What are the advantages of horizontal integration and vertical integration?

Horizontal integration is the process of acquiring or merging with competitors, leading to industry consolidation.

Horizontal integration is a strategy where a company acquires, mergers or takes over another company in the same industry value chain.

What is horizontal integration?

It is a type of integration strategies pursued by a company in order to strengthen its position in the industry. A corporate that implements this type of strategy usually mergers or acquires another company that is in the same production stage. For example, Disney merging with Pixar (movie production), Exxon with Mobile (oil production, refining and distribution) or the infamous Daimler Benz and Chrysler merger (car developing, manufacturing and retailing).

The purpose of horizontal integration (HI) is to grow the company in size, increase product differentiation, achieve economies of scale, reduce competition or access new markets. When many firms pursue this strategy in the same industry, it leads to industry consolidation (oligopoly or even monopoly).

HI can occur in a form of mergers, acquisitions or hostile takeovers. Merger is the joining of two similar sizes, independent companies to make one joint entity. Acquisition is the purchase of another company. Hostile takeover is the acquisition of the company, which does not want to be acquired.

HI may be an effective strategy when:

• Organization competes in a growing industry.
• Competitors lack of some capabilities, competencies, skills or resources that the company already possesses.
• HI would lead to a monopoly that is allowed by a government.
• Economies of scale would have significant effect.
• The organization has sufficient resources to manage M&A.

The following diagram illustrates HI in manufacturing industry:

Difference between horizontal and vertical integrations

HI is different from vertical integration, where a firm usually expands into another production stage rather than merging or acquiring the company in the same production stage. For example, a company is vertically integrating if it expands from manufacturing industry to retailing industry, while HI would mean buying other firms in the same manufacturing industry.

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What’s it: Horizontal integration means combining several businesses in the same supply chain level under one coordination or control. For example, two car manufacturers decide to merge and leave one surviving entity. It increases the size of the business, supporting to gain competitive advantage and higher market power.

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Integration is not only through mergers but also through acquisitions. The acquired company may be a direct competitor. For example, for example, the acquisition of Bank OCBC NISP by OCBC Bank. Alternatively, the two companies may focus on different market segments. The target company has an intersection with the acquirer’s non-core businesses. In this case, the subsidiary will focus on these non-core businesses.

The next option for integration is to form a subsidiary or joint venture in another country with the same business. For example, Japanese automakers set up production facilities and subsidiaries in Indonesia.

Some other examples of horizontal integration are:

• Facebook acquired Instagram for $1 billion in 2012. Both of them focus on social networking business.
• Heinz and Kraft Foods merged on March 25, 2015, and worked on the processed food market.
• Marriott International bought Starwood Hotels for $13.6 billion on November 16, 2015, making it one of the world’s largest hotel chains.
• The Walt Disney acquired 21st Century Fox for $52.4 billion on December 14, 2017.

The difference between horizontal integration and vertical integration

Based on their linkages in the supply chain, integration falls into two categories:

• Horizontal integration involves businesses in the same supply chain level. In other words, before integration, the two were in competition with each other.
• Vertical integration involves businesses at different levels of the production chain. Before integration, one company may be a supplier or distributor for another.

Both integrations can take place through mergers, acquisitions, or the establishment of a subsidiary.

Horizontal integration increases the size of the firm’s operations. For example, when one car manufacturer acquires another car manufacturer, it increases the scale of operations. It allows the acquirer to achieve better economies of scale. Also, market power increases due to a higher market share.

Meanwhile, a company is pursuing vertical integration to capture profits in each supply chain. The company gains better control over its inputs and distribution channels.

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Benefits of horizontal integration

Horizontal integration offers several advantages, such as:

• Cost savings
• Increased market power
• Eliminating business duplication
• Increasing financial capacity
• Facilitating knowledge transfer between entities
• Increased differentiation
• Reduced competition intensity
• Increasing bargaining power over suppliers and buyers

Cost savings

The scale of the company’s operations becomes larger, enabling it to achieve higher economies of scale.

In the high-fixed-cost industry, achieving economies of scale through large output is essential in lowering costs. Firms can spread fixed costs a large amount of output, resulting in a decrease in average costs.

Increased market power

Horizontal integration leads to industry consolidation. Because of operating at the same stage in the industry value chain, integration can enhance the company’s strategic position.

To positively contribute to competitive advantage, the net value creation from horizontal integration must be positive. For example, a merger can increase a company’s business scale, which leads to a larger share of the market. As the number of firms decreases, the intensity of competition also weakens.

Eliminating business duplication

The parent company focuses on the core business. Meanwhile, the subsidiary is working on a non-core business.

Increasing financial capacity

When it acquires or sets up a subsidiary, the company consolidates revenues from under-controlled entities. The financial capacity becomes larger, allowing the company to obtain a better credit rating. Therefore, companies can get cheaper funding.

Reduced competition intensity

Overall, the industrial structure is becoming more consolidated and potentially more profitable. Integration changes the market structure and supports existing companies. Competition tends to decline, assuming no new entrants.

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Suppose the company is in an oligopolistic industry structure. In that case, this will direct the focus of competition to a non-price strategy.

Increasing differentiation

Horizontal integration provides opportunities for companies to fill gaps in product offerings. Combined entities can offer a complete range of products and services.

Weaknesses of horizontal integration

While it can strengthen a company’s business model in several ways, integration also contains several problems, limitations, and potential dangers. Several reasons explain why the horizontal strategy failed and did not result in higher profitability. Among others are:

• Management turnover and critical staff, especially in the case of a merger. Companies are streamlining the number of employees to avoid duplication of work.
• Flexibility decreased. Business sizes are becoming more complex and more challenging to manage. It makes companies less flexible in introducing new products to the market or dealing with competition and market demand dynamics.
• Overpaying. Management often overestimates the potential gain from acquisitions. They are willing to pay exorbitant premiums.
• Does not create synergy. Ideally, integration results in a synergy in which the capabilities and resources between entities complement each other. The absence of synergy eliminates opportunities for value creation.
• Conflict culture and leadership styles, which often accompany mergers and acquisitions.
• Tighter supervision from regulators. Horizontal integration leads to increased monopoly power. 

Stricter oversight from regulators

Horizontal integration may lead to anti-competitive practices. Mergers or acquisitions reduce competition and increase market power, and companies can abuse their market power to increase profits. For this reason, horizontal integration is usually subject to greater scrutiny.

Increased market power raises regulator concerns. Firms may also raise prices above competitive levels, which is detrimental to consumers.

Also, it is in the interests of regulators to prevent the abuse of market powers. Dominant firms abuse their market power to crush potential competitors. For example, they cut prices to prevent new players from entering the industry. Or, it is to force competitors out of business. Even if they have cut prices, the company may still operate profitably, thanks to the higher economies of scale. As the intensity of competition weakens and new entrants’ threat is lower, companies then raise prices.

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