What Are Horizontal and Vertical Mergers?
Different forms of business mergers have different implications
Mergers occur when one business firm buys or acquires another business firm—the acquired firm—and the combined firm maintains the identity of the acquiring firm. Business firms merge for a variety of reasons, both financial and non-financial. Horizontal and vertical mergers are just two of many types of mergers that are usually classified as non-financial mergers.
Mergers are popular for many reasons, and it's important for business owners to understand the details surrounding them.
Horizontal mergers are a type of non-financial merger. In other words, a horizontal merger is undertaken for reasons that have little to do with money, at least directly. Simply stated, a horizontal merger is usually the acquisition of a competitor who is in the same line of business as the acquiring business. By acquiring the competitor, the acquiring company is reducing the competition in the marketplace.
One excellent example of horizontal mergers is in the banking industry. In 1980, The Depository Institutions Deregulation and Monetary Control Act of 1980 was passed by Congress. This legislation allowed investment and commercial banking to share some of the same functions. It also allowed banks to branch across state lines along with expanding the powers of bank holding companies.
This deregulation act allowed investment and commercial banks to undertake more horizontal mergers than they had ever been allowed to undertake in the past. The result was a contraction in the banking industry and fewer banks. Investment banks could offer services that only commercial banks had been allowed to offer before 1980 and vice versa. Small, hometown banks were gobbled up by big regional banks. The very definition of a horizontal merger happened on a grand scale—larger competitors acquired smaller competitors and the result was fewer banks in the U.S.
When the Great Recession of 2008 happened, we saw some of the results of the deregulation act of 1980. Many banks failed. Large investment banks had abused the power that had been given to them by the deregulation act, and there was a call for re-regulation in the banking industry. This is the reason that government anti-trust officials watch horizontal mergers carefully: They can lead to too much market power for the acquiring firms.
A vertical merger or vertical integration happens when the acquiring firm buys buyers or sellers of goods and services to the company. In other words, a vertical merger is usually between a manufacturer and a supplier. It is a merger between two companies that produce different products or services along the supply chain toward the production of some final product. Vertical mergers usually happen in order to increase efficiency along the supply chain which, in turn, increases profits for the acquiring company.
Just like horizontal mergers, vertical mergers can result in anti-trust problems in the marketplace by reducing competition. For example, consider if an automobile manufacturing company were to buy up other businesses that exist along its supply chain. It takes many different types of businesses to support automobile manufacturing. If an automobile company bought a seat belt manufacturing company, companies that manufactured different parts of the engine block and the transmission, as well as sources of its raw materials, transportation, technology, and sales, imagine the market power that would accrue to that automobile manufacturing company.
It would effectively totally control the price of its vehicles without having to consider any other factors. That is the kind of market power that anti-trust laws are meant to control.