At present scenario of globalization, firms try to gain competitive advantages by using different strategies and approaches such as generic strategies of cost leadership and differentiation. In addition, some aggressive strategies of mergers and acquisitions have also been applied in various industries to beat the existing competition (Porter, Michael E, 1985).
In this red-ocean of competitive forces, vertical integration strategies; forward integration that is owning downstream buyers and distribution channels and backward integration that is owning upstream suppliers have also gained much significance, however, decision for these strategies depend upon different aspects of that specific industry environment such as the bargaining power of suppliers, barrier to entry, pricing strategies, and competition bases Chen, Y. 2001).
Backward integration strategy can be exploited in those competitive markets where the bargaining power of suppliers is much high and they have much control over prices of raw materials and intermediate manufacturing. This strategy would enable a firm to buy some suppliers and integrate some of the manufacturing processes into its own existing manufacturing facilities in order to gain control over cost and thus cost leadership advantage in the market. In addition if the firm has a strategic vision of becoming a low-cost producer and wins the cost leadership position in the market, this strategy of having control over cost of the backward process and intermediate manufacturing would create a strong barrier to entry. For instance, many Chinese firms due to the impacts of globalization have become cost leadership through becoming backward integrated units. As backward integration comes with precompetitive efficiency effect, it creates an anticompetitive foreclosure effect for rival forms as they produce less and thus don’t achieve the benefits of more economies of scale (Cook G., 1997).
In contrast, in such industrial environments where competition is not solely based upon the cost efficiencies and greater output at lower cost and where bargaining power of suppliers is also low, this approach of backward integration may not enable a firm to achieve the greater cost benefits from suppliers. In addition, if the merging firm is already integrated to a larger extent, the backward integration may not be much beneficial and cost-efficient choice and it is more likely to be anticompetitive. If a firm has a long-term strategy of differentiation and focus, its efforts to shift to cost efficiencies and economies of scale may harm it competitive position in the market (Cook G., 1997). Hence, it is essential to closely observe not only the existing strategic goals of a firm but also the nature of the competitive forces before adopting vertical integration strategies.