Reviewed by Oct 05, 2020| Updated on
Backward integration refers to a form of vertical integration in which a company expands its role to accomplish tasks that were previously completed by companies up the supply chain. Simply put, backward integration is when a company purchases another company which supplies the products or services required for its production.
For instance, a company might buy inventory or raw materials from its supplier. Companies often complete backward integration by purchasing or combining with these undertakings. Still, they may also set up their subsidiary to perform the task.
Backward integration is a strategy that takes advantage of vertical integration to increase efficiency. Vertical integration is when a company expands across multiple supply chain segments to control a portion, or all, of its production process.
Companies use convergence as a way of taking over a portion of the supply chain of the business. A supply chain is the network of individuals, organisations, services, activities, and technology involved in manufacturing and selling a product. The supply chain starts with the distribution of raw materials to a producer and finishes with the selling of a finished product to an end consumer.
Vertical integration may lead a company to monitor its distributors who ship their product. It can help the retail locations that sell their product, or their inventory suppliers and raw materials in the event of backward integration. In short, backward integration happens when a company initiates vertical integration by going backwards in the supply chain of its business.
A backward integration example could be a bakery that buys a wheat processor or a wheat farm. In this case, one of the suppliers is acquired by a retail supplier, thereby cutting the middleman out, and hindering rivalry.
Industries are seeking backward integration as it is supposed to lead to higher productivity and cost savings. Backward integration will reduce freight costs, increase profit margins, and make the business more competitive. Prices can be substantially regulated, ranging from production till the final delivery.
Backward integration can be capital-intensive, which means buying a part of the supply chain will often require large sums of money. If a company needs to purchase a manufacturer or a manufacturing plant, it may need to take on significant amounts of debt to achieve backward integration.
Forward integration is also a form of vertical integration, involving purchasing or controlling distributors of a product. Backward integration consists of buying part of the supply chain that takes place before the manufacturing phase of the product. In contrast, forward integration involves the purchase part of the process that takes place after the manufacturing activity of the company in the supply chain.