Backward and Forward Integration: Benefits for Businesses

Forward and backward integration

Both forward and backward integration are vertical integration strategies to gain better control of the value chain, reduce dependence on the suppliers and increase business competitiveness.  The two strategies can help companies gain higher control of their business and reduce the bargaining power of suppliers. There are some major benefits to be obtained from these strategies. Both can have an impact on the bottom line directly. Integration happens if a company moves upward or downward in its supply chain.

Starting from the suppliers from whom the company obtains raw materials, the chain moves downstream towards the distributors and the retailers. If the suppliers’ power is very high, it can be financially burdensome for the company. Suppose the number of suppliers of a company is low and the company does not have many sources to obtain raw material from. The burden in that case will be upon the company’s shoulders giving rise to higher bargaining power for the suppliers. Its expenditure on raw materials will also be high.

Backward Integration:

The pressure can be lower if the company has a higher number of options. However, this is not always possible. So, the companies with limited number of suppliers or those which want to improve their control of the supply chain and cut down the manufacturing costs would try to obtain the raw materials directly rather than through suppliers.

For example, a coffee company to obtain good quality cocoa invests in buying cocoa farms and produces its own coffee. A furniture company buys forests to obtain wood and make its own furniture. This kind of upstream movement in the supply chain is known as backward integration. It is called backward integration because you are moving backward in the value chain. It can be beneficial for companies and reduce their dependence on suppliers. The companies can obtain raw material at reduced costs. The benefits can be passed on to the consumers by reducing prices. This can increase sales and finally the companies’ bottom line will be a lot healthier and market position stabler. Overall, the company gains better control of its business operations. Moreover, reduced dependence on suppliers also ensures timely availability of raw material and less quality concerns giving companies more space to innovate.

Forward Integration:

Forward integration is just the opposite of backward integration. It is a kind of forward movement down the supply chain where companies try to get closer to the customers by extending their operations into distribution and retail. Forward integration can also provide potential benefits. More direct control on the distribution of the products can add to the bottom line.  Selling to the customers directly can reduce the costs of distribution. A brand removes the mediators between it and its customers and starts enjoying higher profits.

Several brands run their own retail and e-retail stores. Dell sells directly to consumers online and Apple has its own chain of stores in various corners of the globe. Both have reduced the distance between the brand and the customers and brought it closer to the customers. It will also mean higher operational efficiency for a company.  The products can be available at the right time in the market and the company will sell directly to the customers. However, a key focus while trying to undertake any of the two must be on aligning the steps with the objectives of the brand. Evaluating customer needs and if these things would add value to the company’s business operations or not is equally essential. The most important benefit of the two vertical integration strategies is that they help a company gain financial and operational efficiency and independence which will increase its profit margins.

Abhijeet Pratap

I am Abhijeet Pratap, editor of notesmatic. I am an MBA with marketing (major). Apart from writing on various topics in business management, marketing and English literature, I like to read and write about technology.