Backward Integration

What is Backward Integration?

“Backward integration refers to the process in which a company purchases or internally produces segments of its supply chain.”

Backward integration can be simply defined as a process where a business or company acquires or merges with other businesses for supplying raw materials needed for its operations. Asides acquiring or merging with other businesses for raw materials, a company can as well create a unit under it that would be responsible for the supply of raw materials.

Backward integration is an effective competitive strategy used by companies seeking to gain full control of its supply chain, thereby cutting down on production costs and having direct access to raw material sources. Having direct access to raw material sources eliminates the position of the middleman. For example, when a sugar processing company decides to collaborate with or purchase the major supplier of its raw materials which is sugarcane in this case. The sugar processing company which is the manufacturer acquires the raw material supplier (sugarcane plantation) and integrates it into the manufacturer’s company as one company. So, instead of the regular flow of raw material supplier to manufacturer to end consumer, the flow becomes from the manufacturer (integrated with raw material supplier) to end consumers.

Why Backward Integration?

Backward integration is a good business strategy for companies seeking to get market advantage and also help its bottom line. Through this, costs can be controlled all through the production and distribution processes.

Since raw materials are scarce natural resources that greatly affect the productivity and operations of most manufacturers, therefore, many businesses seek to control raw materials directly. Most companies that engage backward integration do it for the purpose of improving efficiency, productivity, cost savings, and overall operations. Backward integration also gives companies that engage it an advantage over the competition, especially over new industry entrants.

Advantages of Backward Integration

• Competitive advantage: Companies that engage backward integration by acquiring raw material suppliers gain an advantage over the competition by control a whole branch of raw material suppliers. Assuming there are only four major suppliers of corn in the U.S. with about eight cereal manufacturers. If two of the cereal manufacturing companies acquire two of the raw material suppliers, the rest of the competition would be left with a lesser number of raw material suppliers to do business with. (The example given is only stating an instance for better understanding). By doing this, such backward integration companies create scarcity for other industry manufacturers or still, hinders competitors from gaining full access to the market.

• Cost Savings: This is made possible by eliminating the middleman and make direct sales to end buyers. The basic supply chain structure allows the middleman to earn a profit through a mark-up. The middleman may not necessarily be “one-man” but have a lot of people involved, thereby, incurring additional costs on the company. The cost of transportation is also considered and other wasted costs can now be controlled or completely avoided.

• Increased Control: In backward integration, the company can now control the value chain more effectively. It also has access to controlling both the production and distribution phases of the company. The company would also have control over the quality of materials being used in the production of the end product.