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. There are a number of types of mergers. Horizontal and vertical mergers are just two of many types of mergers that are usually classified as non-financial mergers.
Before the Great Recession of 2008, merger and acquisition activity was at a high level in the U.S. and in the world. As the recession got underway, merger activity dropped off sharply as business firms held on to what cash they could instead of using it to buy other firms. As the recession eased, merger activity started to pick up again. Since mergers are popular for many reasons, it is important for business owners to understand the details surrounding them.
What is a Horizontal Merger?
Horizontal mergers are often a type of non-financial merger. In other words, a horizontal merger is undertaken for reason 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 over the past 30 years is in the banking industry. In 1980, The Depository Institutions Deregulation and Monetary Control Act of 1980 was passed by Congress. At the time, no one knew what wide-ranging effects this act would have but we certainly know now. 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. 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.
What is a Vertical Merger
Vertical mergers 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. An example would be 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 (dealerships), imagine the market power that would accrue to that automobile manufacturing company. It would effectively totally control the price for its vehicles without having to consider any other factors. That is the kind of market power that anti-trust laws are meant to control.