Backward Integration Concept

Vertical integration is referred to as the degree to which a firm is integrated with its upstream suppliers
and downstream distributors in an industry.

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Description:
Vertical integration is referred to as the degree to which a firm is integrated with its upstream suppliers
and downstream distributors in an industry. Vertical integration is very important for an organization as
it has a great impact on business units’ strategy in relation to cost, differentiation and other strategic
issues. The expansion of the strategies upward is called as backward integration, while the downstream
is called as forward integration.
The vertical integration concept is just like the value chain. If a firm makes its product through a value
chain, it will have to integrate itself with the upward suppliers and downward distributors, i.e. vertical
integration. This can be seen from the figure given below.

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There are two main issues that need to be kept in mind, cost and control. A firm must assess the cost of
marketing a product between firms as compared to marketing it internally. The second aspect is the
control issue, which relates to the control of assets that impacts on barriers to entry.
The vertical integration has following advantages:
 It reduces the transportation cost if there is common ownership in closer territories.
 The supply chain coordination is improved.
 There is a chance of differentiate more than before due to increased regulation of inputs.
 Take share in upward and downward profits.
 Raises the potential entrant barriers high.
 There is control over the downward distribution channel.
 Overall acquisition of core competencies.
With the number of advantages of vertical integration, there are few disadvantages as well. The
drawbacks of the vertical integration make this process unattractive to many businesses. The
examples include:
 Capacity issues; with increased integration both upward and downward, the firm has to
create more space so that’s its running processes are not affected.
 The firm efficiency gets decreased because of lack of supplier competition, this increases the
cost.
 Since previously, the firm was not integrated and there was a chance of flexibility in the
arrangements with suppliers and distributors but with vertical integration there is no room
for flexibility.
 There is less opportunity to make new products as the space is not available plus it will
affect the whole integrated network.
 There is an additional cost of bureaucracy.
Although vertical integration is the best way a business can earn profits, yet there is high cost issue
attached to it that is a problem for many organizations. There are few alternatives for such
organizations for making long term explicit contracts with suppliers and distributors, making joint
ventures, franchising agreements etc.


Reference: http://www.researchomatic.com/Vertical-Integration-Process-38425.html