Backward Integration
Backward Integration
Backward Integration
By WILL KENTON
Reviewed By DAVID KINDNESS
Updated Sep 29, 2020
KEY TAKEAWAYS
In short, backward integration involves buying part of the supply chain that
occurs prior to the company's manufacturing process, while forward integration
involves buying part of the process that occurs after the company's
manufacturing process.
Netflix Inc., which started out as a DVD rental company supplying TV and film
content, used backward integration to expand its business model by creating
original content.
Advantages of Backward Integration
Companies pursue backward integration when it is expected to result in improved
efficiency and cost savings. For example, backward integration might cut
transportation costs, improve profit margins, and make the firm more competitive.
Costs can be controlled significantly from production through to the distribution
process. Businesses can also gain more control over their value chain,
increasing efficiency, and gaining direct access to the materials that they need. In
addition, they can keep competitors at bay by gaining access to certain markets
and resources, including technology or patents.
In some cases, it can be more efficient and cost-effective for companies to rely
on independent distributors and suppliers. Backward integration would be
undesirable if a supplier could achieve greater economies of scale–meaning
lower costs as the number of units produced increases. Sometimes, the supplier
might be able to provide input goods at a lower cost versus the manufacturer had
it became the supplier as well as the producer.
Companies that engage in backward integration might become too large and
difficult to manage. As a result, companies might stray away from their core
strengths or what made the company so profitable.
Although it still sells books produced by others, its own publishing efforts have
boosted profits by attracting consumers to its own products, helped control
distribution on its Kindle platform, and given it leverage over other publishing
houses. In short, Amazon used backward integration to expand its business and
become both a book retailer and a book publisher.
Horizontal Integration
By WILL KENTON
Horizontal Integration
Reducing Competition
The real motive behind a lot of horizontal mergers is that companies want to
reduce “horizontal” competition in the form of competition from substitutes,
competition from potential new entrants and the competition from established
rivals. These are three of the five competitive forces that shape every industry
and which are identified in Porter’s Five Forces model. The other two forces, the
power of suppliers and customers, drive vertical integration.