Definition
Backward integration is a business strategy that involves a company expanding its role to control more of its supply chain. This typically includes tasks such as buying a supplier or starting to produce its own resources. The goal is to increase control over inputs, potentially reducing costs or increasing efficiency.
Key Takeaways
- Backward Integration is a strategy used by firms to increase control over their supply chain and is considered a vertical integration that involves buying or merging with suppliers.
- By executing a backward integration strategy, a company can enhance its efficiency, secure a steady stream of materials, bring down costs, and have improved access to innovation or technology.
- However, the implementation of backward integration could lead to less focus on core competencies, high setup costs, or increased monopolistic practices due to reduced competition.
Importance
Backward Integration is an important finance term because it represents a strategic business move that occurs when a company acquires or merges with businesses operating in its earlier stages of the supply chain.
This vertical integration strategy can give a company greater control over its supply sources, enhance process efficiencies, reduce costs, and secure the supply of key inputs.
It facilitates companies to protect and increase their market share, improve bargaining power over suppliers, and achieve more consistent delivery times and quality of inputs.
Overall, backward integration strengthens a company’s competitiveness and boosts its profitability.
Explanation
Backward integration is a strategic move by a company designed to improve its efficiency, control, and competitive standing. Its primary aim is to either internalize key processes or secure direct ownership of suppliers or distributor networks that provide crucial resources, inputs, or services.
In other words, a company attempts to control its supply chain by acquiring other businesses that previously supplied it with raw materials, components, or services. This strategic action of backward integration serves several purposes.
It can lead to reductions in production costs, increased control over the quality of input materials, better inventory management, and a secure supply of critical components or resources – thereby reducing the risk of supply chain disruptions. Additionally, backward integration can bolster a company’s competitive position by enabling it to access proprietary or specialized knowledge or technologies via their acquired entities.
This method can also prevent rivals from obtaining vital resources, creating a strong competitive advantage.
Examples of Backward Integration
Amazon’s Acquisition of Whole Foods: In 2017, tech giant Amazon acquired Whole Foods Market, a move that allowed Amazon to backward integrate into grocery and retail goods. This acquisition gave Amazon direct control over a significant portion of its supply chain, broadening its distribution network and improving the delivery speed of its products.
Starbucks’ Coffee Roasting Plants: Starbucks is a perfect example of backward integration in that the coffee chain doesn’t just rely on other suppliers for its coffee beans. Instead, Starbucks purchases and roasts the high-quality whole bean coffees itself. This grantes Starbucks direct control over the supply, cost, and quality of its main product.
Apple Manufacturing its own Chips: Well known tech company Apple Inc., once relied heavily on third-party suppliers for its device components. However, in recent years, Apple has shifted toward designing and producing its own chips for devices like the iPhone and iPad, reducing its dependence on suppliers, having greater control over the supply chain, and increasing the profit margin of its products.
FAQs for Backward Integration
What is Backward Integration?
Backward integration is a business strategy that involves a company taking control of its supply chain. This can be achieved by buying suppliers, setting up its production operations, or setting up partnerships with key suppliers.
What is the purpose of Backward Integration?
The main purpose of backward integration is to secure a supply of raw materials, reduce costs, improve efficiency, and have better control over the production process. It can also be an effective way to cut out the middleman and make the production process more profitable.
What are the pros and cons of Backward Integration?
The pros of backward integration include better control over supply chain, potential for cost reductions, improved product quality, and competitive advantage. The cons include high implementation costs, increased operational complexity, potential antitrust issues, and potential for distraction from core business.
Can you give examples of Backward Integration?
Examples of businesses that use backward integration include Apple, which designs its own components for its devices; Starbucks, which owns its own coffee farms to ensure supply and quality; and Amazon, which has integrated vertically by creating its own distribution centers. These companies have sought more control over their supply chains and have achieved cost and efficiency benefits.
Related Entrepreneurship Terms
- Vertical Integration
- Supply Chain Management
- Merger and Acquisition
- Cost Saving Strategy
- Competitive Advantage
Sources for More Information
- Investopedia – A comprehensive online resource that provides definitions, explanations, and examples on a broad range of financial terms and concepts.
- The Motley Fool – An investment and finance website that offers a broad swath of financial advice, stock recommendations, and other financial services.
- Corporate Finance Institute – An online educational platform that provides courses, resources, and certifications in financial analysis and modeling, investment banking, corporate development, and other finance-related topics.
- The Economist – A respected publication that covers a variety of topics, including finance and economics, and it often includes detailed explanations and analyses of financial terms and tactics.
