What is Forward Integration?

What is Forward Integration?

Definition

When a firm expands by making an acquisition that allows it to get one step closer to its customer, it is referred to as forward integration. A manufacturer may buy the distributor that sells its products or an oil company may acquire a chain of gas stations. The objective of forward integration is to reduce costs and to play a greater role in interacting with the user of a company’s product.

What does forward integration mean?

A company may expand its operations by growing vertically or horizontally. Horizontal expansion refers to one firm buying out another in the same or a similar line of business. Vertical integration, on the other hand, is different. Here, the organization tries to gain an advantage by taking over a company that it either sells to or buys from.

Vertical integration can be either backward or forward:

⇨ Backward integration – here, a firm moves upstream. It acquires a company from which it buys raw materials.

⇨ Forward integration – when a company makes a downstream acquisition, it does so with the intention of increasing its presence in the market in which it sells its products.

One of the primary motivators for taking this step is to get a greater share of the customer’s money. A company that manufactures canned foods may buy out one of the distributors that it sells to. This will allow it to retain the profit margin that the distributor earns. Forward integration by this company may also mean purchasing a retail chain that the distributor supplies to.

Apple, one of the world’s most valuable companies, has opened a large number of Apple stores in various markets. This step allows it to stay in direct touch with its end customers.

One of the advantages of opening these stores is that the company can incorporate the feedback that it receives from customers into its new products. Of course, it also gets to retain the dealer’s margin that it would have to pay if it sold its phones and computers through a third party.

Example of forward integration

Target Corporation is a general merchandise retailer that sells products through its brick and mortar stores and its digital channels. It owns a number of proprietary brands. These include Archer Farms and Market Pantry, both of which are food brands.

Why should a retailer sell its own brands from its stores? By doing this, it gets to retain the margin that it would have to pay to manufacturers. It can also make changes to the products that it sells. It does not need to go through the lengthy process of convincing the manufacturer to make the required alterations.

This strategy of promoting its in-house brands has worked well for Target. It has helped it to compete in the market and to stay ahead of its rivals.

Summary

Forward integration refers to downstream expansion by a company. It can be a good strategy to stay in closer contact with the customer and to receive a greater share of the money that the end customer spends.