Forward integration is a vertical integration strategy in which a company expands its operations to control its products’ direct distribution or supply. This strategy is usually employed by manufacturers who want greater control over their product’s supply chain, from production to point of sale.
Forward integration can involve activities such as:
- Setting up owned or controlled distribution or retail outlets.
- Acquiring or merging with existing distributors or retailers.
- Direct selling to customers through e-commerce or direct mail.
The main advantages of forward integration are:
- Increased control over the supply chain, ensuring quality and timely delivery.
- Enhanced customer relationship and understanding of customer needs.
- Better margins by eliminating the middleman’s costs and profits.
- Improved competitive position makes it difficult for competitors to access customers.
However, forward integration also has potential drawbacks:
- It can require significant capital and resources.
- The company may lack the necessary skills and knowledge to effectively manage the new business segments.
- It can lead to less focus on the core business.
- There may be regulatory issues or anti-trust considerations in some jurisdictions.
Companies typically consider forward integration when they want to gain better control over their product distribution, increase profit margins, or are unsatisfied with the performance of intermediaries in their supply chain.
Horizontal & vertical integration strategy: Meaning | Types | Examples
Types of forward integration
The types of forward integration can be categorized based on the approach a company uses to extend its control over the distribution of its products or services. Here are a few common types:
- Direct Selling: This involves selling products or services directly to the consumer, bypassing intermediaries. This can take place online (through an e-commerce website, for example), through direct mail, over the phone, or through physical retail locations owned and operated by the company.
- Company-Owned Retail or Outlets: This type of forward integration involves a manufacturer opening retail locations or outlets to sell its products directly to consumers. For example, Apple has a network of Apple Stores.
- Acquisition of Distributors: Some companies choose to acquire existing distributors or retailers. This can provide immediate access to established distribution networks and eliminate competition.
- Franchising: In this type of forward integration, the company allows entrepreneurs to use their brand name, products, and business model to open their outlets. Although the company doesn’t own these outlets, it exerts significant control over its operations.
- Vertical Marketing System: In a vertical marketing system, a manufacturer, wholesaler, and retailer act as a unified system. One channel member owns the others, has contracts with them, or has so much power that they all cooperate.
A company’s method will depend on various factors, including its specific goals, the resources available, the nature of its products or services, and the market they operate in.
Examples of Forward integration
Sure, here are some examples of forward integration:
- Apple: Apple Inc. is a prime example of a company that uses forward integration. The company designs and manufactures its products and then sells them directly to consumers through Apple Stores (both physical and online) worldwide. This helps Apple maintain control over the retail experience, which is a key part of its brand image.
- Netflix: Originally, Netflix was a DVD rental-by-mail service. However, the company integrated into streaming services and then further into content production, creating original shows and movies. This forward integration allows Netflix to control its content pipeline and reduce dependency on external production studios.
- Starbucks: Starbucks uses forward integration by owning most of its cafes instead of franchising them, as many other food service businesses do. This allows the company to control the quality of the customer experience across its stores.
- Amazon: Amazon has increasingly moved into physical distribution and retail, including purchasing Whole Foods, thereby integrating forward from its online retail platform into physical grocery retail.
- Zara: The fashion retailer Zara, part of Inditex Group, controls all the stages of its supply chain, from design and production to distribution and retail. This lets the company respond quickly to changing fashion trends and customer demands.
These examples show how forward integration can provide companies with increased control over their products and services, from production to sale, and enhance their competitive position in the market.
What is a backward integration strategy?
Backward integration is a business strategy where a company takes control of its supply chain by acquiring or establishing operations that produce raw materials or intermediate goods that it needs for its production process.
For instance, a car manufacturing company that buys a tire company or a rubber processing plant would integrate backward, as it controls more of its supply chain by producing some of its raw materials or components in-house.
Backward integration offers several potential benefits:
- Cost Control: A company can reduce its production costs by controlling its supply chain. It doesn’t have to pay a markup for its inputs to produce its goods or services.
- Quality Control: When a company produces its inputs, it has more control over its quality.
- Supply Chain Reliability: Backward integration can ensure a reliable, steady supply of inputs. This can be particularly valuable in industries where raw materials are scarce or subject to price volatility.
- Increased Differentiation: By controlling more of its supply chain, a company can create more unique or differentiated products in the market.
However, there are also potential drawbacks:
- Increased Capital Requirement: Backward integration often requires substantial capital expenditure to buy suppliers or establish new operations.
- Reduced Focus: A backward integration company may lose focus on its core business.
- Risk of Negative Impact on Suppliers: Backward integration can harm a company’s relationships with its suppliers, particularly if the company continues using third-party suppliers while producing some of its own inputs.
Overall, the decision to pursue a backward integration strategy will depend on various factors, such as the company’s industry, the stability of its supply chain, the quality of its inputs, and the capital available for investment.
Types of backward integration
Backward integration can be categorized into a few types, depending on companies’ strategies to control their supply chains. Here are some common types:
- Acquisition of Suppliers: A company may directly acquire a supplier or a group of suppliers. This is the most direct form of backward integration and gives the company immediate control over its supplies. For example, a car manufacturer might acquire a tire manufacturer.
- Merger with Suppliers: Similar to acquisition, a merger brings a supplier into the company. However, the two companies combine to form a new entity in this case.
- Internal Development: A company may develop its supply capabilities. For example, a clothing retailer might start its own cotton farming or fabric manufacturing operations.
- Strategic Partnerships/Alliances: A company could establish a strategic partnership or alliance with a supplier. While this doesn’t give the company ownership of the supplier, it can provide high control over supplies.
- Joint Ventures: A company could establish a joint venture with a supplier. This means creating a new company that the two parties jointly own. Joint Venture: Meaning | Types | Examples
A company’s specific strategy will depend on various factors, including its financial resources, the nature of its industry, and the availability and suitability of potential suppliers for acquisition or partnership.
Examples of backward integration
Sure, here are some examples of backward integration:
- Coca-Cola: Coca-Cola executed a backward integration strategy when acquiring its bottling operations. This allowed Coca-Cola to control both the production of its syrups and the bottling and distribution process.
- Apple: Apple decided to design and manufacture the chips used in its devices. This backward integration strategy allows Apple to control the hardware that powers its products, leading to better optimization and efficiency.
- Starbucks: In some cases, Starbucks has bought coffee farms, a form of backward integration that gives the company control over its raw material supply and ensures the quality and sustainability of its coffee beans.
- Amazon: Amazon has backward integrated into shipping and delivery, building its logistics network with delivery vans, cargo planes, and even an ocean freight forwarding license. This gives Amazon control over a significant portion of its supply and delivery chain.
- Zara: Zara’s parent company, Inditex, owns the factories that produce a significant portion of Zara’s clothes. This allows for quick turnarounds from design to store shelves and gives Zara control over its supply chain.
These examples show how backward integration can give a company increased control over its supply chain, potentially leading to cost savings, improved efficiency, and better quality control.
