Horizontal vs. Vertical Integration: An Overview
Horizontal and vertical integrations are strategies used by businesses in the same industry or production process. In a horizontal integration, a company takes over another that operates at the same level of the value chain in an industry. A vertical integration, on the other hand, involves the acquisition of business operations within the same production vertical.
- 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.
When a company wishes to grow through horizontal integration, its aim is to acquire a similar company in the same industry.
Companies may choose to undergo horizontal integration in order to increase their size, diversify product or services offerings, achieve economies of scale, or reduce competition. They may also wish to gain access to new customers or markets, including overseas. For example, a department store may choose to merge with a similar one in another country to start operations overseas.
The result of horizontal integration, when successful, is the ability to produce more revenue together compared to if they were to compete independently. In addition to this, a newly merged company can cut down on costs by sharing technology, marketing, research and development (R&D), production, and distribution.
Some examples of horizontal integration include:
- Marriott's 2016 acquisition of Starwood Hotels & Resorts Worldwide in the hospitality industry
- Beer company Anheuser-Busch InBev's 2016 acquisition of competitor SABMiller
- AstraZeneca's 2015 acquisition of ZS Pharma
- Facebook's 2012 acquisition of Instagram
- Disney's 2006 acquisition of Pixar
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. By merging two companies that operate in the same supply chain together, it can cut down on competition, thereby reducing the choices available to consumers. And 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.
In order to prevent monopolies, horizontal integrations are subject to anti-trust laws in the United States. These laws are in place to protect consumers from a merged entity if it has too much influence and a high market concentration.
A company that undergoes vertical integration acquires a company that operates in the production process of the same industry. Some of the reasons why companies choose to integrate vertically include strengthening their supply chain, reducing production costs, capturing upstream or downstream profits, or accessing new distribution channels. To do 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.
This strategy is important for many companies for several reasons. Not only does it increase profits from the newly acquired operations by selling its products directly to consumers, 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 undergoing a backward integration if it acquires a tire manufacturer. This ensures the manufacturer it has a steady supply of tires in order to keep making its cars.
Forward integration occurs when a company decides to take control of the post-production process. So that car manufacturer from the example above may acquire an automotive dealership through forward integration—the process of acquiring a business ahead of its own supply chain. This not only gets the manufacturer closer to the consumer, but it also gives the company more revenue.
Some examples of vertical integration include:
- Google's 2012 acquisition of smartphone producer Motorola
- Ikea's 2015 purchase of forests in Romania to supply its own raw materials
- Amazon's integration into hardware by producing Kindle Fire tablets