BACKWARD INTEGRATION
AS A BUSINESS STRATEGY TO INCREASE COMPANY PROFITABILITY
Binsar Energia Pratama Napitupulu �
Bandung
Institute of Technology
Received:
25-05-2022�������������������� ��������������� Accepted: 29-05-2022���������������������� ��������������� Published: 16-06-2022������
ABSTRACT
PT.
Graha Alam Indo Sentosa is a developer operating in the real estate industry.
Budiman Napitupulu and his son Binsar Napitupulu founded the company in 2017 in
Semarang, Central Java. The organization prefers to construct housing zones for
low- to middle-income people. The program is known as "Perumahan
Bersubsidi." PT. Graha Alam Indo Sentosa is in the process of constructing
a residential community (Perumahan the Sambeng Village) in Pemalang Regency,
Central Java. The overall area to be developed is 5,6 hectares and will feature
around 530 homes and 37 stores. The developer has built and sold 220 residences
and five shops as of November 2021. As part of its backward integration
business strategy, PT Graha Alam Indo Sentosa owned the business unit Sambeng
PreCast in order to reduce construction costs. The business unit is intended to
assist the corporation in generating the building materials needed to create
houses, roads, and water channels. This research will elaborate on the success
of the backward integration approach and whether or not it can significantly
contribute to the company's sales and profits. Based on the discussion in the
all chapters available (business exploration, business solution,and financial
analysis), profitability has been positively benefited by the backward
integration business plan followed by PT Graha Alam Indo Sentosa via the
business unit (Sambeng PreCast). Using a backward integration strategy, the
corporation can reduce building costs (COGS) and improve revenues and profits
automatically. So, the company is advised to continue or even expand the
backward integration business strategy.
Keyword: Backward
Integration, Business Strategy, Profitability Analysis.
Corresponding Author: Binsar Energia Pratama Napitupulu
E-mail: [email protected]
INTRODUCTION
The Indonesia Government, through the Ministry of
Public Works and Housing (PUPR), will give incentives to the developers that
build subsidized housing to support the one million houses program (Caritas et al., 2017). The subsidized housing area program benefits the
buyers and the developers. Buyers may enjoy advantages such as a 40 million
rupiah house discount, long time payback period, and flat interest. The
developer would also enjoy tax relaxation 2 and support for public facilities.
Due to the benefits of subsidized houses, people are starting to use this
government program to buy their dream house rather than rent a home.
PT Graha Alam Indo Sentosa is currently building a
housing area (Perumahan the Sambeng Village) in Pemalang Regency, Central Java,
Indonesia. The total area will be built is 5.6 hectares and includes around 530
houses and 37 shops. Until November 2021, the developer has built and sold 220
homes and five shops. Due to the high demand for cheap/subsidized houses, the
company regularly builds more or less six houses each month. Bank BTN also
supports PT Graha Alam Indo Sentosa as the official partnered bank to give the
buyers funding to buy a house. Based on the survey by Top Brand Award in 2018,
Bank BTN got the first position for its KPR/housing funding product (Yanto & Prabowo,
2020).
In order to press the construction cost, PT Graha Alam
Indo Sentosa owned a business unit called Sambeng PreCast, as the backward
integration business strategy implemented by the company. The business unit is
designed to support the company in producing the construction material to build
houses, roads, and water channels (three main aspects of a housing area).
Sambeng PreCast has already operated since March 2020 and successfully cut down
the company cost in terms of construction cost. It is also essential to reduce
infrastructure construction costs (Pineda-Jaramillo et
al., 2020). Sambeng PreCast owns three production machines to produce light brick,
paving blocks, and precast u-ditch.
Since the developer is the one who also produces
construction material, it will be easier to do the quality control. Inspection
at various stages of production is critical to achieving the product's desired
quality (Kang, 2018). Construction specification quality is the crucial point
for a house is worth buying or not. Besides cost-efficiency, Sambeng PreCast
also contributes to finishing the housing area project faster. Stakeholders
typically desire a speedier project completion (Colucci & Albino,
2016).
Sambeng PreCast operates in a 200-meter square
workshop with one supervisor, finance admin, and ten laborers. The labor-paying
system is based on how many products they could produce per day (pay/unit) to
ensure they always have the spirit to produce more. Wages are decided according
to output units by an agreement reached between management and employees
(Shintia, 2019).
Since the government regulates the subsidized house
selling price, the developer struggles to provide the best quality building to
meet the low selling price (the situation is getting worse due to the covid-19
pandemic which last for the past two years). In order to deal with that, the
developer implements the backward integration business strategy by producing
the building material by itself through the business unit called Sambeng
PreCast. A backward integration strategy also will be helpful to deal with
further expected demand due to the pandemic situation, 9 which is getting
better. This paper will discuss more regarding the effectiveness of the
backward integration strategy and whether the strategy can contribute
significantly to the company's revenue and profit or not. The other available
business strategy alternatives will also be discussed in this paper, completed
with why those other strategies are not recommended compared to the backward
integration
Based on the research questions above, the objectives
of this research are: 1. To give PT Graha Alam Indo Sentosa the big picture of
the importance of backward integration strategy (Sambeng PreCast), does the
strategy give the profit to the company or not. 2. To make sure that further
investment in the backward integration strategy can be done and generate more profit
in the future. 3. To find the best possible funding alternative to be taken by
PT Graha Alam Indo Sentosa to enlarge the backward integration business
strategy.
METHOD
The author uses the
descriptive analysis research method to prove that backward integration is
profitable for the company. The author uses the descriptive analysis method
since the author has full access to the company's operational and financial
data. The sequences of this research are:
1. Company Current Business Analysis
The author uses
almost all available business environments analysis such as Porter's Five
Forces, Business Model Canvas, SWOT analysis, and PEST Analysis. All of those
analyses will be useful in determining the surrounding business environment.
2. Generate future demand projections
The author uses the
company's past historical data to determine future demand projections. The
demand projections are essential to ensure that the supply and demand of the
company market will be balanced in the future.
3. Find the Investment Sources
The author also
does a financial feasibility analysis to find the best possible funding option
to execute the business strategy. The risk and opportunity analysis of each
possible funding method also become the author's consideration to decide.
4. Give the Company Recommendation
The final output of
this research will be a bunch of recommendations for the company to be followed
based on any financial calculations provided in this research.
Figure 1. Conceptual Framework
Moreover, The
financial aspect commonly becomes the concern for the investor with the profit
orientation. It helps the investor estimate how profitable the investment will
be. Financial considerations include a revenue model and a cost analysis (Engelken et al., 2016). Several approaches are commonly used in the financial
aspect of the feasibility study; the approaches are as follow:
1. Payback Period
The payback period
is the needed time for an investment to be recovered or how long it takes to
reach the break-even point (BEP). The use of the payback period is generally
recommended when significant uncertainties are present because it allows
assessing the duration during which an investor's capital is at risk (Orioli & Di Gangi,
2015). Usually, the shorter the payback period, the more
attractive the investment. However, it still depends on the investor's
preference, whether they want it to be a long-term or short-term investment.
The formula of the payback period will be as follow:
2.
Incremental Cost
The
incremental cost method determines the number of additional costs when using a
particular production pattern (Ningtyas et al.,
2018). Additional costs of a chosen investment alternative that correlates
with production volume change are also considered incremental costs. The value
calculation of the incremental cost is vital information for company management
in deciding the amount of production capacity (addition and reduction).
3.
Net Present Value (NPV)
Net present value
calculates the present value of future cash flows (Wicaksono et al., 2019). When the NPV and the initial cash flow are compared and
have a positive result, the investment project can be executed or accepted. Net
Present Value is the value of the difference between cost and earning (or
benefit) and is dependent on total time (years), discount rate, and
cost-earning growth (Gumilang et al., 2016). The net present value can be calculated using the
following formula:
|
: |
Net
Cash Flow at Time T |
|
: |
Discount
Rate |
|
: |
Time of
the Cash Flow |
4. Internal Rate of Return (IRR)
The Internal Rate
of Return (IRR) has been used for years by economists and engineers to estimate
projects' profitability (or potential profitability) (Mellichamp, 2017). IRR is commonly used to calculate the real rate of
return. It is an important influence on the measurement of the financial
attractiveness of an investment (Patrick & French,
2016). The formula used to calculate the Internal Rate of
Return (IRR) is as follow:
|
: |
lower
discount rate chosen |
|
: |
higher
discount rate chosen |
|
: |
PV at
lower discount rate chosen |
|
: |
PV at
higher discount rate chosen |
5. Profitability Index (PI)
The profitability
index is none other than the ratio of the present value of cash inflows (so the
benefits) and outflows (so the costs) (Erm�nyi, 2015). Economic researcher prefers to use the profitability
index (PI) instead of the net present value (NPV) since it is easier to
understand. The profitability index (PI) solves this NPV limitation by
comparing future net revenues discounted to present value (Rangel, 2016).
Moreover, the profitability index (PI) is also famous as the Profit Investment
Ratio (PIR) / Value Investment Ratio (VIR). The general formula of the
profitability index can be seen below.
Or
6. US� Index Theory
Dr. Ir. Uke Marius
Siahaan, MBA, firstly founded the US' Index theory. He works as an MBA program
lecturer in the School of Business and Management � Institute of Technology
Bandung (SBM-ITB). The idea of the US Index is to assess the company's
repayment capability by comparing its Basic Business Profitability (BBP) to the
Loan Interest Rates (I) (Siahaan, 2021). The formula of the US Index is available below:
Moreover,
the formula of the Basic Business Profitability (BBP) is as follow:
The US
Index's calculated value can give the company the indicators of whether the
company should focus on leverage or equity.
RESULTS AND DISCUSSION
By doing the BMC analysis, it would be easier for the
researcher to get the big picture of the business situation in the company.
Moreover, PT Graha Alam Indo Sentosa and Sambeng PreCast business model canvas
(BMC) analyses are available below.
Figure 2. Business Model Canvas
Moreover, one of the famous approaches that commonly be
used to analyze the market aspect is the SWOT analysis. SWOT Analysis (short
for strengths, weaknesses, opportunities, threats) is a business strategy tool
used to determine how a firm stacks up against its competitors (Teoli et al., 2019). SWOT analysis can also be considered a preliminary
stage for a company before making a decision.
Figure 3. Business Model Canvas
Based on the building cost (COGS) calculation, the
backward integration strategy implemented by the company since March 2020 is
really impactful to the company's profitability. For each unit, the strategy
contributes Rp. 2.600.000,00 savings for the company. The total savings
calculation of the backward implementation is available below. House Sold March
2020 � December 2021 = 111 units Total Saving = 111 units x 2.600.000,00 = Rp.
288.600.000,00. The business unit only produces three types of building
material (lightweight brick, u-ditch precast, and paving block). Suppose the
company can expand the backward integration strategy even further and produce more
material quantity and types. In that case, the savings will automatically
become higher and higher.
Moreover, the author uses Minitab software to project the
future demand using the past historical data. The error of this calculation
(MAPE, MAD, and MSD) can also be considered usable, so the projection
calculation data is fair enough to be used in this research calculation. Based
on the projection calculation, the developer is projected to sell six to ten
houses on average.
Figure 4. Business Model Canvas
Table 1. Future Projection of House
Sales per Month
House Sold / Month |
|
2022 |
6 |
2023 |
7 |
2024 |
8 |
2025 |
9 |
2026 |
10 |
Table 2. Company Future Savings
Projection
Year |
Unit Sold |
Total Saving |
2022 |
72
Units |
Rp187,200,000.00 |
2023 |
84
Units |
Rp218,400,000.00 |
2024 |
96
Units |
Rp249,600,000.00 |
2025 |
108
Units |
Rp280,800,000.00 |
2026 |
104
Units (Rest of the Unit) |
Rp270,400,000.00 |
Total |
|
Rp1,206,400,000.00 |
Table
3. Needed Investment Detail
Backward Integration Expansion Needed Investment |
|||
Item Needed |
Qty |
Item Price |
Total Price |
New Paving Block Hydraulic Press
Machine |
4 |
Rp 80.000.000 |
Rp 320.000.000 |
Water Pump And Pond |
1 |
Rp 27.000.000 |
Rp 27.000.000 |
New Light Brick Special Mixer |
4 |
Rp 42.000.000 |
Rp 168.000.000 |
New Foam Generator |
1 |
Rp 18.000.000 |
Rp 18.000.000 |
New U-Ditcch Precast Mold |
4 |
Rp 20.000.000 |
Rp 80.000.000 |
New Drying Fans |
1 |
Rp 15.000.000 |
Rp 15.000.000 |
New Truck as Transportation |
2 |
Rp 400.000.000 |
Rp 800.000.000 |
Workshop Building Expansion |
1 |
Rp 50.000.000 |
Rp 50.000.000 |
Material Warehouse |
1 |
Rp 32.000.000 |
Rp 32.000.000 |
Diesel Generator |
4 |
Rp 22.000.000 |
Rp 88.000.000 |
Administration and Paperwork |
1 |
Rp 2.000.000 |
Rp 2.000.000 |
Total Neede Investment |
Rp 1.600.000.000 |
Table
4. Financial Statement
PT
Graha Alam Indo Sentosa Financial Statement |
|||||
|
72
units |
84
units |
96
units |
108
units |
104
units |
|
2022 |
2023 |
2024 |
2025 |
2026 |
Sales |
Rp
10.836.000.000 |
Rp
12.642.000.000 |
Rp
14.448.000.000 |
Rp
16.254.000.000 |
Rp
15.652.000.000 |
COGS |
Rp
7.992.000.000 |
Rp
9.324.000.000 |
Rp
10.656.000.000 |
Rp
11.988.000.000 |
Rp
11.544.000.000 |
Gros profit |
Rp
2.844.000.000 |
Rp
3.318.000.000 |
Rp
3.792.000.000 |
Rp
4.266.000.000 |
Rp
4.108.000.000 |
Over head |
Rp
600.000.000 |
Rp
600.000.000 |
Rp
600.000.000 |
Rp
600.000.000 |
Rp
600.000.000 |
Depreciation |
Rp
300.000.000 |
Rp
300.000.000 |
Rp
300.000.000 |
Rp
300.000.000 |
Rp
300.000.000 |
EBIT |
Rp
1.944.000.000 |
Rp
2.418.000.000 |
Rp
2.892.000.000 |
Rp
3.366.000.000 |
Rp
3.208.000.000 |
Interest exp |
Rp
480.000.000 |
Rp
360.000.000 |
Rp
240.000.000 |
Rp
120.000.000 |
Rp
0 |
EBT |
Rp
1.464.000.000 |
Rp
2.058.000.000 |
Rp
2.652.000.000 |
Rp
3.246.000.000 |
Rp
3.208.000.000 |
Tax, 30% |
Rp
429.200.000 |
Rp
617.400.000 |
Rp
795.600.000 |
Rp
973.800.000 |
Rp
962.400.000 |
NAT |
Rp
1.024.800.000 |
Rp
1.440.600.000 |
Rp
1.856.400.000 |
Rp
2.272.200.000 |
Rp
2.245.600.000 |
R/G, 60% |
Rp
614.880.000 |
Rp
864.000.000 |
Rp
1.113.840.000 |
Rp
1.363.320.000 |
Rp
1.347.360.000 |
End profit/year |
Rp
409.920.000 |
Rp
576.240.000 |
Rp
742.560.000 |
Rp
908.880.000 |
Rp
898.240.000 |
Table 5. Feasibility Study
Calculation Result
Description |
Result |
Needed investment (100%
Loan) |
Rp1,600,000,000 |
Bank Interest Rate /
WACC |
12% |
IRR |
48.80% |
PP |
2 Years |
NPV |
1922642571.50 |
ROI |
172.85% |
PI |
2.201651607 |
US Index |
14.40416667 |
Financial Condition |
Go For Loan |
CONCLUSION
Based on the discussion above, it can be concluded
that backward integration business strategy implemented by PT Graha Alam Indo
Sentosa through the business unit (Sambeng PreCast) has successfully impacted
the company profitability. Using a backward integration strategy, the company
can minimize the building cost (COGS) and automatically increase the revenues
and profits. The company may further minimize costs by producing more building
materials and types. Until today, the business unit only produces three
different building materials (lightweight brick, u-ditch precast, and paving
block). Based on the future projected demand by Minitab software, the current
condition of the backward integration strategy is not enough to cover the
projected demand. So, strategy expansion is not an option anymore. However, it
has become a must for the company to take the backward integration strategy to
a different level. Since backward integration is not the company's initial
strategy (just started in 2020), the company can choose internal financing as
the fund source to expand the business unit. The company has already decided to
use the retention for growth money to buy new land and start another housing
area project after this project is finished. The backward integration expansion
feasibility study shows that the company has enough power and capability to
seek external financing. All the IRR, PP, NPV, ROI, PI, and US Index
calculation shows a positive 54 value, which means the company is safe to take
a loan from the bank or the venture capital. The bank loan is the best option
for the company to fund the backward integration expansion project since the
company's financial condition can ensure the bank can pay off the debt in the
future. The company may choose the best possible loan program offered by the
banks.
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