What Are the Effects of Backward Integration?

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What Are the Effects of Backward Integration?
03 Feb 2022
6 min read

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Backward integration happens when a corporation gains complete control of its supply chain by acquiring suppliers or forming its subsidiary. Businesses will be able to increase supply chain efficiency and cut expenses as a result of this shift. #TWN

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Backward integration, a type of vertical integration, allows companies to gain control over their suppliers and increase supply chain efficiency. To gain a competitive advantage over competitors and cut costs, businesses combine with and buy their suppliers. In some markets, this could lead to monopolies and antitrust violations. Most organizations will benefit from this strategy, but they should be mindful of the risks associated with backward integration.

Backward Integration

When a company decides to take on the duties that its suppliers formerly performed, this is known as backward integration. When a company buys a company that supplies it with raw materials, goods, or services, this happens. A company that makes sweaters and gets its wool from a sheep farm, for example, would backward integrate if it bought the sheep farm. Backward integration allows businesses to have complete control over supply chain sectors, decreasing inefficiencies, and costs. The company believes that controlling some portions of its supply chain, rather than relying on outsiders over whom it has no control, would cut costs, enhance margins, distribute faster, and expand its customer base.

Backward Integration Advantages

Backward integration has several advantages, the most important of which is complete control. A corporation will have complete control from the time it obtains raw materials until it sells the finished product, depending on the suppliers it has chosen. A corporation has control over the quality of raw materials, the speed with which they are converted into finished products, and the speed with which they are supplied to clients in this regard. Backward integration offers a competitive benefit as well. If a supplier supplies multiple companies, a firm that buys the supplier gains an edge over its competitor because the competitor will have to find a new source.

Backward Integration Disadvantages

There are various obstacles and risks associated with backward integration. Companies that are unable to successfully manage their supply chain after acquiring suppliers risk losing money and producing lower-quality goods. It's possible that the costs of managing suppliers aren't in the best interests of the company or that the organization lacks the necessary competence to make products. Furthermore, purchasing suppliers' competitive advantage may result in a lack of competition, which often leads to a lack of innovation. Furthermore, acquiring a supplier involves integrating its personnel, which can be challenging if there are cultural clashes or unwanted bureaucracy.

Real-World Example

Netflix is one of the best and most recent examples of backward integration. Netflix began as an online DVD rental service, with consumers logging into their accounts, selecting movies, and receiving them via mail. As the Internet evolved and streaming video capabilities increased, Netflix transitioned to offering movies and episodes via a streaming platform. Netflix negotiated licensing agreements with the media businesses to make these films and episodes available. Netflix eventually backward integrated by creating its original content, which allowed them to generate more money. It reduced the company's dependency on external artists and met the need of its customers for more unique material. Netflix's original material, rather than licensed programming, has been the main lure for its users over time.

Conclusion

As part of their business plan, companies should carefully assess the risks and benefits of a backward integration strategy. Midsized enterprises should be cautious since they may not be prepared for the additional risk of acquiring suppliers. Backward integration, on the other hand, maybe advantageous if controlling suppliers allows for higher profit margins and ensures the availability of materials for manufacturing.