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Forward Integration

A form of vertical integration in which a company moves forward on its production path towards the distribution of its products or services

What is Forward Integration?

Forward integration is a form of vertical integration in which a company moves forward on its production path towards the distribution of its products or services. Essentially, a company undertakes forward integration by acquiring or merging with business entities that were its customers while still maintaining control over its initial business.

 

Forward Integration

 

Understanding Forward Integration

The concept of forward integration is inherently related to the concept of supply chain. In many industries, the major components of supply chain include raw materials, intermediate goods, manufacturing, marketing and sales, and after-sales service. An example of forward integration is a situation when a manufacturer purchases its retailer to secure control over the distribution channels.

Forward integration is the opposite of backward integration, which is a strategy of acquiring the companies that were once its suppliers.

 

Benefits of Forward Integration

Generally, forward integration allows companies to sustain profits while minimizing profit losses to intermediate entities. Additionally, the strategy can be implemented for different reasons, including:

 

1. Increase the company’s market share

A company may increase its market share by implementing forward integration strategy. Generally, the strategy eliminates various transaction and transportation costs that subsequently result in a lower final price for the company’s product. Thus, a company can achieve greater market share through lower product prices.

 

2. Gain control over distribution channels

A company employs the strategy if it is willing to obtain control over distribution channels in its industry. Control is crucial for companies that operate in industries that lack qualified distributors or in situations when distributors charge significant costs. The control over distribution channels ensures the strategic independence of a company from third parties.

 

3. Competitive advantage

Successful implementation of the strategy may provide a company with a competitive advantage over its competitors. Low costs and control over industry distribution channels can become key factors in achieving competitive advantage.

 

4. Create barriers to potential competitors

The integration of entities forward of the company’s production vertical strengthens its position in the industry and establishes obstacles to potential rivals. For example, if a company integrates a large industry retailer, probable competitors could face limited access to distribution channels.

 

Risks of Forward Integration

Despite its benefits, forward integration can still involve certain risks to a company that wants to adopt the strategy. Some of the risks associated with the strategy include the following:

 

1. Bureaucratic inefficiencies

Merger and acquisition deals related to forward integration may create various inefficiencies as a result of the enlarged bureaucratic apparatus of the new business entity.

 

2. Failure to realize synergies between the companies

In the forward integration strategy, a company may fail to realize synergies between the involved entities. Improper implementation of the strategy can be one of the reasons for the unrealized synergy potential.

 

3. High costs

Mergers or acquisitions necessary for undertaking forward integration may require substantial funds to execute. A company must be certain that the benefits from the implementation of the strategy will exceed its costs.

 

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Horizontal Merger
  • M&A Process
  • Original Equipment Manufacturer (OEM)
  • Products and Services

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