An Insight Into Backward Integration

A legal study of the USA

Backward integration is a method of vertical integration that involves the acquisition or merger with suppliers in the supply chain. Products are manufactured and sold by a process called the supply of chain which is a set of people, organizations, resources, activities, and technologies used to manufacture and sell a product. The supply chain begins with the delivery of raw materials from supplier to the factory and ends with the sale of the final product to the final consumer. Companies seek backward integration when it is expected to improve efficiency and save costs. For example, this type of integration may lower transportation costs, improve profit margins and make the company more competitive. Popular global companies such as and Tesco cooperated with suppliers in a similar manner. It can also reduce the legal complications of a middleman. If the companies face any legal complications they can reach out to the well-qualified corporate lawyers

An example of backward integration is when a bakery moves the supply chain to purchase a wheat processor or a wheat farm. Thus, a retail supplier purchases one of its manufacturers, eliminating the middleman and hindering competition.

Many companies and conglomerates do backward integration. For example, Amazon, when it expanded into a book publishing and retail business.  Furthermore, it has been able to differentiate itself from other competitors by choosing where to distribute its published books, and by keeping its published authors exclusively to its platform, it can organize the sale of its books.

Some of the more well-known examples of backward integration include Apple Inc. and Carnegie Steel.

Apple Inc. has been using the backward integration strategy for decades. Its software products are put into electronic devices and computer systems that Apple makes and assembles using hardware and components also made by the company itself. Backward integration has proven to be a great success for Apple, allowing the corporation to develop new products and technology at a faster rate. One of the first examples of backward integration was found at Carnegie Steel, which controlled many inputs to steel mills. The Carnegie Steel Company owned the mines that extracted iron ore, coal mines, railways that brought coal to factories, ships that brought iron ore, and factories that produced steel. The Carnegie Steel, through this comprehensive integration of the supply chain, increased its production efficiency.


Advantages of Backward Integration

The companies can benefit from the backward integration in the following ways:

  1. Increase control: Companies can control their supply chain in an efficient manner, through the process of backward integration. The production of raw materials is controlled until the production of the final product. Through the process of integrating backwards, companies will have greater control over the quality of the raw materials that will be used in production. In this way, the company ensures that it receives adequate supplies when required without worrying about raw materials being sold to competitors or not being manufactured by suppliers.
  2. Cost Control: Generally, backward integration is done to reduce costs. There is always an increase in price in the supply chain when goods are sold from one party to the other. The supply chain includes many suppliers, distributors, and intermediaries. The company can remove the middlemen from the supply chain by integrating the business with the producer of the material. Thus, reducing the costs of labelling, transportation, and other unnecessary expenses involved in the entire process.
  3. Competitive advantage and barriers to entry: Companies can acquire the supplier to keep competition away from the market. Consider a scenario where a significant supplier supplies materials to two companies but one of them buys the supplier so that it can stop the supply of goods to the competitor. In this way, the company tries to get the current competitor out of business or to find another supplier and create entry barriers for new competitors.
  4. Efficiency: Backward Integration also provides better efficiency in the entire manufacturing process. A company, by controlling the supply side of the chain, can control when and what materials are produced and how much is produced. With improved efficiency, the company can save cost on materials that are wasted unnecessarily due to excessive purchasing.


Drawbacks of Backward Integration

  1. Huge Investments: The backward integration will require huge investments. It will be an additional burden on the company’s balance sheet.
  2. Costs: In backward integration, costs will not always be reduced. As the lack of supplier competition can reduce efficiency and thus lead to higher costs. Moreover, it will be an additional burden on the company if it cannot achieve the economies of scale that the supplier can achieve individually and produce the goods at a lower cost.
  3. Quality: The company will become less efficient in terms of innovation, if there is no or less competition in the market because it knows it can sell whatever it produces. Hence, lack of competition can lead to less innovation and thus lower quality of products.
  4. High bureaucracy: Acquiring the resource means acquiring the workforce of the resource as well. This will increase the size of the company and thus introduce new employee policies and lead to a bureaucratic culture in the company.


A legal Study of Backward Integration in the USA

A recent study was conducted in the US to evaluate backward integration. Whereas a company, engaged in the manufacture of mattresses, has not been able to meet the high consumer demand. There were possible shortages in three main categories of raw materials herein referred to as supply markets 1, 2 and 3.

In supply market 1, it was found that backward integration can be beneficial. The market was inherently weak, and an upstream acquisition could reduce supply shocks in the future. Acquisition here also looked desirable because the market is growing rapidly, margins are likely to be built up, and customers can gain a competitive advantage by controlling supply.

However, supply markets 2 and 3 did not support the backward integration strategy. These markets were highly unattractive (showing low growth, complex regulatory hurdles, and disruption with industry headwinds), and supply shortages of a contractual nature (not caused by underlying supply market conditions). Moreover, the acquisition will require significant capital investment, and the potential targets do not share the core competencies of the client.


Case Laws

  1. In Ford Motor Company v. United States, Ford Motor Company wanted to acquire a company called Autolite. This work made spark plugs. The measure was condemned on the grounds that the integration would entrench too much market power in the company and thus discourage other competitors from entering the market. Ford Motors attempted to argue that the acquisition would make Autolite a more efficient company, but this was rejected by the Supreme Court, which held that the potential anticompetitive effects of vertical integration were a more important concern. (U.S v. Ford Motor Co., 405 U.S. 562, 1972)
  2. The firm also integrates inversely by producing the materials or capital goods used in the production of the final output. For example, in United States v. Aluminum Corporation, Alcoa acquired bauxite mines to supply its alumina refineries. (U.S. v. Alcoa, 1945)