What is Horizontal Integration?
Horizontal Integration occurs from mergers among companies directly competing in the same or closely adjacent markets.
The companies involved in a horizontal merger are normally close competitors that provide goods or services at the same level in the overall value chain.
Horizontal Integration – Merger Strategy
Horizontal integration is a type of merger where competitors operating in the same market combine their operations to benefit from economies of scale.
If two companies that offer virtually identical or similar goods or services decide to undergo a merger, the transaction is considered to be horizontal integration.
The horizontal integration strategy – in which two companies operate at the same level of the value chain and decide to merge – enables companies to increase in size and scope.
Together, the combined entity’s reach is far broader in terms of expanding into new markets and diversifying a consolidated portfolio of offerings.
The result is the creation of economies of scale, wherein the post-merger company obtains cost savings from the expanded scale.
- Economies of Scale → The cost per unit of output declines with increased scale up to a certain point
- Greater Production Output → The efficiencies related to production such as streamlined processes enable the company to produce a greater number of units at their manufacturing facilities.
- Buyer Power → The combined company can purchase raw materials in bulk for steep discounts and negotiate other favorable terms.
- Pricing Power → Given the limited number of competitors in the marketplace, the combined company can make the discretionary decision to increase prices (and the few other companies in the market then normally follow suit).
- Cost Synergies → The entity benefits from cost synergies, namely shutting down redundant facilities and duplicate job functions deemed to no longer be necessary.
Regulatory Risks of Horizontal Integration
If integrated properly, the profit margins of the merged company are most likely to increase, although the revenue synergies can take substantially more time to materialize (or may never actually occur).
The major risk associated with horizontal integration is the reduction in competition within the market in question, which is where scrutiny from regulatory bodies comes into play.
The benefits derived from the companies participating in the merger come at the expense of consumers and suppliers or vendors.
- Consumers: Consumers now have fewer options because of the merger while suppliers and vendors have lost more of their bargaining power.
- Suppliers and Vendors: The merged company possesses a greater proportion of the total market share, which directly causes its buyer power to increase and gives it more negotiating leverage over its suppliers, vendors, and distributors.
Of course, the risk of the merger failing to deliver the expected synergies is inevitable.
Horizontal mergers are therefore not without risk.
If the integration is done poorly – for example, suppose the differing cultures of the companies cause other issues – the result from the merger could be value-destruction, rather than value-creation.
