Forward Integration

What is Forward Integration?

Forward integration is a strategy adopted by business to reduce production costs and to improve the efficiency of the firm by acquiring supplier companies and therefore, replaces the third party channels and consolidates its operations.

Explanation

How Forward Integration Works?

Forward Integration Example

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Let us see an example. The company Intel supplies the company DELL with processors, which are intermediate goods which are then placed within DELL’s hardware. If Intel decided to move forward in the supply chain, it may think of a mergerMergerMerger refers to a strategic process whereby two or more companies mutually form a new single legal venture. For example, in 2015, ketchup maker H.J. Heinz Co and Kraft Foods Group Inc merged their business to become Kraft Heinz Company, a leading global food and beverage firm.read more or acquisition of DELL in order to own the manufacturing portion of the industry.

Again if DELL wants to implement this strategy, it can think of taking control over the marketing agency that the company previously used to market its end product. But DELL cannot take over Intel if it plans to integrate forward because only a backward integration allows a movement up the supply chain.  If Intel decides to follow them, then, in the long run, it can operate as a monopoly and dominate the market by being in control of both raw material and finished product.

When to Follow Forward Integration?

Amazon’s Example – WholeFoods Acquisition

Forward Integration

source: money.cnn.com

  • Amazon’s purchase of whole foods is one of the highest-profile examples of forward integration strategy in the current years.
  • Amazon publishes the book itself as well as provides a publishing platform for independent writers.
  • It also has its own transportation (Amazon Transportation Services) and distribution, which is forward and backward integration-toward suppliers-and forward integration because Amazon directly delivers to the end-users.
  • This as brick and mortarBrick And MortarBrick and Mortar is a kind of business that offers goods and services to its customers face-to-face through a physical outlet. It represents a physical presence of a business. read more Whole Foods outlets for Amazon. The Whole Foods outlets act as places to sell their products or have the customers pick them up at their convenience.
  • Amazon was already in the grocery business in a small way, but this acquisition made Amazon a top player in the market. Shares of traditional food retailers fell to new lows because Amazon has the potential to shake up the industry.
  • Similarly, DELL sells online directly to the customers, and Apple has its own stores to reach out to the customers, which are also good examples of such integration strategy.

Top Examples of Forward Integration Strategy

  • A bicycle tyre manufacturer starts manufacturing bicycles, i.e., the end product.
  • An FMCG company like Britannia builds up its own distribution network, including regional warehouses, so that it can directly sell to the retailers without having to go via wholesalers.
  • A farmer, i.e., a producer of vegetables, directly sells his products at the farmer’s markets.
  • A manufacturing company of ski equipment opens its outlets in various ski resorts to offer the customers a brand experience to improve its brand image and brand recognition, along with having direct selling contact with the customers.
  • Myntra, an e-commerce company starts its own logistics service- Myntra Logistics, to reduce costs, improve turnover time, and reach its customers timely.
  • A software company starts its own consulting and software development services so that it does not have to depend on a network of partners to help customer implement their products.
  • Flipkart, an e-commerce company, has its own customer service functions instead of outsourcing them to improve customer experience.

Key Differences between Forward and Backward Integration

Forward IntegrationBackward Integration
Here the company acquires or merges with a distributor.Here the company acquires or merges with the supplier or manufacturer.
The main objective is to achieve a larger market share.The main objective of backward integration is to achieve economies of scale.
Here the companies are looking to expand their distribution or improve the placement of their products in the market.Involves internal steps to reduce overall dependency on suppliers and service providers.
Gives control over the supply chain;Gives control over purchasing power;

Advantages

Disadvantages

  • Leads to higher cost if new activities are not managed properly.
  • May lead to a lower quality of product and reduced efficiency due to lack of competition.
  • Increased bureaucracy and high investments may lead to lesser flexibility.
  • The inability to offer product variety as in-house efficiency and skillsets are required.
  • Possibilities of monopoly arise.
  • Organizational structure may become rigid due to the shortcomings of such implementations.

Forward Integration Video

This article has been a guide to what is Forward Integration and its definition. Here we discuss how forward integration works, along with examples (Amazon-Wholefoods acquisition) and integration strategies. Also, we discuss their advantages and disadvantages. You can learn more about Corporate finance from the following articles –

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