This article is written by Saumya Sharma, pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho. The article has been edited by Tanmaya Sharma (Associate, LawSikho), Ruchika Mohapatra (Associate, LawSikho) and Arundhati Das (Intern at LawSikho).
This article has been published by Abanti Bose.
Table of Contents
Introduction
Today, when geographical limits are shrinking and global markets are available at the click of a mouse, there exists a possibility of access to better products due to more efficient and competitive markets. A merger is one such means that help the merged entity to achieve economies of scale, economies of scope, diversification in their production, and enhanced efficiency. A merger can be defined as “a combination of two or more entities into one; the desired effect being not just the accumulation of assets and liabilities of the distinct entities, but the organization of such entities into one business[…] Generally, in a merger, the merging entities would cease to exist and would merge into a single surviving entity.” However, there are also certain situations in which a merger can come under the radar of competition law related restrictions if such a merger would lead to appreciable adverse effects.
Mergers can be further categorized under different categories like a horizontal merger, vertical merger, congeneric merger, conglomerate merger, cash merger, etc. Horizontal mergers cover the merger of entities dealing in the same or similar commodity or industry, while vertical merger deals with the merger of entities in the same supply chain. When the merger of entities of related industries occurs, it is called a congeneric merger and when the merger of entities of unrelated industries occurs, it is called a conglomerate merger.
In the case of a horizontal merger, there is the merger of entities on a parallel plane whereas in the case of a vertical merger, there is the merger of entities dealing vertically with each other. A vertical merger can be in the form of a backward vertical merger when there is integration with an upstream company, or in the form of forwarding vertical merger when there is integration with the downstream company. The present article provides a detailed comparison between a horizontal merger and a vertical merger.
What is known as horizontal mergers?
A horizontal merger can be defined as a merger of two companies that are producing “similar products and/or services” or are “operating in the same or similar industry.” Therefore, in the case of a horizontal merger, the companies that are generally competitors to each other would merge as they are operating at the same level; for instance, in a supply chain. Further, such mergers would come under the lens of the competition laws when they tend to reduce competition and establish a monopoly in the market by merging an entity that could happen to be the major player in the same space. The “purpose of a horizontal merger is to more efficiently utilize economies of scale, increase market power, and exploit cost-based and revenue-based synergies.”
For instance, in the ‘Diagrammatic Representation of Horizontal Merger’ given as Figure 1, wherein ‘+’ (plus) symbol signifies merger, there are three levels in the chain of production including the base level having 2 suppliers, middle level including 2 manufacturers and top-level having 3 distributors. Further, herein Supplier 1 is supplying materials to both Manufacturer 1 and Manufacturer 2, and Supplier 2 is only providing material to Manufacturer 2. Furthermore, Manufacturer 1 and Manufacturer 2 are further distributing their finished products through Distributor 1, Distributor 2 and Distributor 3. In the present situation, when there is a merger of Manufacturer 1 and Manufacturer 2, it results in a horizontal merger as both the manufacturers were operating at the same level in the supply chain.
A horizontal merger has the following advantages:
- Expansion of business segments including an increase in production.
- Efficient utilization of economies of scale thereby increasing profitability.
- Enhanced expertise with the integration of research and development of both companies.
- Combating existing competition.
- Enhancing authority in the market is evident through increased market share.
- Realizing cost advantage due to economies of scope.
- Geographical expansion of merged entities.
- Increased adaptability and lowering the response time to ever-increasing market demands.
- Creation of considerable shareholder value.
- Diversification of goods segment especially beneficial in case of complementary goods.
However, there are also certain disadvantages that may become evident pertaining to the horizontal merger, which are as follows:
- Conflicting work cultures of merging entities.
- Difficulties in harmonizing management and working patterns.
- Non-attainment of desired synergies could act as a hurdle in achieving expected value addition.
- Increase in monopolizing tendencies that would have a negative cascading effect like lowered competition, increased prices, compromise on quality, merged entity’s own urge to grow against competition decreases, etc.
Understanding vertical mergers
Vertical mergers involve the consolidation of two companies that are at different stages of verticals in the production of goods or services. The vertical mergers may include backward integration or forward integration, wherein the former relates to mergers with upstream companies with producers, manufacturers, etc., while the latter relates to mergers with downstream companies with distributors.
For instance, in the ‘Diagrammatic Representation of Vertical Merger’ in Figure 2, wherein ‘+’ (plus) symbol signifies vertical merger, there are three levels of production wherein at the base level there are 2 (two) suppliers, at the middle level there are 2 (two) manufacturers and top-level including 3 (three) distributors. Further, Supplier 1 is supplying materials to Manufacturer 1 and Manufacturer 2, and Supplier 2 is only providing material to Manufacturer 2. Furthermore, the distribution channels of both the manufacturers, Manufacturer 1 and Manufacturer 2 include Distributor 1, Distributor 2 and Distributor 3. In this scenario, when there is a merger of Supplier 2 with Manufacturer 2, it results in a vertical merger as Supplier 2 with Manufacturer 2 being part of the same supply chain operating at different levels in the supply chain.
Further, the benefits of the vertical merger are as follows:
- Enhanced efficiency throughout the vertical.
- Efficient quality control at all stages of production.
- Strengthened production and distribution channels thereby making the merged entity self-reliant and independent.
- “Better flow and control of information along the supply chain.”
- Operating cost reduction along with better coordination across the vertical.
- Better management and administrative functioning through the deployment of efficient personnel along the supply chain.
However, there are also certain disadvantages that may become evident pertaining to the vertical mergers, which are as follows:
- Inefficiencies caused due to non-assimilation of varied cultures of management of merging entities that may include losing the major management personnel who doesn’t want to be part of the merged entity.
- Enhanced cost due to increase of personnel at all verticals.
A detailed comparison between horizontal and vertical mergers
Horizontal mergers and vertical mergers are two different types of mergers wherein the former deals with the merger of entities on a parallel level while the latter deals with the merger of entities on the vertical level in the same supply chain. Both these types of mergers help in achieving economies of scale and economies of scope. Additionally, both these forms of mergers help in creating immense shareholder value as the two entities after merging lead to a more efficient entity.
Further, the horizontal merger helps to increase the ambit of production or output of the merged entity and it may also increase the market geographically as for instance when an entity is formed after merging one entity operating in a certain region of a country with another entity functioning in a different region, the merged entity acquires the markets that were served by both the merging entities separately. This diversification of the merged entity is not limited to geographic diversification but may also extend to diversification in the range of production of commodities along with the consolidation of research and development of the merging entities thereby making the merged entity more efficient.
In the case of a vertical merger, more efficiency, coordination, and quality is assured as the entire vertical held by the merged entity tends to work on standard operating procedures and parameters of the merged entity, as in the case of an upstream vertical merger, where the quality of raw material procured and to be processed is ensured. Also, it makes the merged entity self-sufficient.
Further, the cons relating to both the mergers, vertical and horizontal are comparable as they suffer from similar problems pertaining to non-synchronization that arise due to the merging of management coming from different working environments and cultures. Additionally, there is a possibility of the emergence of a monopolizing tendency, which may affect the whole ecosystem negatively, as in the absence of any major competing partner, the balance of demand and supply equation relating to that product gets negatively affected posing further concerns relating to higher prices, deteriorating quality, decrease in merged entity’s own desire to grow against competition, among others.
Conclusion
A merger is a union of two or more entities wherein generally one of the merging entities ceases to exist but it has several advantages that range from diversification of bucket of commodities to capturing larger markets geographically, to enhancing efficiency and quality. A merger is categorized under different heads like a horizontal merger, vertical merger, congeneric merger, conglomerate merger, etc.
A horizontal merger relates to the merger of entities dealing in the same or similar commodity, and a vertical merger relates to the merger of entities in the supply chain. Both, horizontal mergers and vertical mergers help to create economies of scale and economies of scope. On one hand, the horizontal merger may help the merged entity to diversify its production, its regional ambit, and at the same time upgrade its research and development, while on the other hand, vertical merger helps to attain a more efficient and coordinated system in the supply chain thereby creating an independent merged entity.
Moreover, there can be certain negatives relating to mergers both, vertical mergers and horizontal mergers that might include the problem of harmonizing the different cultures of the entities merging and thereby creating problems relating to adjustments in various hierarchies in the merged entity. So, just like two sides of the same coin, both horizontal mergers and vertical mergers have their own reasons leading to merged entities along with their own pros and cons.
References
- https://www.investopedia.com/ask/answers/051415/what-are-advantages-and-disadvantages-horizontal-integration.asp
- https://cleartax.in/g/terms/horizontal-merger
- https://corporatefinanceinstitute.com/resources/knowledge/strategy/horizontal-merger/
- https://www.investopedia.com/terms/h/horizontalmerger.asp
- https://www.investopedia.com/ask/answers/051315/what-difference-between-horizontal-integration-and-vertical-integration.asp
- https://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Mergers___Acquisitions_in_India.pdf
- https://www.investopedia.com/articles/stocks/09/merger-acquisitions-types.asp
- https://www.investopedia.com/terms/v/verticalmerger.asp
- https://corporatefinanceinstitute.com/resources/knowledge/strategy/vertical-merger-integration/
- https://www.investopedia.com/ask/answers/012715/when-does-it-makes-sense-company-pursue-vertical-integration.as
Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.
LawSikho has created a telegram group for exchanging legal knowledge, referrals, and various opportunities. You can click on this link and join:
Follow us on Instagram and subscribe to our YouTube channel for more amazing legal content.
