Horizontal vs. Vertical Integration: An Overview
Horizontal integration and vertical integration are competitive strategies that companies use to consolidate their position among competitors. Horizontal integration is the acquisition of a related business. A company that opts for horizontal integration will take over another company that operates at the same level of the value chain in an industry. Vertical integration refers to the process of acquiring business operations within the same production vertical. A company that opts for vertical integration takes complete control over one or more stages in the production or distribution of a product.
While horizontal integration and vertical integration are both ways that companies grow, there are important differences between the two strategies. Vertical integration occurs when a business owns all parts of the industrial process while horizontal integration occurs when a business grows by purchasing its competitors. This article will help explain the most important distinctions between horizontal integration and vertical integration and will help companies decide which strategy is the most advantageous for them by elucidating the pros and cons of each approach.
- A horizontal acquisition is a business strategy where one company takes over another that operates at the same level in an industry.
- Vertical integration involves the acquisition of business operations within the same production vertical.
- Horizontal integrations help companies expand in size, diversify product offerings, reduce competition, and expand into new markets.
- Vertical integrations can help boost profit and allow companies more immediate access to consumers.
- Companies that seek to strengthen their positions in the market and enhance their production or distribution stage use horizontal integration.
When a company wishes to grow through horizontal integration, its primary goal is to acquire a similar company in the same industry. Other goals include increasing in size, creating economies of scale, increasing market power over distributors and suppliers, increasing product or service differentiation, expanding the company's market or entering a new market, and reducing competition.
For example, if a department store wants to enter a new market, it may choose to merge with a similar one in another country to start operations overseas. The goal of doing so would be to create more revenue after the merger. Ideally, the company would make more money than when they were two independent companies.
A newly-merged company can cut down on costs by sharing technology, marketing efforts, research and development (R&D), production, and distribution.
Horizontal integration works best when the two companies have synergistic cultures. Horizontal integration may fail if there are problems when merging the two company cultures.
Pros and Cons of Horizontal Integration
While there can be many benefits to horizontal integration, the most obvious benefit is an increased market share for the company. When two companies combine, they also combine their products, technology, and the services that they provide to the market. And when one company multiplies its products, it can also increase its consumer foothold.
Along those same lines, companies can benefit from a larger customer base after horizontal integration. By merging two businesses into one, the new organization now has access to a larger base of customers.
When a company's customer base increases, the new company can now boost its revenue. Finally, companies that opt for horizontal integration benefit from reduced competition in their industry, increasing the synergy between two companies (including marketing resources), and reducing some production costs.
Even though a horizontal integration may make sense from a business standpoint, there are downsides to horizontal integration for the market, especially when they succeed. This kind of strategy faces a high level of scrutiny from government agencies. Merging two companies that operate within the same supply chain can cut down on competition, thereby reducing the choices available to consumers.
If that happens, it may lead to a monopoly, where one company plays a dominant force, controlling the availability, prices, and supply of products and services. Big mergers like these are the reason why antitrust laws are in place. Antitrust laws are intended to prevent predatory mergers and acquisitions that may create a monopoly. where one company has too much influence and a high market concentration.
After horizontal integration, the new, larger company may take advantage of consumers by raising prices and narrowing product options.
In addition, there are other potential drawbacks to horizontal integration, including reduced flexibility within the new organization. Prior to horizontal integration, the two companies may have been able to operate more nimbly, but now the new company is a larger organization. With more employees and internal processes, a company is now beholden to more bureaucracy and a greater need for transparency. Finally, if there is not synergistic energy between the two companies, despite the costs of the process, horizontal integration can fail. This can result in a reduction of value between the two companies, rather than adding value to the operation.
Increased market share
Larger consumer base
Synergistic efforts (combined marketing efforts, technology, etc.)
Create economies of scales and economies of scope
Reduce production costs
High level of scrutiny from government agencies
Creation of a monopoly
Higher prices for consumers
Less options for consumers
Reduced flexibility for the new, larger company
Lack of alignment between company values destroys overall company value
Horizontal Integration Examples
Horizontal integration takes place when two companies that compete in the same industry and at the same stage of production merge. Three examples of horizontal integration are the merger of Marriott and Starwood Hotels in 2016, the merger of Anheuser-Busch InBev and SABMiller in 2016, and the merger of The Walt Disney Company and 21st Century Fox in 2017.
Marriott and Starwood Hotels
In 2016, Marriott International, Inc. acquired Starwood Hotels & Resorts Worldwide, Inc. At the time, this created the world's largest hotel company. The goal of the merger was to create a more diverse portfolio of properties for the company. While Marriott had a strong presence in the luxury, convention, and resort segments, Starwood's international presence was very strong. The combination of the two companies created more choices for consumers (as guests of the hotel franchise), more opportunities for employees, and added value for the company's shareholders. After combining, the two companies had approximately 5,500 hotels and 1.1 million rooms worldwide.
Anheuser-Busch InBev and SABMiller
The merger between Anheuser-Busch InBev and SABMiller, finalized in October 2016, was valued at $100 billion. The new company now trades under one name, Newbelco. Because this merger combined the world's leading beer companies, prior to the closing the companies had to agree to sell off many of their popular beer brands, including Peroni, Grolsch, and the Czech Republic’s Pilsner Urquell, in order to comply with anti-trust laws.
One of the goals of the merger was to increase Anheuser-Busch InBev's market share in developing regions of the world, such as China, South America, and Africa, where SABMiller already had established access to those markets.
The Walt Disney Company and 21st Century Fox
The Walt Disney Company's acquisition of 21st Century Fox was finalized in March 2019. The goal of the merger was to increase Disney's content and entertainment options to satisfy consumer demands, expand into the international market, and expand its direct-to-consumer offerings, including ESPN+, Disney+, and the two company's combined ownership stake in Hulu.
The acquisition also included Twentieth Century Fox, Fox Searchlight Pictures, Fox 2000 Pictures, Fox Family and Fox Animation, Twentieth Century Fox Television, FX Productions and Fox21, FX Networks, National Geographic Partners, Fox Networks Group International, Star India, and Fox’s interests in Hulu, Tata Sky and Endemol Shine Group.
A company that undergoes vertical integration acquires a company operating in the production process of the same industry. Some of the reasons why a company may choose to integrate vertically include strengthening its supply chain, reducing production costs, capturing upstream or downstream profits, or accessing new distribution channels. To accomplish this, one company acquires another that is either before or after it in the supply chain process.
Companies may achieve vertical integration through internal expansion, an acquisition, or a merger.
Not only does vertical integration increase profits from the newly acquired operations by selling its products directly to consumers, but it also guarantees efficiencies in the production process and cuts down on delays in delivery and transportation.
Companies can integrate vertically in two ways: backward or forward. Backward integration occurs when a company decides to buy another company that makes an input product for the acquiring company's product. For example, a car manufacturer is pursuing backward integration when it acquires a tire manufacturer.
Forward integration occurs when a company decides to take control of the post-production process. So, the car manufacturer in the previous example may acquire an automotive dealership through the process of forward integration—acquiring a business ahead of its own supply chain. This gets the manufacturer closer to the consumer and gives the company more revenue.
Pros and Cons of Vertical Integration
Vertical integration helps a company to reduce costs across different parts of its production process. It also creates tighter quality control and guarantees a better flow and control of information across the supply chain.
Further benefits of vertical integration include increasing sales and improving profits. Backward integration—when a company purchases another company that makes an input product for the acquiring company's product—can reduce or eliminate the leverage that suppliers have over the company, and thus, can reduce costs.
One of the major drawbacks of vertical integration is that a company can end up with all of its resources concentrated in one approach. This strategy can be especially risky in an uncertain market environment. In addition, there are high costs in coordinating a vertical integration.
Any company that is considering a vertical integration strategy should be aware of the capital that it takes to finance an acquisition. If this strategy requires taking on additional debt, a company should proceed with the knowledge that it must be able to pay for that debt through the additional revenue generated by the integration.
Reduce costs across various parts of production
Ensure tighter quality control
Better flow and control of information across the supply chain
Better control over production volume
Concentrates resources and prospects in one approach
High organizational and coordination costs
Vertical Integration Examples
Vertical integration takes place when a company acquires some or all of the players within its supply chain. Three examples of vertical integration are Google's acquisition of the smartphone producer Motorola in 2012, IKEA's purchase of forests in Romania to supply its own raw materials in 2015, and Netflix's foray into creating its own original content that it would distribute through its streaming service.
Google and Motorola
In 2012, Google acquired Motorola Mobility. Motorola created the first cell phone and had invested in Android technology that was valuable for Google.
Ikea and Forests in Romania
In 2015, IKEA bought an 83,000 acre woodland in northeastern Romania. It was the first effort the company had made at managing its own forest operations. IKEA purchased the forest in order to manage wood sustainably at affordable prices.
Netflix Produces Its Own Content
Netflix is one of the most significant examples of vertical integration in the entertainment industry. Prior to starting its own content studio, Netflix was at the end of the supply chain because it distributed films and television shows created by other content creators. However, Netflix leaders realized they could generate greater revenue by creating their own original content. In 2013, the company expanded its original content offerings.
Horizontal Integration and Vertical Integration FAQs
What Is Horizontal and Vertical Integration?
Horizontal integration is an expansion strategy adopted by a company that involves the acquisition of another company in the same business line. Vertical integration refers to an expansion strategy where one company takes control over one or more stages in the production or distribution of a product. Both of these strategies are undertaken by a company in order to consolidate its position among competitors.
What Is an Example of Horizontal Integration?
Horizontal integration is one of the most common types of mergers. As a result of horizontal integration, competitors in the same market combine their operations and assets. An example of horizontal integration would be if two consulting firms merge. One of the firms offers software development services in the defense industry; the other firm also provides software development but in the oil and gas industry.
Who Uses Horizontal Integration?
Companies that seek to strengthen their positions in the market and enhance their production or distribution stage use horizontal integration.
Why Is Horizontal Integration Important?
Horizontal integration can greatly benefit companies. It is important because it can grow the company in size, increase product differentiation, achieve economies of scale, reduce competition, or help the company access new markets.
The Bottom Line
While horizontal integration and vertical integration are both ways that companies can expand their operations, there are important differences between the two strategies. Horizontal integration is the process of acquiring or merging with competitors, while vertical integration occurs when a firm expands into another production stage (rather than merging or acquiring the company in the same production stage).