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Understanding Vertical Mergers

What are Vertical Mergers?

In every consumer-based industry, a supply chain of companies exists to fulfill different roles. Each one of the companies in the chain provides a service that the other needs in order to bring a product closer to the customer. Sometimes, two or more companies that exist in different points of the supply chain may come together for the purpose of increasing synergies, reducing costs and improving productivity and efficiency. When this merging of companies occurs, it is referred to as a Vertical Merger.

Vertical Integration and Horizontal Mergers

The terms “vertical merger” and “vertical integration” are interchanged regularly in the business world. But it is necessary to make a distinction. Vertical Integration occurs when a business expands its presence and operations to other points of the supply chain. For instance, a piano making company could also decide to make the piano stands instead of purchasing from their suppliers. This would not require a merger with another company and is not the same as a vertical merger. A vertical merger would happen if the piano maker and the piano stand maker were to come together.

On the other end of the merger spectrum, a horizontal merger occurs when two companies who compete against each other in the same point of the supply chain and produce the same thing find that they would have more value together than against each other and so decide to join forces. The result of this type of merger is often an exponentially larger share of the market for the new entity and less threat from competition.

Some Examples of Vertical Mergers

One example of a vertical merger is that of the piano and the piano stand makers. Another example is of a local bakery buying the flour factory. A vertical merger of this nature would drastically reduce the cost of buying flour for the bakery, and give it the chance to expand business by supplying flour to other local and regional bakeries.

This expanse in business and revenue streams inevitably leads to a bigger bottom line. An example of a profitable vertical merger is that of Disney, the once humble cartoon maker. After decades of growth in the animated movie field, Disney acquired independent film distributor Miramax Films in 1993. They expanded their activity into the distribution arm of the entertainment industry and in 1997, they were able to enter a 10-year distribution partnership with Pixar Animation Studios. The partnership brought forth many global best-sellers like Toy Story, The Incredibles, and Coco.

These benefits of reduced costs and increased revenues show how vertical mergers can offer multiple benefits to the company conducting the merger.

The Downsides of Vertical Mergers

Vertical Mergers definitely have benefits, but they are not without their risks. When vertical mergers occur within an industry, the sheer increase in power gives the possibility of reduced market competition and the chance that the larger entity could breach anti-trust laws. Some merged companies have been known to use their advantage to stop competition from getting materials they need to conduct business so as to push them out of the market.

Take again, for instance, the example of the bakery that acquires the flour factory. While the merger would give the baker reduced costs in flour purchase, the baker can also increase the price of flour for other local bakers, making it difficult for them to compete. They could also sell bread at whatever price they wanted, and customers would have to purchase because they would have little or no competition. This risk of creating a monopoly is why vertical mergers are often scrutinized before being carried out.

Bottom Line

Vertical Mergers are beneficial to companies within a supply chain. It allows them to reduce their costs, increase their revenue, and improve sustainability.

However, they come with the risk of creating monopolies which is not the desired outcome.

If you like to learn more about Mergers and Acquisitions, reach out to us here at A. Neumann & Associates, LLC and speak to one of our M&A specialists.

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