular supply of RM. Also to create sustainability in business for competitive advantage.

Backward integration requires huge sum of capital and large amount of fixed assets which gives good return in long run.

What’s in it for me?

1. VERTICAL INTEGRATION STRATEGY
2. SUITABILITY OF BACKWARD INTEGRATION STRATEGY
3. ADVANTAGES
4. DISADVANTAGES
5. HOW BACKWARD INTEGRATION WORKS?
6. BACKWARD INTEGRATION V/S FORWARD INTEGRATION
7. EXAMPLES
8. CONCLUSION
9. FAQs

VERTICAL INTEGRATION STRATEGY

Meaning- Combination of forward and backward integration strategy is called vertical integration.

1.    Backward coordination (upstream) means giving a few or all of the items used in making its present items.

2.    Forward coordination (downstream) means allocating its items.

3.    Balanced coordination (both upstream and downstream) moves in the two slots, for example, forward as well as backward.

SUITABILITY OF BACKWARD INTEGRATION STRATEGY

A firm can achieve in backward combination by beginning it’s tasks in the creation of raw materials or by acquiring the firm who was dealing in the similar business. At the point when the providers of a firm are dishonest, or when the providers can’t address the issues of the firm, it is clearly understood that the company should to go for reverse mix. All the more, in reverse mix for a firm might be implemented when:-

1. The company’s current providers are particularly uncertain or unfit to address the issues.
2. The number of providers are few.
3. The firm needs to expand.
4. The firm has adequate amount of assets from which it can create raw material.
5. To stable the cost of raw material.
6. The firm needs to increase it’s assets quickly.

ADVANTAGES OF BACKWARD INTEGRATION

1. Centralized Control-

Company can take control over their supply chain network together with distribution channel. Hence decision of moving the material will be centralized.

Source: Supply Chain by Sahil Khanna

2. Cost Control-

As single unit operation act as a fundamental decrease in overhead cost and petty expenditure, which are profitable in the long run.

3. Speed-

Since no external channel is involved, speed of producing goods will be increased.

4. Reliability-

While the source of origin of basic raw material is generated from the parent company. Hence the raw material are produced as per the company standards.

5. Quality Assurance-

Quality is the standard or benchmark created by company. So each and every raw material produced by the company will be the subject to company standards. Consequently high supply and usage of raw material will reflect a premium brand.

6. Barrier to entry for new player-

Since the strategy approach centralized model and diversification of business, It’s gets difficult for a new business to compete with it.

7. Differentiation-

As the company creates it’s own raw material it will be unique from the existing products provided by their suppliers in the market. Unique raw material will ultimately bring uniqueness in the finished products.

8. Guarantee of timely supply of raw material-

Being able to produce its raw materials, the company will be able to have continuous raw materials supply. Therefore company would not rely on other sources for their supplies. This will eliminate possible interruption in the production cycle and minimize possible differences when comparing production cost with budgeted.

For example- Apple

DISADVANTAGES OF BACKWARD INTEGRATION

1. Huge Investments-

After all adopting this strategy needs huge amount as one have to purchase the whole production chain. Thus companies required deep pocket and huge cost to regulate the business operations.

2. Increase in business risk–

The entering into production of raw material for personal consumption is like investing into a new line but related business. Hence this might be quite risky in the initial but once the business operations get habitual, it gets normal. 

3. Decrease in rate Return on Investment (ROI) percentage-

Entering into a new line of business though may effect in business working capital in short run.

4. Loss of fund-

If business is failing then they should already prepare to fail for every business accordingly. After all planning and proper feasibility of fund matters a lot.

 5. Competencies-

Change is the only constant but many a times businesses forget about it. Generally speaking change in business policy or structure leads to conflict in operation and management.

HOW DOES BACKWARD INTEGRATION WORK?

This can be explained with the help of an Example:

• JG associated deals in manufacturing and supply of plastic product like bottle, jar, box, rack, almirah in whole Central India. They buy raw material which is from RK and sons.
• JG associated acquire local vendor who manufacture plastic.
• This leads to elimination of contract from RK and sons.

BACKWARD INTEGRATION V/S FORWARD INTEGRATION

What is Forward Integration?

Forward Integration is a strategy where the company straightaway eliminates all the middle person by owning their own distribution channel as well as sell it’s product directly to the customer. Since, giving your product to any wholesaler or distributor might get costly to you. The intermediaries earns some profit through it by adding some extra margin on it, eventually this will make the product costly to the customer.

For Example-

1. There is a Chinese company which manufactures and assembles Iphone named Foxconn and then the finished product is sold by Apple. Suppose if Foxconn does the work of Apple i.e. if it starts selling Iphone without distributing it to Apple. Meanwhile it will be able to sell Iphone directly to the customer, manufacturing it and directly selling it to customer. This is called forward integration.

2. Another example is of Amazon, Suppose you bought a Dell keyboard or a Dell mouse from the Amazon website. Now you will get that Dell keyboard or mouse through a shipping chain company named UPS. Meanwhile to eliminate these shipping chain, Amazon started it’s own shipping network under the name of Amazon, this is forward integration. So as to eliminate production cost it started manufacturing it’s own keyboard along with mouse in the brand name of Amazon, this is backward integration. Thereupon from manufacturing keyboard and mouse to delivering it, Amazon owned the whole supply chain network.

Difference between Backward and Forward Integration:

	Backward Integration	Forward Integration
Gets control over	Dealers/Supply Chain/ Manufacturers	Distribution channel
Eliminates profit margin	Primary profits	Tertiary profits
Gets specialized into	Manufacturing products	Shipping/ Distributing products
Objective	Larger market share	Economies of scale
For Example	Zara, McDonald’s, Amazon, etc.	Britania, Myntra, etc.

Also read:

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6 Characteristics of Entrepreneurship| Qualities of Entrepreneurship

Building a Marketing Plan in 5 Simple Steps

EXAMPLES

There are plenty of companies which are now using backward integration strategy to diversify their business, eliminating cost and earn more profit. In this case, some Brands who brought revolutionary product with backward integration, namely:

• Netflix- At the present time this no.1 platform for Over The Top media started their company as DVD rental Shop in the beginning. But now in the meantime they have started creating NETFLIX Original their own content. From time to time they have created many original content which holds the position of mostly watched show in a week.
• AMAZON- Jeff Bezos started online book shop way back in 1995, which only deals in selling others publisher book online.Later from 2009 they decided to create their own publishing house.
• ZARA- Zara adopts the strategy of lean management for the purpose of avoiding a greater extent of wastage. It uses only limited resources to meet the current demand of the market as well as avoid wasting outdated product. It fills their inventory only when there is 20% of their stock is left or even less. To keep this model efficient, it needs an simple supply chain network. So It decided, when supply chain is so important element of their management then why to be dependent to any other network why not to own it. Hence, they manufacture their own raw material by their own.

CONCLUSION

In this article we covered most of the relevant topics on Backward Integration. Defined what Vertical Integration is. Suggested some advantages and disadvantages of the topic. Differentiated it with forward integration and lastly also mentioned various examples in brief.

FAQs