Horizontal Integration

How Does Horizontal Integration Work?

Horizontal integration is a type of merger where competitors operating in the same market combine their operations to benefit from economies of scale.

If two companies that offer virtually identical or similar goods or services decide to undergo a merger, the transaction is considered horizontal integration.

The horizontal integration strategy – in which two companies operate at the same level of the value chain and decide to merge – enables companies to increase in size and scope.

Together, the combined entity’s reach is far broader in terms of expanding into new markets and diversifying a consolidated portfolio of offerings.

The result is the creation of economies of scale, where the post-merger company obtains cost savings from the expanded scale.

• Economies of Scale → The cost per unit of output declines with increased scale up to a certain point
• Greater Production Output → The efficiencies related to production, such as streamlined processes, enable the company to produce more units at their manufacturing facilities.
• Buyer Power → The combined company can purchase raw materials in bulk for steep discounts and negotiate other favorable terms.
• Pricing Power → Given the limited number of competitors in the marketplace, the combined company can make the discretionary decision to increase prices (and the few other companies in the market normally follow suit).
• Cost Synergies → The entity benefits from cost synergies, namely shutting down redundant facilities and duplicate job functions deemed no longer necessary.

What are the Risks of Horizontal Integration Merger Strategy?

If integrated properly, the profit margins of the merged company are likely to increase, although the revenue synergies can take substantially more time to materialize (or may never actually occur).

The major risk associated with horizontal integration is the reduction in competition within the market in question, which is where scrutiny from regulatory bodies comes into play.

The benefits derived from the companies participating in the merger come at the expense of consumers, suppliers or vendors.

• Consumers: Consumers now have fewer options because of the merger, while suppliers and vendors have lost more of their bargaining power.
• Suppliers and Vendors: The merged company possesses a greater proportion of the total market share, which directly causes its buyer power to increase and gives it more negotiating leverage over its suppliers, vendors, and distributors.

Of course, the risk of the merger failing to deliver the expected synergies is inevitable.

Horizontal mergers are therefore not without risk.

If the integration is done poorly – for example, suppose the differing cultures of the companies cause other issues – the result from the merger could be value-destruction, rather than value-creation.

Sprint and T-Mobile Merger – Anti-Trust Suit and Controversy

After the completion of a horizontal merger, competition in the market declines, which is usually promptly brought to the attention of the appropriate regulatory bodies.

In practice, anti-trust concerns are the primary drawback to horizontal integration.

For example, the Sprint and T-Mobile merger is a relatively recent horizontal merger under heavy regulatory scrutiny.

The U.S. Justice Department approved the controversial merger and Federal Communications Commission (FCC) in 2020, after a multi-year anti-trust suit, once the carriers agreed to divest certain prepaid wireless assets to satellite provider Dish.

The expectation was that Dish would subsequently create its own cellular network and maintain the number of competitors in the market.

Even as of the present date, the merger is criticized frequently as one of the worst, anti-competitive acquisitions that was approved and later resulted in widespread price increases from reduced competition, i.e. greater pricing power from market leadership and the limited number of market participants.

^{Court Order Allows Divestitures to Proceed (Source: Department of Justice)}

Horizontal Integration vs. Vertical Integration: What is the Difference?

In contrast to horizontal integration, vertical integration refers to a merger between companies at different levels of the value chain, e.g. upstream or downstream activities.

The companies involved in vertical integration each have their own unique role at different stages of the production process.

For instance, a car manufacturer merging with a producer of tires would be an example of vertical integration, i.e. the tire is a necessary input to the end product in a car production line.

The distinction between horizontal and vertical integration is that the former occurs among similar competitors, while the latter occurs between companies at different stages in the value chain.