Backward Integration Strategy: Pros and Cons for Businesses

Backward integration is a type of vertical integration strategy wherein a company purchases segments of the supply chain to improve its ability to control its own manufacturing. Rather than rely on other companies for raw materials, a company will either purchase their existing supplier or develop a new company to make these materials itself. This shortens the pipeline from raw materials to an end product. Consider a publishing house for books. For this company to manufacture books, they rely on and must pay individual paper, ink, and glue companies to help them print and bind books. In a backward integration business strategy, the publishing house would subsume one or all of these businesses to cut costs and control its own manufacturing.

Integrations are business strategies that aim to improve a company’s operations or profits—ideally, both. Here are four types of integrations:

1. 1. Backward integration: A business might buy portions of its supply chain to have more influence over its manufacturing processes, such as the raw supplies or ingredients. Backward integration is a form of vertical integration.
2. 2. Forward integration: In contrast to backward integration, a forward integration strategy relies on acquiring distributors rather than manufacturers of raw goods. Consider an online book retailer who relies on postal workers or private delivery companies to send out their books to retail stores and individual consumers. In a forward integration strategy, the retailer would purchase these distributors or develop its own distribution channels.
3. 3. Horizontal integration: This business strategy focuses on increasing market share by buying up similar companies. Horizontal integration might increase a manufacturing company’s own production capacity by putting these new subsidiaries to work on bolstering its already existent supply chain.
4. 4. Vertical integration: Whenever businesses purchase part of the supply chain they use—whether in the manufacturing process or on the distributive end—they’re pursuing a vertical integration strategy. Both backward and forward integration are forms of vertical integration. Among many other reasons, businesses use multiple vertical integration strategies to ensure products end up in the end consumer’s hands quicker and at lower costs than they would otherwise.

There are a few benefits to a business pursuing a backward integration strategy with regard to its supply chain.

1. 1. More control: By purchasing raw materials suppliers, companies reduce dependency on outside vendors and gain better control of their own products. Once a business owner brings these inputs in-house, they garner far more power over their supply chain.
2. 2. Competitive edge: By producing greater economies of scale through backward integration, companies gain a competitive advantage. Not only can they increase efficiency through controlling their own supply chain, they also subsume a potential—if peripheral—competitor.
3. 3. Cost reduction: In general, backward integration leads to a lower cost of production overall and lower transportation costs, too. Without backward integration, companies rely on an external middleman to supply them the goods necessary to make their final products. That middleman company will need to mark up prices to ensure a return on its own profit margins. After backward integration, business owners eliminate these mark-up costs—their supplier is now in-house and no longer needs to make a profit of its own.

Backward integration—the business strategy of buying up parts of the supply chain—can sometimes lead to negative consequences.

1. 1. Business bloat: A company might integrate a raw materials aspect into its production process, but it might lack the competency to handle the newly acquired business. Raw material suppliers focus exclusively on producing those materials as goods, whereas a company that acquires such a supplier might not have the same expertise. This can bloat the business and lead to both inefficiency and the reduced quality of raw materials themselves.
2. 2. High debt load: Buying a company requires a lot of money, and borrowed money can add a lot to a company’s balance sheet. Particularly for a new company, backward integration might lead to a very high or even unsustainable amount of debt. It’s wise to weigh cost savings against debt potential when thinking about pursuing a backward integration strategy.
3. 3. Ingenuity reduction: Reducing competition via backward integration can be a blessing and a curse. It can potentially lead to positive synergies between the parent and now acquired companies, but it can also create inefficiencies since both entities are no longer creatively competing for profits. Greater differentiation in markets often leads to lower costs and greater quality for all. The goal of backward integration should be a better finished product—it’s important to consider whether implementing the strategy will bring that about or kneecap innovation.

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