Updated July 21, 2023
Introduction to Horizontal Merger
In the corporate world, the term “horizontal merger” refers to the union of two entities that are either operating in the same industry or in a similar industry as competitors.
In other words, it means that a financially stronger company buys out a financially weaker competitor or they mutually reach an agreement to combine their forces to create a new merged entity. A horizontal merger is also known as horizontal integration.
Explanation
A horizontal merger is a business strategy that is used by companies that intend to grow inorganically by acquiring other smaller entities. Typically, horizontal mergers occur in highly concentrated industries where the number of operating firms are fairly low and so such mergers can be favorable due to synergies. Eventually, the combining entities enjoy the benefits of economies of scale as both the companies prior to the merger were operating as a competitor on the same stage of the supply chain. In the long-run, these merged entities are also able to grow their market share, reduce their operating costs, and increase their product offering to the customers without any additional capital investment.
Examples of Horizontal Merger
There are several examples of horizontal merger and some of the major ones have been discussed below:
- HP and Compaq: In the year 2001, HP and Compaq agreed to join forces in a stock-for-stock merger with an exchange ratio of 0.63 HP shares for each Compaq share, which was valued at ~$25 billion. Post-merger the new entity’s shareholding was 64% HP and 36% Compaq and the merged entity was valued at $87 billion. It became the global technology leader that offered one of the most comprehensive sets of IT products and services.
- Facebook and Instagram: In the year 2012, Facebook acquired Instagram at a purchase value of $1 billion. Both the entities operated in the social media industry and offered similar products as part of their photo-sharing services. However, Facebook intended to further bolster its market position in the social media space and acquisition of Instagram exactly fitted in its scheme of plan. The merger eventually helped Facebook in increasing its market share, eliminating competition, and gaining access to a wider audience.
- Pixar and Walt Disney: In the year 2006, Walt Disney Company acquired Pixar Animation Studios for $7.4 billion as part of its horizontal integration strategy. Basically, despite being one of the entertainment giants, Disney was struggling with its creativity and as such was facing market saturation with its current operations. In such a scenario, Pixar with its cutting-edge technology and an innovative vision for digitally animated movies came as a breath of fresh air.
Reasons for Horizontal Merger
Two companies agree to a horizontal merger with the sole intention to boost the intrinsic value. Often a successful horizontal merger would help the combining companies to leverage each other’s technical expertise and business know-how, which eventually drive the entity’s value such that the intrinsic value of the merged would be more than the intrinsic value of the individual companies under their independent ownership. Effectively, the underlying principle of a horizontal merger is that if the intrinsic value of the two combining companies is X and Y respectively, then the intrinsic value of the merged entity should be greater than (X + Y).
Difference Between Horizontal Merger and Vertical Merger
Some of the major differences between a horizontal merger and vertical merger are as follows:
- The horizontal merger takes place between two companies that have offer similar products and operates at the same level of the value chain, while vertical merger refers to the combination of two companies that operate at different stages of the value chain.
- Horizontal merger is focused on increase of scale of production and eventually grow the size of the business, while vertical merger is often aimed at integrating downstream and upstream companies to develop better operational efficiency.
- Horizontal merger helps in eliminating competition between companies and extending market share, while vertical merger helps in reducing the cost of production and controlling other operational wastages.
- Horizontal merger offers the benefits of synergy but not self-sufficiency, while vertical merger offers the completed package of synergy along with self-sufficiency.
- A horizontal merger helps in acquiring more control over a certain market, while vertical merger helps in gaining more control over the supply chain.
Advantages and Disadvantages
Some of the major advantages and disadvantages are as follows:
Advantages
Some of the major advantages are as follows:
- It helps in eliminating competition in the industry by combining with one of the competitors.
- Combination of two entities that operate in the same market results in increased market share.
- Economies of scale given that both the entities deal in similar products, which results in a lower cost of production.
- The combined entity has a wider and diversified geographical presence.
- Exchange of technical expertise and business know-how among combining entities helps in realizing economies of scope.
- Both entities are able to leverage the shared talent pool and resources.
Disadvantages
Some of the major disadvantages are as follows:
- Merging two entities with a fairly different cultural background can be a difficult task.
- The difference in the management style of the combining entities can be a hindrance to a healthy working relationship.
- In some cases, the combining entities are unable to achieve synergies, which eventually leads to deterioration of the overall intrinsic value as against the expected increased value.
- In case some of the largest players of an industry combine force, then it can lead to a monopoly market condition, which is never a desirable market situation. In fact, there might be legal repercussions if such mergers take place.
Conclusion
So, it can be seen that horizontal mergers can be very beneficial for the combining entities as it can help in widening their reach, eliminating competition, gaining institutional knowledge, and reducing the costs of production while increasing the top line. So, by now you have good knowledge about the horizontal merger and its importance in corporate parlance.
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