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Which Way to Grow? Horizontal vs. Vertical Mergers

Axial | April 27, 2015

There are many ways to grow a business. When it comes to mergers and acquisitions (commonly referred to as “inorganic growth”), there are two fundamental types of transactions a business owner might pursue. The types of acquisition targets and the integration strategy is what defines such a transaction as either a vertical or horizontal merger.

While different in nature, both vertical and horizontal mergers can have a meaningful and positive impact on a company looking for a more aggressive style of growth. Depending on what a business owner is looking to achieve, there are considerations and benefits to both.

Vertical Mergers

The goal of a vertical merger is not directly to increase revenue but rather to improve operational efficiencies and reduce costs, often to the tune of significant competitive advantage. Vertical mergers involve a company buying a supplier, distributor or other part of its supply chain so these various components can be brought under the control of one entity.

For example, a high-end consumer goods brand might acquire the factories responsible for manufacturing their goods, or on the other end of the supply chain, the boutiques or stores that distribute them. In gaining control of the entire supply chain, vertically integrated companies can better control production and price. In fact, this is exactly the practice well known luxury bag designer Louis Vuitton employs, and why his popular handbags never go on sale.

By buying the companies different stages of their operations rely on, businesses not only better control the entire chain, but particularly in the case of suppliers, cut down on the time it to takes to find and negotiate with these different parties. Vertical mergers also help to reduce expenses by ensuring that the means of production and distribution work together harmoniously so there aren’t any surpluses or shortages of the goods being sold.

In addition to the aforementioned benefits, businesses might pursue a vertical merger as a means of securing greater control over their inputs. For example, if a manufacturer uses a component that is provided by either one or few companies, purchasing these suppliers not only ensure continued access to that input, but also undermines the position of competitors.

Horizontal Mergers

The aim of a horizontal merger has a more direct path to the bottom line, helping a company to either increase market share or diversify its product offering and therefore its addressable market. In a horizontal merger, a company purchases another business within the same industry value chain (either a competitive or complementary business). Doing so frequently results in the expansion of current operations instead of the formation of new operations.

You might call the recent acquisition of lynda.com, an online learning and skills development platform, by Linkedin, the largest professional social network, a horizontal merger. Identifying an area where Linkedin could further penetrate it’s customer base – those who might be currently or eventually seeking a new professional opportunity – by offering complementary services in career development led to the pairing of companies whose mission is said to be highly aligned and a tremendous opportunity for Linkedin to expand its overall customer base and potentially even capture more revenue with the additional product offerings unlocked by the lynda.com deal.

An acquirer might decide it’s a better investment to add a company already excelling at additional or complementary products and services rather than invest the time, money and headcount into developing those products or services themselves. Horizontal mergers also represent one way to quickly access new geographical markets if the target company has a customer base or distribution centers in other regions.

Perhaps even more obviously than in a vertical merger, a horizontal merger can significantly increase a company’s competitive position, either by taking out some of the competition through the acquisition or by enabling a company to provide a higher value offering than its existing competition. Companies often pursue such a strategy purely for this reason.

Business owners deciding between these different inorganic strategies must consider their growth objectives. While both vertical and horizontal mergers represent significant benefits, a company must remember that such a transaction is only successful if the new company is integrated strategically and seamlessly. We’ll cover more about integrating an acquired company in a future article, but in the meantime, if you’re looking to elevate your competitive position, reduce costs, bolster efficiencies and boost the bottom line, carefully considering the goals and benefits of horizontal and vertical mergers is likely time well spent.

 

 

Axial is the deal network for the middle market.

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