Horizontal Integration vs. Vertical Integration: An Overview
Horizontal integration and vertical integration are competitive strategies that companies use to consolidate their positions and set themselves apart from their competitors. Both are corporate growth strategies that involve the acquisition of other businesses. While they can help companies expand, there are important differences between these two strategies. Horizontal integration occurs when a business grows by purchasing related businesses—namely, its competitors. Vertical integration, on the other hand, occurs when a business takes control of one or more stages in production or distribution, thereby owning all of the parts of the industrial process.
- 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.
Horizontal integration is a growth strategy that many companies use to boost their position within their industries and to get an edge on their competition. They do this by taking over another company that operates at the same level of the value chain. This means both companies offer similar (if not the same) goods and services, and deal with the same customer base.
The primary goal of horizontal integration is to grow through the acquisition of one or more competitors that function within 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
- Reducing competition
If a department store wants to enter a new market, merging with a similar company in another country can help it to start operating overseas. Doing so would allow the company to generate more revenue and reach a wider market. Ideally, the newly-formed company would make more money as a single unit compared to when they operated independently.
Horizontal integration allows companies to cut down on their costs by sharing technology, marketing efforts, research and development (R&D), production, and distribution.
Horizontal integration usually works best when two companies have synergistic cultures. The process may fail if there are problems when the two cultures merge.
Vertical integration is a corporate strategy that involves growth through streamlining operations. This occurs when one company acquires a producer, vendor, supplier, distributor, or other related company within the same industry. Companies that choose to integrate vertically do so to strengthen their supply chains, reduce their production costs, capture upstream or downstream profits, or access new distribution channels.
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 by moving backward or forward:
- Backward integration occurs when a company decides to buy another business that makes an input product for the acquiring company's product. For example, a car manufacturer pursues backward integration when it acquires a tire manufacturer.
- Forward integration occurs when a company decides to take control of the post-production process. So, that car manufacturer may acquire an automotive dealership through forward integration by acquiring a business ahead of its own supply chain. This gets the manufacturer closer to the consumer and gives the company more revenue.
Companies may achieve vertical integration through internal expansion, an acquisition, or a merger.
Advantages and Disadvantages of Horizontal Integration vs. Vertical 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.
Here are some of the other benefits associated with horizontal integration:
- A larger customer base
- Greater revenue
- Cutting out the competition
- More synergy between two companies (including marketing resources)
- Reducing 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, which is why antitrust laws are in place.
- Merging two companies that operate within the same supply chain can cut down on competition and reduce the choices available to consumers.
- It may lead to a monopoly where one company plays a dominant force that controls the availability, prices, and supply of products and services.
- The new, larger company may take advantage of consumers by raising prices and narrowing product options.
- Reduced flexibility, increased bureaucracy, and a greater need for transparency
- The chance of failure if there isn't synergistic energy between the two companies.
Increased market share
Larger consumer base
Economies of scales
Reduced 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
Deterioration of company value
Vertical integration helps a company:
- Reduce costs across different parts of its production process
- Creates tighter quality control and guarantees a better flow and control of information across the supply chain
- Increase sales
- Improve profits
- Reduce or eliminate the leverage that suppliers have over the company (backward integration)
The drawbacks of vertical integration include:
- A concentration of resources in one approach
- Increased risk when market environments are uncertain
- High costs to coordinate the strategy, including the potential of additional debt
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
Increased risk during uncertain times
High organizational and coordination costs
Horizontal Integration vs. Vertical Integration Examples
Horizontal Integration Examples
- Marriott and Starwood Hotels: Marriott International (MAR) acquired Starwood in 2016, creating the world's largest hotel company in the hopes of diversifying its portfolio of properties. While Marriott had a strong presence in the luxury, convention, and resort segments, Starwood's international presence was very strong. The merger offered greater choice for consumers, more opportunities for employees, and added value for shareholders. Both companies had approximately 5,500 hotels and 1.1 million rooms worldwide after the merger was completed.
- Anheuser-Busch InBev and SABMiller: Finalized in October 2016 with a valuation of $100 billion, the new company now trades under the name Newbelco. Each company 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 antitrust laws before the merger was approved. One of the goals 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.
- Walt Disney Company and 21st Century Fox: Disney's (DIS) acquisition of 21st Century Fox was finalized in March 2019. The goal was to increase Disney's content and entertainment options, expand internationally, and grow its direct-to-consumer offerings, including ESPN+, Disney+, and the two company's combined ownership stake in Hulu. The deal 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.
Vertical Integration Examples
- Google and Motorola: Alphabet's Google (GOOG) acquired Motorola Mobility in 2012. Motorola created the first cell phone and invested in Android technology that was valuable for Google.
- Ikea and Forests in Romania: The Swedish furniture giant bought an 83,000 acre woodland in northeastern Romania in 2015. It was the first effort the company 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 (NFLX) 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 creators. But company leaders realized they could generate more revenue by creating original content. In 2013, the company expanded its original content offerings.
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
Horizontal integration and vertical integration are two different growth strategies that can help companies expand their operations. Although the ultimate goals may be the same, there are important differences between the two strategies. Horizontal integration involves acquiring or merging with competitors while vertical integration occurs when a firm expands into another production stage like acquiring a supplier or distributor. As such, vertical integration is the process of acquiring business operations within the same production vertical. A company that opts for vertical integration, though, takes complete control over one or more stages in the production or distribution of a product.