What is Forward Integration?
A company can decide to expand its business activities to include control of the direct distribution or supply of the company’s products. This kind of business strategy is known as forward integration.
- In practice, companies can opt for forward and backward integration to gain the competitive advantage over the competitors. This helps a company to extend its reach in the market, helping it to get control of the demand side, on the contrary, backward integration helps the company to get control of the supply side.
- In general, an industry is made up of five steps in the supply chain which are raw materials, intermediate goods, manufacturing, marketing and sales, and after-sales service.
- If a company plans to implement forward integration it has to move forward in the supply chain while it still maintains control of its initial place. This integration is done in order to achieve greater economies of scale, higher market share or greater control over distribution.
- By removing the third parties, the company has ownership of the distribution processes thus having a greater control over the flow of the products.
How Forward Integration Works?
Let us see a forward integration 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 merger or acquisition of DELL in order to own the manufacturing portion of the industry.
Again if DELL wants to implement forward integration 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?
- When the existing distributors as well as the retailers are expensive and are not able to match up to the distribution needs of the company.
- The absence of quality distributors in the market which helps the company in gaining the competitive edge over the competitors.
- When the company has adequate manpower like human resources as well as the financial advantage to meet the expenses of the distribution channel.
- When the company has very good production facilities to satisfy the demand of the customers. Forward integration, in this case, will help in strengthening organization value chain from production to sales and support of the products.
- When the existing retailers and distributors have a higher profit margin which increases the cost of the product and leads to the higher price of the product. With the help of this integration, the company can reduce the cost of distribution hence the product price will be lower thus increasing sales.
Amazon’s Forward Integration Example – Acquisition of WholeFoods
- Amazon’s purchase of whole foods is one of the highest profile examples of forward integration strategy in the current years.
- Amazon publishes 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 Whole Foods acquisition is an example of forward integration strategy, which serves as brick and mortar Whole Foods outlets for Amazon. The Whole Foods outlets act as places to sell its 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 forward 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 build 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 it 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
Here are the 4 key differences between Forward and Backward Integration-
|Forward Integration||Backward Integration|
|Here the company acquires or merges with a distributor.||Here the company acquires or merges with the supplier or manufacturer.|
|The main objective of forward integration is to achieve larger market share.||Main objective of backward integration is to achieve economies of scale.|
|Here the companies are looking forward to expand their distribution or improve placement of their products in the market.||Involves internal steps to reduce overall dependency on suppliers and service providers.|
|Gives control over supply chain.||Gives control over purchasing power.|
Advantages of Forward Integration
- Low costs due to the elimination of market transaction costs.
- Reduction in transportation costs.
- Proper coordination in the supply chain as there is synchronization of supply and demand.
- Bigger market share.
- Strategic independence
- Better opportunities for investment growth.
- Creates entry barrier to potential competitors.
Disadvantages of Forward Integration
- Leads to higher cost if new activities are not managed properly.
- May lead to lower quality of product and reduced efficiency due to lack of competition.
- Increased bureaucracy and high investments may lead to lesser flexibility.
- Inability to offer product variety as in-house efficiency and skill sets are required.
- Possibilities of monopoly arise.
- Organizational structure may become rigid due to shortcomings of such implementations.
This has been a guide to what is Forward Integration. Here we how forward integration works, along with forward integration examples (Amazon-Wholefoods acquisition) and practical forward integration strategies. Also, we discuss the advantages and disadvantages of forward integration. You can learn more about Corporate finance from the following articles –
- Diseconomies of Scale
- Successful Mergers and Acquisitions
- Mergers vs Acquisitions
- What is Statutory Merger?