Backward Integration Definition
This is a type of vertical integration involving the merger with or purchase of suppliers up the supply chain. This type of integration is employed by firms when they expect it will improve efficiency and cost savings. Some of the improvements that companies hope to benefit from by using backward integration include the reduction in transportation costs, developing a more competitive edge and an increase in profit margins.
A Little More on Backward Integration
Vertical integration involves the merge of two or more companies which are at different points on the supply chain. A supply chain is a group comprised of firms, individuals, resources, activities, technologies and other factors necessary in the manufacture and sale of products. This chain begins where the manufacturer receives the raw materials and ends with the final sale to an end consumer. When a company moves backward in its industry’s chain, it initiates backward integration.
For example, a bakery may decide to move up the supply chain by acquiring a wheat processor or a wheat farm. The bakery, therefore, purchases its manufacturer and eliminates the middle man. This means it will, thus, gain a competitive advantage against other firms in the same industry. This is called backward integration.
Backward integration is an essential strategy in business because when executed, costs spanning from the production to the distribution process can be better controlled and this improve a company’s bottom line. It also grants significant control to the company’s value chain, and this increases efficiency since the company has direct access to the required materials.
This strategy also aids companies in staying ahead of the competition since they gain access to various markets and resources as well as technology and patents. The opposite of backward integration is forward integration which entails the purchase and control of distributors.
For example, if the bakery discussed above sold its goods through a chain of retail stores or directly to consumers at farmers markets, then it would be employing a forward integration strategy. If the same bakery did not own anything such as a wheat farm or a retail store, then it would not be vertically integrated.
Sometimes vertical integration is not so good because various firms find that it is more efficient and effective in terms of cost, to rely on independent distributors and suppliers. If an independent supplier achieves great economies of scale and provides lower cost inputs, then backward integration would be undesirable.
An example of backward integration
Amazon Company employed backward integration when it expanded its business to become a book retailer and a book publisher. Amazon was initially an online retailer of books and purchased these books from traditional publishers. After is started printing and marketing its books, it reduced the cost of procuring the books. It also differentiated itself from other competitors since it chose where to distribute its published books and regulated the sale of these books.
References for Backward Integration
Academic Research on Backward Integration
- Power plays: Regulation, diversification, and backward integration in the electric utility industry, Russo, M. V. (1992). Strategic Management Journal, 13(1), 13-27. This paper examines the influences of regulatory oversight on strategic management and develops predictions of the extent to which a firm diversifies and integrates upwards by transaction-cost economics.
- The rhetoric and reality of supply chain integration, Fawcett, S. E., & Magnan, G. M. (2002). International Journal of Physical Distribution & Logistics Management, 32(5), 339-361. This article uses a multi-method empirical approach involving both surveys and case study interviews to seek the experience of industry managers who are engaged in supply chain initiatives and accurate view of supply chain management as it is currently practiced.
- Arcs of integration: an international study of supply chain strategies, Frohlich, M. T., & Westbrook, R. (2001). Journal of operations management, 19(2), 185-200. This paper uses a sample of 322 manufactures to investigate the supplier and customer integration strategies and decide how best to characterize supply chain strategies.
- Ownership without control: Toward a theory of backward integration, Riordan, M. H. (1991). Journal of the Japanese and International Economies, 5(2), 101-119. This article explains that backward integration takes place when a downstream firm purchases equity in an upstream supplier and that even though this establishes an ownership claim of the residual profits, it does not necessarily entail a change in the control rights over the managerial decisions.
- Testing the monopsony-inefficiency incentive for backward integration, Azzam, A. (1996). American Journal of Agricultural Economics, 78(3), 585-590. This article provides an empirical model that can be implemented to test the monopsony-inefficiency incentive for vertical integration.
- Capacity decisions and supply price games under flexibility of backward integration, Wang, L. M., Liu, L. W., & Wang, Y. J. (2007). International Journal of Production Economics, 110(1-2), 85-96. This study sets up a two-echelon supply chain model with one supplier and manufacturer to study an essential issue in supply chain design for manufacturing firms of how to make a trade-off between strategies of vertical integration and outsourcing.
- Buying back subcontractors: The strategic limits of backward integration, Laussel, D. (2008). Journal of Economics & Management Strategy, 17(4), 895-911. This paper attempts to show that backward integration is limited by a strategic adverse effect which is that the prices and profits of an independent supplier increase the merger reduces their number.
- Vertical integration under competition: forward, backward, or no integration?, Lin, Y. T., Parlaktürk, A. K., & Swaminathan, J. M. (2014). Production and Operations Management, 23(1), 19-35. This paper considers two competing supply chains which consist of a supplier, a manufacturer, and a retailer to prove that while backward integration is always beneficial, unilateral forward integration can harm the profitability of a manufacturer.
- Backward integration by a dominant firm, Linnemer, L. (2003). Journal of Economics & Management Strategy, 12(2), 231-259. This article examines the welfare consequences of a vertical merger raising the costs of rivals when downstream competition is a La Cournot between firms having fixed asymmetric marginal costs.
- Supplier switching costs and vertical integration in the automobile industry, Monteverde, K., & Teece, D. J. (1982). The Bell Journal of Economics, 206-213. This study aims to test a transaction cost theory of vertical integration with data derived from the US automobile industry.
- Vertical integration and corporate strategy, Harrigan, K. R. (1985). Academy of Management journal, 28(2), 397-425. This paper develops a new framework to predict when firms use make-or-buy decisions by proposing a fresh look at vertical integration and the dimensions it comprises.