Definition of Forward Integration
Forward integration in layman’s terminology is simply an expansion of the business in a forward or vertical manner to take control of the supply or direct distribution of the products which a company manufactures i.e. it is a business strategy where some kind of vertical integration is applied which involved advancing of the supply chain where the company itself takes the total ownership and control of the supply and direct distribution of the products.
Explanation
Forward distribution involves a business strategy wherein the business takes control or expands its business into the supply and direct distribution of its product to its end customer without depending on any third party in between. It mainly involves advancing the supply chain. It can also mean cutting down the scope of the middle man who eats away the majority of the profit. On one hand, where forward integration strengthens the company to maintain a grip or enhanced control on its product or services, it can also lead to a situation where it brings about the dilution of a company’s core competencies and business. Companies before application of this should be thoroughly aware of the cost and scope of the process. Involvement in such strategies should only be done if the company sees a major cost advantage or a scope to maximize its profit and it should also endure that its core competencies are not hampered in any form. At times it is preferable for companies to rely on external vendors and their own established core competencies rather than to expand on their own which would otherwise affect their business. At times calls for many mergers and acquisitions too where companies find that M&A deals would prove more profitable for them rather than depending on the same company as a vendor.
How does Forward Integration Work?
This strategy is primarily linked to cutting down on middlemen and is an operations focussed strategy implemented with an aim to maintain better control over its suppliers, manufacturers, or distributors with a motif to increase the power in the market. To make this working successful a company has to bring other companies which were once its customers under its own ownership. It is different from backward integration because in backward integration companies try to gain ownership over companies that were once their suppliers. The modernization of technology and the rise of the internet, it has made these integrations even more popular and easier. When a company is desirous to implement a forward integration strategy it must move forward along the supply chain without disrupting its control over its current operation.
Example of Forward Integration
Amazon can be considered as one of the crucial examples of this. Amazon has not only maintained control over its own in-house supply and distribution chain by not depending on third-party vendors to handle its logistics. It has its own logistics where it has applied both forward and backward integration. Also, the acquisition of Whole Foods, a different company has made Amazon make utilize its brick-and-mortar outlets which serves Amazon a scope to serve its customers just not by online mode but also offline mode too. Here customers can come and collect their products physically or even buy new products.
Risks of Forward Integration
The following can the risks:
- The business may lose its core competencies and hold off the core business it is involved.
- It may eventually lead to mergers and acquisitions which if not successful in the future leads to a big loss for the business.
- It may at times lead to unprofitable outcomes.
- It may lead to unforeseen labor issues.
- At times there is rise in obsolescence due to the application of newer technologies.
Forward Integration vs Backward Integration
As the name suggests forward integration means a company has to bring other companies which were once its customers under its own ownership. Backward integration means companies try to gain ownership over companies that were once its suppliers. The main aim of forward integration is to capture a bigger market share whereas the main purpose of backward integration is to take advantage of economies of scale. An example of this can be a car manufacturer taking ownership or acquiring an already-established car dealer in the market whereas an example of backward integration can be a car manufacturer acquiring a tire production company where the tires required for the cars will be produced in-house. It provides control over the supply chain whereas backward integration provides control over the purchasing power.
Benefits
The benefits are as follows:
- It lowers the cost due to the elimination of market-related transaction costs.
- It greatly reduces the cost of transportation.
- It helps is gaining a bigger chunk of market share and thus increases market capitalization.
- It brings about the point of strategic independence for the company.
- It provides better opportunities for the growth of investments.
- It also acts as a barrier for the entry of new competitors or threats to the business.
- Due to better synchronization of demand and supply, there is enhanced coordination of the supply chain.
Limitations
The demerits of backward integration are as follows:
- It leads to a significant rise in cost if new activities are not managed well
- It may impact the quality of product and reduce efficiency when there is no competition.
- It may give rise to a monopoly in the market.
- The organizational structure may become more rigid due to the drawbacks of such implementation.
- It brings about the inability to bring about the variation of the product due to the requirement of in-house efficiency.
- It makes the company less flexible due to increased bureaucracy.
Conclusion
Forward integration if managed well is a great strategy that can serve as a boon to the business and help in increasing the market share and gain market hold. On the other hand, it requires proper implementation of it as if it is wrongly applied it can cause huge losses to the business.
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This is a guide to Forward Integration. Here we also discuss the introduction to forward integration along with the working, benefits, and demerits. You may also have a look at the following articles to learn more –
