Loading the player...

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.

RELATED TERMS
  1. Roll Yield

    Roll yield is the return generated by rolling a short-term futures ...
  2. Inverted Market

    In the context of futures markets, an inverted market occurs ...
  3. Vertical Well

    A vertical well is a well that is not turned horizontally at ...
  4. Horizontal Merger

    A horizontal merger occurs when companies in the same industry ...
  5. Integrated Circuit Card

    An integrated circuit card is a type of payment or identification ...
  6. Chain Store Sales

    An indicator that provides information on the monthly sales volumes ...
Related Articles
  1. Small Business

    What is Backward Integration?

    What is backward integration, and how can it affect industries?
  2. Small Business

    Vertical Integration

    Vertical integration occurs when a company buys and controls other businesses along its supply chain.
  3. Managing Wealth

    Data Integrity Analyst: Job Description & Average Salary

    Learn about the average salary of a data integrity analyst and the required skills, education and previous experience needed to fill this role.
  4. Managing Wealth

    The Top Reasons Why M&A Deals Fail

    A significant number of M&A transactions result in failure. Here are the top reasons why it happens.
  5. Investing

    USO Vs. DBO: Comparing Oil ETFs

    Discover two major oil ETFs, The United States Oil Fund and The PowerShares DB Oil Fund, and the major differences between the two funds.
  6. Personal Finance

    Supply Chain Management Jobs Are Booming

    There has been huge growth in supply chain management, both in the number of positions open and the range of responsibilities assigned to those positions.
  7. Investing

    First Data Launches New Software Segment

    The point-of-sale transaction firm will expand collaborations and commerce capabilities worldwide.
  8. Investing

    Google Stock: Analyzing 5 Key Suppliers (GOOGL)

    Learn about Google's parent company, Alphabet, the tech giant's vast supplier network, and the company's top five individual suppliers.
  9. Investing

    Amazon Announces Lower Prices For Whole Foods Products

    Amazon Prime members are also set to gain rewards from the acquisition.
RELATED FAQS
  1. What are the disadvantages of backward integration for a mid-sized business seeking ...

    Learn more about backward vertical integration and the disadvantages of this business strategy for some small and midsized ... Read Answer >>
  2. What's the best way to play backwardation in the futures market?

    Backwardation is a market condition in which a futures contract far from its delivery date is trading at a lower price than ... Read Answer >>
  3. What are the legal barriers to vertical integration?

    Learn how embarking on a vertical integration through a merger is liable to run into legal barriers if the integration is ... Read Answer >>
  4. Who are Toyota's (TM) main suppliers?

    Here, we'll discuss which companies make up Toyota's supply chain and how it provides awards to its largest and most efficient ... Read Answer >>
Trading Center