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What is 'Backward Integration'

Backward integration is a form of vertical integration that involves the purchase of, or merger with, suppliers up the supply chain. Companies pursue backward integration when it is expected to result in improved efficiency and cost savings. For example, this type of integration might cut transportation costs, improve profit margins and make the firm more competitive.

BREAKING DOWN 'Backward Integration'

Vertical integration is the integration of two or more companies at different places on the supply chain. A supply chain is the summation 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 occurs when a company initiates a vertical integration by moving backward in its industry's chain.

A general example of backward integration is when a bakery business moves up the supply chain to purchase a wheat processor and/or a wheat farm. In this scenario, a retail supplier is purchasing one of its manufacturers, therefore cutting out the middle man, and hindering competition. 

Why Is Background Integration So Important?

Backward integration is a very important business strategy. By executing this strategy, a company can help its bottom line. Costs can be controlled significantly from the 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, another benefit to this strategy includes keeping competitors at bay by gaining access to certain markets and resources, including technology or patents.

Difference Between Backward Integration and Forward Integration

By way of contrast, forward integration is a type of vertical integration that involves the purchase or control of distributors. An example of forward integration is if the bakery sold its goods directly to consumers at local farmers markets, or if it owned a chain of retail stores through which it could sell its goods. If the bakery did not own a wheat farm, a wheat processor or a retail outlet, it would not be vertically integrated at all.

Potential Issues With Backward Integration

Vertical integration is not inherently good. For many firms, it is more efficient and cost effective to rely on independent distributors and suppliers. For example, backward integration would be undesirable if a supplier could achieve greater economies of scale and provide inputs at a lower cost as an independent business, rather than if the manufacturer were also the supplier.

A Real World Example of Backward Integration

Many large companies and conglomerates conduct backward integration. Amazon, for example, became vertically integrated backward when it expanded its business to become both a book retailer and a book publisher. Previous to acting as a publisher, Amazon was the first online retailer of books, and it made purchases from traditional publishers for a fee. Once it decided to print and market its own books as a publisher, it reduced the costs of producing or procuring the books.

Further, it was able to differentiate itself from other competitors by choosing where its published books are distributed. By keeping its published authors exclusive to its platform, it can regulate the sale of its books.

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