Understanding backwards vertical integration
Backward vertical integration involves internalizing activities typically performed by suppliers. Rather than relying on suppliers, a company can bring such activities in-house, undertaking the activity themselves.
For example, a company may traditionally rely on a supplier to process raw material prior to being delivered. The company could backward vertically integrate by undertaking that material processing stage itself – brining an activity that had previously been taken prior to goods being delivered to the firm internal.
Why may a firm want to backward vertically integrate
Greater control over the prior processes
One of the key reasons why firms backward vertically integrate is to gain greater control over prior stages in the production process. Using a supplier makes you dependent on their production activities, product features, and the quality of the goods that they supply. By backward vertically integrating, you remove that company from your supply chain – potentially giving you greater control over your inputs.
Allows greater integration with other stages of production
A connected advantage of backward vertically integrating is that it can allow you to more directly integrate activities together. For example, items that you purchased from a supply potentially with large stockpiles and lead time may now be able to move directly from one stage of the production process to the next.
Remove a powerful supplier
Another reason that a firm may backward vertical integrate is to remove a powerful supplier that was previously capturing a large proportion of the overall value being created. If there are only a limited number of firms that undertake the prior production stage, you may become dependent on them. As such, they may be able to charge a high premium for the inputs that you buy from them.
Moving back in the production process allows you to remove that supplier from your operations. Rather than them capturing a large proportion of the overall value created, by internalizing the activity you capture that value.
The challenges of backward vertically integrating
While there are many advantages from firms from backward vertically integrating, there are also challenges associated with doing so. Some of the difficulties associated with backward vertical integration include:
- Challenges of undertaking the earlier activities: There is likely to be a learning curve associated with undertaking the new activities internally.
- Difficulties gaining economies of scale: Relative to a dedicated supplier, you may not have sufficiently high production volumes to achieve economies of scale.