There are multiple types of mergers including horizontal, vertical, conglomerate, and concentric.
Here we deep dive into horizontal mergers, prepared by DealRoom - one of the most popular, yet often scrutinized, types - from what they are, why they are beneficial, and which companies have utilized them.
So, let's start with definition and meaning.
What is Horizontal Merger?
Horizontal merger happens when two companies in the same industry (eg. they sell similar products/services in the market) come together. The larger thinking behind this type of merger is that the companies together are worth more than they are separate; some practitioners like to express this added value by saying in these cases 1 + 1 equals more than two.
How Horizontal Mergers Work
Horizontal mergers work on the basis that two companies that produce nearly identical products stand to gain from the benefits of scale that come when they merge.
In the most successful cases of horizontal mergers, this means that extra value can be generated at every part of the company’s value chain, from the supply chain where the bigger company can avail of bigger discounts, right through to the end customer, where it now has a much larger customer base.
Reasons for Horizontal Merger
While there can be various reasons for a horizontal merger, the most common include:
1. Reduce competition
Reduced competition equals a larger market share and power over pricing (see Exon/Mobil example below)
2. Generate growth quickly
M&A is a powerful growth strategy as the acquirer fairly quickly gains access to successful elements of the target such as products and people; you can read more about M&A as business growth strategy here.
3. Leverage economies of scale
The ability to buy in bulk and reduce supply chain costs create financial gain for the newly developed company.
4. Gain products, ideas, professionals, and their skill sets, and additional resources
Gaining the best of the target can lead to innovation and entry into new markets.
5. Increase customer demographic via geography or new products/services
As previously mentioned, the acquirer can quickly expand its customer base and break into new markets via horizontal mergers
Horizontal vs. Vertical Mergers
While a horizontal merger occurs when two companies in the same industry come together, a vertical merger occurs when companies that provide different supply chain functions/products/services combine.
Oftentimes, the goals behind this type of vertical merger are to capture synergies and improve productivity by creating a business with a more efficient supply chain.
As with horizontal mergers, there can also be distrust towards vertical mergers in the marketplace; this distrust is often addressed through antitrust violation citations, which stem from concern over reduced market competition.
Examples of Horizontal Mergers
Volkswagen & Porsche
While it has been complicated, Volkswagen’s purchase of Porsche is considered a horizontal merger as the two both occupy the automobile space. Cutting costs and sharing engineering are two benefits of this deal.
HP & Compaq
This horizontal merger allowed HP to better fight off the heavy competition in its industry. More specifically, thanks to the combining of resources and information, the newly formed company believed it would be better able to innovate and face the ever-changing demands of its industry.
Exon & Mobil
The Exxon/Mobil merger created the largest oil company in the world. It was also profitable as it allowed for cost-cutting and higher oil prices due to reduced competition.
Disney & Pixar
When Disney bought Pixar, Disney reaped many benefits, including eliminating competition and acquiring Pixar’s technology and talents.
Microsoft & LinkedIn
Expanded markets and technology for both sides are key elements of this deal. LinkedIn’s CEO also noted he was drawn to Microsoft’s Agile and innovative ways.
Amazon & Whole Foods
In some aspects, this merger is horizontal since both companies sell groceries, although admittedly Amazon’s reach extends well beyond that market segment. Amazon benefits from Whole Foods’ supply chain and strong customer and supplier relationships, while Whole Foods benefits from Amazon’s enormous market reach and advanced delivery technology
Delta & Northwest
This airline industry merger is said to have maintained the best of both companies’ worlds. Delta broke into new markets and benefited from the strategic competitive ways of Northwest, while Northwest’s regional reach was expanded.
Advantages of Horizontal Mergers
All of the advantages of horizontal mergers are essentially benefits of scale. They include, but are not limited to:
- Bulk discounts from suppliers
- Lower manufacturing costs per unit
- Improved access to human capital
- Improved access to financial capital (lower cost of capital, etc.)
- Larger customer base
Disadvantages of Horizontal Mergers
- Antitrust Issues: Nothing attracts the attention of the Antitrust bodies quite like a horizontal merger; in fact, when looking for cases where the US antitrust agencies have become involved in M&A, it’s invariably for horizontal mergers.
- Putting all your eggs in one basket: The merger of Alliance Boots and Walgreens in 2014 to create the largest pharmacy chain in the world seemed like a good deal, but it was a one way bet on traditional pharmacy retail. Now, it looks like the industry is moving online and the Walgreens Boots Alliance has seen its stock price fall as a result.
- Scale becomes unwieldy: Scale has downsides to go with the upsides - extra layers of middle management, loss of control across the organization, and a general lack of agility are all common growing pains for companies after horizontal mergers.
- Overpaying: Horizontal mergers are often associated with overpaying; the threat - real or imagined - of an industry competitor coming along for a deal tends to set alarm bells ringing, putting managers on the defensive, and often leading to deals that are terribly overvalued.
- Reputational risk: The bigger your company becomes, the bigger a target it becomes.
Horizontal Merger Guidelines
Horizontal mergers are closely watched by the Government in order to avoid oligopoly (where the market is highly concentrated and dominated by a few - not to be confused with a monopoly).
More specifically, the Department of Justice and the Federal Trade Commission have established guidelines related to horizontal mergers. In their words, they “seek to identify and challenge competitively harmful mergers while avoiding unnecessary interference with mergers that are either competitively beneficial or neutral.”
While the guidelines are quite extensive, in simpler terms the Department of Justice and the Federal Trade Commission:
- examine the immediate anticompetitive effects of the merger
- work to predict the future anticompetitive effects of the merger
- compare the merger to previous mergers to gain insight and leverage stronger predictions
- review the merging companies’ market shares and the current level of competition in their market
- investigate the impact on customers
- consider how reduced competition will affect innovation
Horizontal Merger Process:
While every deal is different, the following provides an overview of the horizontal merger process. Additional plays and steps might be implemented based on your specific goals and deal characteristics.
- Identify and articulate the overarching strategy and goal behind engaging in M&A, specifically a horizontal merger
- Identify potential targets and cultivate relationships with potential targets
- Gather available information about targets in relation to products/services, culture, leadership, supply chain, and finances
- Engage in valuing and negotiating
- Conduct due diligence with a focus on the goals behind the horizontal merger and the aforementioned benefits and with an eye toward integration
- Complete P&S
- Implement integration strategies and best practices, again with an eye toward the identified specific strategy and goal for selecting this horizontal merger
When to Horizontally Merge
The strongest method for horizontal integration is through merging with local or regional players in the same industry.
Horizontal mergers don’t just happen at the top end of the market: The best way for many smaller players in any industry to scale up is through horizontal mergers with companies that you’re competing with on a regular basis.
Most business owners will know a handful of these companies without even having to think about it.
If merging with them would, on appearances, lead to a stronger company that could avail of more opportunities, then it may make sense to approach them about a merger. Of course, a good approach letter (link to previous article) is an essential first step here.