Backward Integration

By WILL KENTON
Reviewed By DAVID KINDNESS
Updated Sep 29, 2020

What Is Backward Integration?

Backward integration is a form of vertical integration in which a company
expands its role to fulfill tasks formerly completed by businesses up the supply
chain. In other words, backward integration is when a company buys another
company that supplies the products or services needed for production. For
example, a company might buy their supplier of inventory or raw materials.
Companies often complete backward integration by acquiring or merging with
these other businesses, but they can also establish their own subsidiary to
accomplish the task. Complete vertical integration occurs when a company owns
every stage of the production process, from raw materials to finished
goods/services.

What is Backward Integration?

KEY TAKEAWAYS

 Backward integration is when a company expands its role to fulfill tasks

formerly completed by businesses up the supply chain.
 Backward integration often involves is buying or merging with another
company that supplies its products.
 Companies pursue backward integration when it is expected to result in
improved efficiency and cost savings.
 Backward integration can be capital intensive, meaning it often requires
large sums of money to purchase part of the supply chain.
Understanding Backward Integration
Companies often use integration as a means to take over a portion of the
company's supply chain. A supply chain is the group of individuals, organizations,
resources, activities, and technologies involved in the manufacturing and sale of
a product. The supply chain starts with the delivery of raw materials from a
supplier to a manufacturer and ends with the sale of a final product to an end-
consumer.

Backward integration is a strategy that uses vertical integration to boost

efficiency. Vertical integration is when a company encompasses multiple
segments of the supply chain with the goal of controlling a portion, or all, of their
production process. Vertical integration might lead a company to control its
distributors that ship their product, the retail locations that sell their product, or in
the case of backward integration, their suppliers of inventory and raw materials.
In short, backward integration occurs when a company initiates a vertical
integration by moving backward in its industry's supply chain.

An example of backward integration might be a bakery that purchases a wheat

processor or a wheat farm. In this scenario, a retail supplier is purchasing one of
its manufacturers, therefore cutting out the middleman, and hindering
competition.

Backward Integration vs. Forward Integration

Forward integration is also a type of vertical integration, which involves the
purchase or control of a company's distributors. An example of forward
integration might be a clothing manufacturer that typically sells its clothes to retail
department stores; instead, opens its own retail locations. Conversely, backward
integration might involve the clothing manufacturer buying a textile company that
produces the material for their clothing.

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.

Disadvantages of Backward Integration

Backward integration can be capital intensive, meaning it often requires large
sums of money to purchase part of the supply chain. If a company needs to
purchase a supplier or production facility, it may need to take on large amounts
of debt to accomplish backward integration. Although the company might realize
cost savings, the cost of the additional debt might reduce any of the cost savings.
Also, the added debt to the company's balance sheet might prevent them from
getting approved for additional credit facilities from their bank in the future.

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.

A Real-World Example of Backward Integration

Many large companies and conglomerates conduct backward integration,
including Amazon.com Inc. Amazon began as an online book retailer in 1995,
procuring books from publishers. In 2009, it opened its own dedicated publishing
division, acquiring the rights to both older and new titles. It now has several
imprints.

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

Updated Mar 24, 2019

What is Horizontal Integration

Horizontal integration is the acquisition of a business operating at the same level
of the value chain in the same industry. This is in contrast to vertical integration,
where firms expand into upstream or downstream activities, which are at different
stages of production.

Horizontal Integration

BREAKING DOWN Horizontal Integration

Horizontal integration is a competitive strategy that can create economies of
scale, increase market power over distributors and suppliers, increase product
differentiation and help businesses expand their market or enter new markets. By
merging two businesses, they may be able to produce more revenue than they
would have been able to do independently.

However, when horizontal mergers succeed, it is often at the expense of

consumers, especially if they reduce competition. If horizontal mergers within the
same industry concentrate market share among a small number of companies, it
creates an oligopoly. If one company ends up with a dominant market share, it
has a monopoly. This is why horizontal mergers are heavily scrutinized under
antitrust laws.

Advantages of Horizontal Integration

Companies engage in horizontal integration to benefit from synergies. There may
be economies of scale or cost synergies in marketing, research and development
(R&D), production and distribution. Or there may be economies of scope, which
make the simultaneous manufacturing of different products more cost-effective
than manufacturing them on their own. Procter & Gamble’s 2005 acquisition of
Gillette is a good example of a horizontal merger which realized economies of
scope.1 Because both companies produced hundreds of hygiene-related
products from razors to toothpaste, the merger reduced the marketing and
product development costs per product.

Synergies can also be realized by combining products or markets. Horizontal

integration is often driven by marketing imperatives. Diversifying product
offerings may provide cross-selling opportunities and increase each business’
market. A retail business that sells clothes may decide to also offer accessories,
or might merge with a similar business in another country to gain a foothold there
and avoid having to build a distribution network from scratch.

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.

Disadvantages of Horizontal Integration

Like any merger, horizontal integration does not always yield the synergies and
added value that was expected. It can even result in negative synergies which
reduce the overall value of the business, if the larger firm becomes too unwieldy
and inflexible to manage, or if the merged firms experience problems caused by
vastly different leadership styles and company cultures. And if a merger
threatens competitors, it could attract the attention of the Federal Trade
Commission.

Examples of Horizontal Integration

Examples of horizontal integration in recent years include Marriott's 2016
acquisition of Sheraton (hotels) Anheuser-Busch InBev's 2016 acquisition of
SABMiller (brewers), AstraZeneca's 2015 acquisition of ZS Pharma (biotech),
Volkswagen’s 2012 acquisition of Porsche (automobiles), Facebook's 2012
acquisition of Instagram (social media), Disney's 2006 acquisition of Pixar
(entertainment media) and Mittal Steel’s 2006 acquisition of Arcelor (steel).
Market Integration

The nineteenth century saw substantial advances in

international market integration, and the creation of a truly world
economy. Technological advance was critical in this. The
railroad locomotive and the marine steam engine revolutionized
world transport from the 1830s onwards. Steamships connected
the world's ports to each other, and from the ports the railroads
ran inland, creating a new and faster world transport
network. Freight rates fell, and goods could be carried across
the world to ever more distant markets and still be cheaper in
those faraway places than the same item produced locally.
Linked closely to these changes was the electric telegraph,
whose lines often ran along the new railroad networks.
Telegraph systems were established in most countries,
including the major market of British India, until 1854. Beginning
with the first transatlantic cable, which was laid by steamship in
1866, these existing domestic telegraph systems were linked
together by marine cables. The resulting international
information network was crucial in communicating details of
prices and price movements, reducing the cost of making deals
and transactions. An infrastructural change of major
significance came in 1869 with the opening of the Suez Canal,
which linked the Mediterranean Sea by way of Egypt to the Red
Sea: now ships sailing from Europe to Asia could take the new
shortcut rather than sail all the way around Africa. Immediately
Asia was some 4,000 miles closer to Europe in transport terms,
and freight costs fell. Yet the low efficiency of early steamships
meant that many bulk cargoes such as rice still were carried to
Europe from Asia by sail around the Cape of Good Hope.
Technological change in the shape of steel hulls and steel
masts made sailing ships larger and more efficient, and they
continued to be active until the more efficient triple-expansion
engine finally drove the sailing ships from the oceans during the
last quarter of the nineteenth century.
RISE OF FREE TRADE
Physical changes in lowering freight and transaction costs were
not the only forces stimulating market integration. It was normal
for countries to impose import duties on foreign goods, seeking
to gain an inflow of gold in their foreign trade accounts by
selling more to each of their trading partners than they bought
from them. But in 1846 the merchants of Manchester, England,
the center of the world's cotton textile industry, struck their
famous victory for free trade by forcing the British government
to abandon tariffs on all imported goods apart from a few luxury
items. The tariffs on wheat were the first to go, opening up
the Great Plains of the United States for wheat production to
supply Britain. With free trade, no longer did trade relations with
a foreign country have to balance or be in surplus; rather, a
deficit in trade with one country could be offset by a surplus in
trade with another country, liberalizing world trade in a way
never previously seen. Britain moved heavily into deficit on
trade account, but this was sustained by considerable invisible
inflows generated by her substantial overseas investments,
particularly in the railroad systems of the United States.
This policy of open markets became a dominating principle
extended through much of the British Empire, including the key
market of India, although Canada and the State of Victoria in
Australia chose to be notable exceptions. The United States
retained import duties, and after short periods of trade
liberalization most European countries also returned to
protectionism so that their new manufacturing industries could
establish themselves safe from the competition of cheaper
goods from Britain. Britain itself ran heavy trade deficits with the
United States due largely to grain purchases, and it also had
deficits with the newly industrialized countries of continental
Europe, due to purchases of manufactured goods. Britain was
able to sustain these deficits because of its own sales of
manufactures, especially cotton yarn and textiles, to India and
the rest of Asia, including China. So the open-market polices of
the British Empire played a crucial role in sustaining a
complicated interrelated mesh of world payments, and newly
industrializing countries took advantage of these open markets
whilst maintaining their own protective walls. Each country
could specialize in producing those goods they were best
endowed by nature to produce, and could exchange them for
the other products they needed. The vast market of British India
was crucial, and though Britain, the colonial power, was the
leading supplier of manufactured goods there, Germany and
other industrial nations were free to trade, and did so very
effectively. India itself had big surpluses with the rest of Asia,
particularly China, because of its sales of opium and of cotton
yarn and textiles from Bombay.
INTEGRATION OF GRAIN MARKETS AT THE TURN OF THE
CENTURY
Within Asia major effects of market integration were seen.
Where a market area is fully integrated, prices of a particular
commodity will equalize across that area. Fluctuations in prices
across the region will synchronize, demonstrating that they are
subject to the same influences. Transport costs are crucial, and
a commodity will only move from one location to another if the
cost of production in the place of origin plus the cost of transport
is less than the prevailing price for that commodity in the
destination. In Asia the late nineteenth century saw market
integration in one of Asia's key commodities, rice. Prices moved
in the same way in the exporting countries (Burma, French
Indochina, and Siam), in the great redistribution centers (the
British free ports Singapore and Hong Kong), and in the
receiving countries (India, Ceylon, the Straits Settlements, the
Dutch East Indies, the Philippines, China, and Japan). The
movement of migrant workers to tin mines and rubber and tea
plantations in places like the Straits Settlements, the Dutch East
Indies, and Ceylon had created increased demand for rice in
those countries which was now satisfied by rice imports from
those countries capable of producing supplies. Shifts in the flow
of rice from country to country and from year to year reflected
harvest variations in both producers and consumers. The
transport and information networks established in the second
half of the nineteenth century had created an intra-Asian
economy in which the income received by rice cultivators was
spent on the products of the new manufacturing industries of
the region, particularly the cotton yarn and textiles of the
factories of Bombay, Shanghai, and Osaka. Rice was also
supplied in very substantial quantities to Europe, where it was
used for food, brewing, and starch. It joined a flow of wheat to
Europe from Karachi. This period saw the integration of the
world wheat market and the world rice market, creating a global
market in basic food grains. The two markets interlocked in
British India, which both consumed and exported both crops.
Now the world price of wheat and rice moved in unison, which
meant that the incomes of U.S. farmers and other world wheat
producers were influenced by forces such as a monsoon in
India!
But this integration of the world wheat markets and world rice
markets had serious consequences. During the 1920s there
was great expansion in the amount of land under wheat and
rice in the world at large. Normally, good wheat harvests were
offset by poor rice harvests, and good rice harvests were offset
by poor wheat harvests. But when favorable climatic conditions
occurred for both grains, particularly beginning in 1928, this
resulted in a glut, forcing down prices and bankrupting farmers
all over the world. As farm incomes fell, so did the ability of
farmers to purchase manufactured goods, and this affected
manufacturers, contributing to the worldwide Great
Depression of the 1930s. As the depression bit, countries
increased their tariff duties to keep foreign products out of their
markets in order to help their own manufacturers and farmers.
In 1932 even Britain, with its deep commitment to free trade,
was forced to turn to protectionism and surrender the free trade
ideal. Free trade and open markets were unfortunate casualties
of the Great Depression, and in fact their breakdown
contributed to the slump's prolongation. The restoration of free
trade and open markets was one of the primary aims of those
planning the operation of the world economic system after the
end of world hostilities in 1945.