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What is Backward Integration?

Definition: Backward integration is a method of vertical integration that extends to the previous levels of the supply chain, aiming to protect the quality of a product or a service by gaining control over the raw materials. In other words, itís when a company purchases a supplier in or a supplierís rights to materials in an effort to control its supply chain.

What Does Backward Integration Mean?

What is the definition of backward integration? Backward integration takes place when a firm enters a merge with a supplier to take advantage of specialized resources and protect the quality of the goods and services produced. Firms participate in backwards integration to protect the supply of raw materials, thereby creating a competitive advantage.

Usually, this type of integration creates barriers to entry for the competitors that wish to enter a sector or an industry because the firm controls the scarce resources and the raw materials. Furthermore, it creates economies of scale as, due to the merger, the new firm lowers the repair costs as well as the suppliersí expenses. The only shortcoming that needs attention is that this may also lead to increased monopoly power.

Letís look at an example.

Example

Company ABC is a manufacturer of frozen food and seeks to acquire one of their suppliers who owns a poultry processing plant. By acquiring the poultry processing plant, the company will be able to control the cost of production, the quality of raw materials, and the quality of the produced food.

Furthermore, the company will be able to differentiate its products from its competitors as by assuming control over the supplier it will hinder competitive companies from buying supplies from the poultry processing plant. In doing so, the company will control the scarce resources and the raw materials, but also its costs due to the economies of scale.

Therefore, with backward integration, a firm controls its supply chain, lowers its costs and controls the raw materials, while hindering the access of competitors to these raw materials.

Summary Definition

Define Backward Integration: Backward integration is the business strategy of purchasing or merging with companies farther back in the supply chain in an effort to control the supply of materials and costs in the production process.

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