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
- In practice, companies can opt for forward and backward integrationBackward IntegrationBackward Integration is a vertical integration type in which a Company buys or integrates with its supplier firms to improve efficacy, save costs, & gain more control over the production process.read more to gain a competitive advantage over their 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, the 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 this strategy, 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 greater control over the flow of the products.
How Forward Integration Works?
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For eg:
Source: Forward Integration (wallstreetmojo.com)
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?
- 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 a 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. In this case, it will help in strengthening the organization’s value chain from production to sales and support of the products.
- When the existing retailers and distributors have a higher profit margin, Profit Margin, Profit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read morewhich 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 Example – WholeFoods Acquisition
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 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 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
- Low costs due to the elimination of market transaction costs
- Reduction in transportation costs.
- Proper coordination in the supply chain as there is a synchronization of supply and demand.
- Bigger market share.
- Strategic independence
- Better opportunities for investment growth.
- Creates an entry barrierEntry BarrierBarriers to entry are the economic hurdles that a new entrant must face in order to enter a market. For example, new entrants must pay fixed costs regardless of production or sales that would not have been incurred if the participant had not been a new entrant.read more to potential competitors
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
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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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