What is Backward Integration?
Backward integration refers to the process in which a company purchases or internally produces segments of its supply chain. In other words, it is the acquisition of controlled subsidiaries or external company / organization, aimed at the creation or production of certain inputs that could be utilized in the production.
Case Study to understand the Backward Integration
One of the recent example of backward integration is Micro Lab’s acquisition of majority controlling stake in R A Chem Pharma Limited.
R A Chem Pharma Limited
The mid-sized Hyderabad-based company is a USFDA approved manufacturing facility for active pharmaceutical ingredients (APIs). It is also engaged in the production of formulations and has a CRO.
Micro Lab is basically focus on formulations. Therefore RA Pharma’s forte in API capabilities strengthens Micro Lab’s operation. This is a classic example of backward integration.
Other Benefit of the acquisition:
1. US FDA approved facility gives us an additional production site.
2. RA Pharma is the company based on Hyderabad. Hyderabad is the bulk drug capital of the country, known for competitive costs.
3. This acquisition will take the total head count of the Micro Lab to approximately 10,000.
Forward Integration vs Backward Integration
Forward integration is an instance where the company acquire or merge with a distributor or retailer whereas backward integration is an instance the company acquire or merge with a supplier or manufacturer. This the key difference between forward and backward integration.
Advantages of Backward Integration
- Increased control: Through the process of integrating backward, companies can control their value chain in a more efficient manner. When retailers take the decision to develop or acquire a manufacturing business, they attain increased control over the production segment of the distribution phase.
- Cost Control: Through backward integration, costs can be considerably controlled all along the distribution process. In the conventional distribution process, each phase of product movement includes mark-ups to enable the reseller to earn profit.
Disadvantages of Backward Integration
- It builds up excess upstream capacity to ensure that downstream has an adequate supply even when the demand is heavy. This involves increased investment.
- The process leads to lack of supplier competition that will lead to low efficiency resulting in potentially higher costs.
- In due course, there are high chances that the flexibility will get reduced owing to previous investments upstream and also downstream.
- In case there is a need for substantial in-house requirements, then it will diminish the capability of producing the product variety.
- At certain times, existing competencies need to be sacrificed in order to develop fresh core competencies.