Vertical Integration Strategy: Forward vs. Backward Control

Understanding Vertical Integration Strategy

Vertical integration is a strategy used by a company to gain control over its suppliers or distributors in order to increase the firm’s power in the marketplace, reduce transaction costs, and secure supplies or distribution channels. This strategy is one of the major considerations when developing corporate-level strategy.

The important question in corporate strategy is whether the company should participate in one activity (one industry) or many activities (many industries) along the industry value chain. For example, a company must decide if it only manufactures its products or if it will engage in retailing and after-sales services as well.

Forward Integration: Controlling Distribution

Forward integration is a strategy where a firm gains ownership or increased control over its downstream customers (distributors or retailers). This strategy is implemented when the company wants to achieve higher economies of scale and larger market share.

Forward integration became very popular with the increasing appearance of the internet. Many manufacturing companies have built online stores and started selling their products directly to consumers, bypassing traditional retailers.

Forward integration strategy is effective when:

• Few quality distributors are available in the industry.
• Distributors or retailers have high profit margins.
• Distributors are very expensive, unreliable, or unable to meet the firm’s distribution needs.
• The industry is expected to grow significantly.
• The company has enough resources and capabilities to manage the new business, benefiting from stable production and distribution.

Backward Integration: Securing Supply Chains

Backward integration is a strategy where a firm gains ownership or increased control over its upstream suppliers. Firms implement backward integration strategy in order to secure a stable input of resources and become more efficient.

Backward integration strategy is most beneficial when:

• The firm’s current suppliers are unreliable, expensive, or cannot supply the required inputs.
• There are only a few small suppliers but many competitors in the industry.
• The industry is expanding rapidly.
• The prices of inputs are unstable.
• Suppliers earn high profit margins.
• A company has the necessary resources and capabilities to manage the new business.

Balanced Integration

Balanced integration strategy is simply a combination of both forward and backward integrations.