Q 411. What is the difference between the two business value chain consolidation approaches - Forward and Backward Integration? Elaborate with examples from both manufacturing and service industries.

 

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Before explaining Forward Integration and Reverse Integration, let me start with the introduction of 2 strategies viz. Horizontal Integration and Vertical Integration are the most common 2 Business Strategies used by the companies to consolidate their position among their competitors.

 

Vertical Integration is the Business Strategy where the company takes complete control over the one or more stages in the production or the distribution of it. A company may opt for Vertical Integration to take full control over the raw material supply or in the distribution of it's final finished product. Or else the company may go for Horizontal Integration in which the company can go for the acquisition of the business which is at the same level of value chain in similar or dissimilar industries.

 

Vertical Integration is further classified into Forward Integration and Backward Integration.

 

The Process of Forward Integration and Backward Integration is shown below:

 

Source:https://studiousguy.com/backward-and-forward-integration/

 

Backward Integration: is the form of Vertical Integration, in which the company acquires or merges with another Business unit that supplies raw material for the production, eliminating the need for suppliers. The term "Backward" is used because here the company moves backward in the value chain. This process will result reduced costs, increased revenues and enhanced efficiency in the production.

 

Advantages of Backward Integration:

• Better Control: Since the company having a good control over the  the raw material supply, on time production and delivery are possible. Also the Quality of the raw material can be controlled based on the product quality required in the final product.
• Cost Control: By In-house production of raw material we can avoid the profits eaten-up by the middlemen and also the transportation costs.
• Competitive advantage:  For example in the technology Industry, companies can go for their own new low cost, high beneficial technology by making it proprietary, trademarks or by patenting allowing the competitors to search for the alternative methods.

 

Disadvantages of Backward Integration:

• Inefficiencies:  Since the raw materials are produced In-House, the company may limit competition resulting in the lack of Innovation leading to poor quality of final products, increasing the cost of customer complaint handling.
• Investment: Since huge initial investment is required, company may be forced to utilize all it's reserves and even take more debts resulting in losses in case of failure of business.

 

Forward Integration: is the form of Vertical Integration, in which the company moves in the direction of controlling the distribution of products/services, eliminating the need for 3rd person in between the producer and the consumer. In other terms the company may eliminate the wholesaler selling the products to the retailer directly, or eliminating the retailer selling the products to the customer directly. Here also the aim is to reduce the cost and it may also increase the efficiency of the firm by getting closer to the end consumer.

 

Advantages of Forward Integration: 

 

• Increases Market Share: Since there is a transportation cost and other transactional cost reduction, company can sell the product at a lower price, achieving more market shares.
• Control over distribution: since we can eliminate the 3rd party intervention like wholesale retailers or brokers we will be having better control over the dispatches.
• Competitive advantage: Lower costs and controlled distribution gives companies competitive advantage over the other companies.

 

Disadvantages of Forward Integration:

• Bureaucratic Inefficiency: Various merger and acquisition deals  create inefficiencies as a result of entry of new apparatus of the new entity.
• Realization of synergies between the companies: Improper implementation of strategy can be the reason for not realizing the synergy potential.
• High Costs: Mergers/acquisitions may need substantial high funds, benefits obtained from the strategy implementation may be less compared to the cost spent.

 

Example from Manufacturing:

Steel Production Plant: Here Iron Ore, Lime Stone and Coke are the major raw materials which are conveyed into the Blast Furnace for producing a hot metal which in turn in the later stages produces Steel. Usually company sources them from different Vendors. It also does the transportation of final finished product using 3rd party logistics.

 

Now let's consider a Backward Integration application here. Instead of procuring these raw materials from different vendors, if the company creates it's own sources like captive mines, Integrated Lime Calcination Plant and Coke Oven plants, then it's an approach of Backward Integration.

Now applying Forward Integration, If the company thinks about it's own transportation mode say it's own trucks or it's own rakes, then the company can save a significant amount of transportation cost and also dependency on 3rd party vendors for the transportation ensuring on time delivery of goods to the customers.

 

Example from Services:

E-Commerce Companies like Amazon and Flipkart: As a part of Backward Integration both Amazon and Flipkart both has their customized products (products like Alexa, Fire TV Stick , Speakers for Amazon and Furniture's like Happy home etc. for Flipkart) along with other seller related products.

As a part of Forward Integration both have their excellent their own logistics connectivity to the almost all cities of a country ensuring on time delivery of products and avoiding customer breach.

 

Balanced Integration: There is a 3rd type of Vertical Integration called Balanced Integration, which is the mix of Forward and Backward Integration Strategies and this type of strategy is used in most of the companies, since it provides a balance of the 2 strategies.

 

When should go for  Vertical Integration?

• When the current raw material supply is unreliable.
• When the quality of raw materials are not stable
• When the prices are unstable or the distributors charge high amount.
• When the company has the sufficient resources to manage the show
• When the company is willing to grow significantly

 

Conclusion: The Integration strategies may not always work for an Organization because of many other reasons. So one should be  careful before going for Integration. These 2 aspects one should always consider before going for Integration.

 

a)Cost: The Organization should go for Integration only when the In-House production is cheaper than buying that raw material in the market.

 

b)The Scope of Organization:  Before the adoption of Integration, firm should think whether the moving into a new area of activities will weakens it's current competencies. Therefore it's necessary to carefully analyze before going to Integrate.

Backward and Forward integrations are two major strategies which is used my major organization to gain competitive advantages in the market and to get required control over the value chain of the industry & diminish the dependency on supplier/customers. These strategies are majorly used while developing future growth expansion plans for any organization. these two strategies are known as vertical integration altogether too.

 

Forward Integration: Company selects forward integration when a manufacturer decides to execute distribution or retail functions within the distribution channel. In simple terms, it means to eliminating the middleman role. In this situation, manufacturers may eliminate the retailers/ wholesaler & sell directly to customers only. The major objective here is to optimize cost and gain the efficiency. For Example,An Apparel company which has its own manufacturing & control over distributors can sell directly product to customer without any middleman.

 

Backward Integration: Here companies aim for control over their supply chains and try to procure raw materials directly by eliminating the suppliers. The term “Backward” is used because the company moves in backward direction to obtain business advantage. Example- An Apparel company build its own manufacturing unit rather than taking parts from supplier.

Forward Vs Backward Integration

Every company forms part of a value chain that is established from the source of supply to the end customer in order to deliver a product or a service to the end-user.

Vertical Integration. This is a form of business strategy when a company integrates with other companies either up or down the value chain in order to take advantage of either economy of scale, reduce risk, optimize the output or reduce cost. Forward integration would be manufactures merging or acquiring distributors or retailers whereas backward integration would be for a manufacturer merging or acquiring its supplier.

Vertical integration is not suitable in cases where the up-chain supplier or down-chain distributer is already operating at economies of scale.

Examples

A good example of Forward integration is Disney acquired over 300 retail stores that market products based on Disney movies and characters.

Amazon, Ford Motors are good examples of Backward Integration. The companies acquired the affiliates of their key supply input. For example, Ford Motors acquired the supplier of glass, metal, and rubber to increase efficiency, reduce cost, and to reduce the supply chain risk.

Apple is a good example of both forward and backward integration in that Apple has not only integrated with the manufactures of the components that go into the Apple products but has also integrated with the retailers through the exclusive Apple Retail Stores.

Advantages. Some of the advantages of integration are to secure the value chain and minimize disruption to the supply chain. Besides this, integration enables unifying culture, uniform norms of quality, communication, objectives, better planning, taking advantage of economies of scale, etc. Overall vertical integration leads to higher productivity, efficiency, and lower costs.

Disadvantages. The disadvantages of Vertical integration are that it kills competition, leads to oligarchic or monopolistic companies thereby increasing the price. At times it may kill flexibility, creativity, and innovation as it loses its ability to be agile and flexible.

Antitrust Laws. Some countries have Antitrust laws that aim to prevent vertical integration. Antitrust laws are in place to protect customers from businesses whose practices are predatory in nature and aim to kill the competition with the aim to increase the price.

References

https://www.differencebetween.com/difference-between-forward-and-vs-backward-integration/

https://www.investopedia.com/ask/answers/09/antitrust-law.asp#:~:text=Antitrust%20laws%20are%20statutes%20developed%20by%20governments%20to,market%20allocation%2C%20bid%20rigging%2C%20price%20fixing%2C%20and%20monopolies.

Varuna Kakathkar has provided examples from both manufacturing and service industries and hence it has been selected as the best answer. 

Johanan's answer is also a must read as he has highlighted a very pertinent disadvantages with respect to integrations.