Vertical Mergers: the Ultimate Guide with Examples

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Commercial & Corporate Law

Andrew Lopez

Andrew is the founder and managing member of Sequoia Legal, LLC headquartered in Denver. He advises domestic and foreign companies and organizations, entrepreneurs and individuals on a variety of corporate and international regulatory and transactional matters

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Vertical Mergers Guide

You've probably heard about mergers & acquisitions many times. Vertical mergers can bring many benefits to the companies involved. Learn about the advantages and disadvantages of vertical merges from this article.

What Are Vertical Mergers?

A general definition of a vertical merger is the merger of two companies that occupy different parts of the same supply chain. A factory, for example, might merge with a wholesaler, or a wholesaler might merge with a retailer. The purpose of vertical integration of the supply chain is to benefit the economics of both of the merged entities.

Synergies Created by Vertical Mergers

“Synergy” refers to the combined effect of cooperation that is greater than the sum of the separate effects. Vertical mergers create many potential synergies.

Operating Synergy

examples of vertical mergers

Vertical mergers can create operating synergy by enhancing the efficiency of internal workflow. The efficiency of communication, to cite one example, can improve. The successful aspects of each company can be combined, and the less successful aspects can be dropped.

Financial Synergy

Vertical mergers create financial synergy by increasing liquidity and free cash flow. They can also increase debt capacity, reduce the cost of capital, and increase the new company’s credit rating.

Managerial Synergy

A vertical merger makes it easier to replace poor-performing managers with better managers, with effects that ripple throughout the entire company.

What Is the Difference Between Horizontal and Vertical Mergers?

The question most commonly asked about mergers is this: How do horizontal mergers and vertical mergers differ?

Horizontal mergers and vertical mergers are two distinctly different types of mergers. A prominent example of a vertical merger is the merger between eBay and PayPal. eBay provides a platform that allows people to sell items, while PayPal allows buyers to pay for these items. This kind of merger can greatly increase efficiency.

A prominent example of a horizontal merger is the merger between T-Mobile and Sprint, which allowed the combined entity to increase its market share by buying out its competition.

Companies in the same business might form vertical mergers to streamline their supply chain process, while they might choose horizontal mergers as a way to reduce competition.

Which Type of Merger is Right for Me?

What Is a Vertical Merger

It is important that you clearly understand the implications of both vertical and horizontal mergers before you even consider executing one. A successful vertical merger, for example, will enhance your competitive position in your market. It will also help you lower prices related to production. A successful horizontal merger, by contrast, will increase your revenue.

There is no crystal ball that can tell you with certainty exactly what form your merger should take. All you can do is analyze the details with a good understanding of your market and of how mergers work.

Advantages and Disadvantages of Vertical Mergers

In a merger, whether vertical or horizontal, two different companies integrate their operations. This is more than just a joint venture, however. The companies consolidate ownership to become one company.

The reasons for a vertical merger are to create one entity that is worth more than the sum of its parts because the new company occupies a greater share of the supply chain.

The Benefits of Vertical Mergers

Vertical mergers can bring significant benefits for all companies involved. They can provide greater control over the supply chain, lead to lower prices for raw materials, and reduce competition for businesses within the same industry.

Below are some of the key factors that might compel a company to pursue a vertical merger:

  • Better management: A vertical merger can improve the management structure of the surviving company, thereby improving management performance. The merging of companies leads to a greater number of managers to choose from. This allows the new company to choose its top managers from a greater pool of applicants, increasing the amount of talent at the top.
  • Higher profits: Another advantage of a vertical merger is the likelihood of increased profits. A merger increases a company’s competitive position in its market, resulting (ideally) in an increase in profits.
  • Cost control/cost reductions: A vertical merger can result in greater control over costs. A vertical merger allows the new company to eliminate redundancies that increased costs when two companies were operating separately.
  • Better quality control: Better quality control is another benefit of vertical mergers. Suppose, for example, that a manufacturer merges with a wholesaler. Centralized management will allow both the production and distribution arms of the company, now divisions of the same company rather than separate companies, to smoothly integrate their operations.

Some of the most famous vertical mergers succeeded because a company identified that the best way to achieve its business goals was through the vertical acquisition of another element of its supply chain.

Vertical Mergers Disadvantages

Vertical mergers can entail significant changes — and these aren’t always enacted without bumps in the road. While the supply chain benefits of a vertical merger can increase profits and lead to long-term growth, some disadvantages need to be considered before moving forward with vertical M&A transactions:

  • Additional costs: The bureaucratic costs associated with vertical integration are sometimes significant enough to overshadow the benefits of lower production costs. This undermines the overarching objective to cut costs and increase profits.
  • Employee pushback: Vertical acquisition can significantly change business function and structure. Even economically successful vertical mergers can bring opposition from key personnel dissatisfied with such large-scale changes. Companies involved in a vertical merger should consider this element and prepare for the possibility of losing valued employees.  
  • Culture clash: Company culture is a large factor in why employees choose to work for one company over another in the same industry. Vertical integration can lead to internal clashes over workplace expectations, management styles, and other elements that impact employee satisfaction, workplace cohesiveness, and overall productivity. Proactively planning for these challenges can help the companies involved in a vertical merger avoid the growing pains that accompany a clash of company cultures.

The disadvantages of vertical mergers fall into two distinct categories: uncontrollable and controllable. Vertical mergers that don’t economically make sense are unlikely to become a reality. However, considering the human element at play can allow executives to plan for how to ease the transition in a way that prevents internal dissatisfaction from disrupting what is an otherwise advantageous move for a company’s supply chain process.

The Main Challenges of a Successful Merger

Company Mergers Benefits and Challenges

Although a vertical merger offers many possibilities for creating a better company, in many cases most of the potential synergy is never realized. These challenges can be daunting, as detailed below.

Different Corporate Cultures

Consider the interpersonal challenges faced by a married couple. This is a decent analogy to the challenges faced by merging companies with different corporate cultures. To succeed, you must harmoniously integrate operational and managerial styles. All of this must be done within the constraints of market demands. Consider corporate cultures before even attempting a merger.

Increase in Costs of Control

A badly executed merger can result in a form of anti-synergy. Instead of increasing efficiency, you might actually increase costs, introduce redundancies and retain many now-useless employees, departments, and functions. You must plan very carefully to avoid this consequence. Remember, there is no such thing as an unimportant detail--everything matters in a vertical merger, especially between companies with very different corporate cultures.

Loss of Key Personnel

When companies combine, it is not at all uncommon for key personnel members to leave the company during or after the merger. This is especially likely when companies with clashing corporate cultures merge. In most vertical mergers, the top few percent of employees are responsible for most of a company’s productivity. Loss of these employees can send the new company into a “death spiral” from which recovery might be impossible.

Are Vertical Mergers Legal?

Are Vertical Mergers Legal

Vertical mergers, of course, are not illegal per se. They do, however, require the approval of the Antitrust Division of the Department of Justice (DOJ)  and the Federal Trade Commission (FTC). A poorly planned merger is unlikely to win approval, and the government might deny even a well-planned merger if it is likely to reduce market competition or create a monopoly. The assistance of a merger/antitrust law firm is a practical necessity throughout the merger process.

How Do Vertical Mergers Work?

Vertical M&A transactions can occur when a company recognizes the economic practicality of incorporating another element of its supply chain. This allows greater control over logistics and expenses related to both the supply chain and many other aspects of business operations.

Suppose that a furniture company receives the fabrics used in its manufacturing process from a textile company. These companies form two different levels of the supply chain. The textile company sells its fabrics at a profit to the furniture company.

If the furniture company undergoes a vertical merger with the textile company, the two will combine into one company. Now, two different stages of the supply chain have been incorporated into one. Efficiency is maximized, and costs are reduced.  

Another example of a vertical merger would be the merging of an automobile manufacturer with a parts supplier. The companies aren’t competitors, but a successful vertical merger can lead to increased revenue in both areas of the industry.

In comparison, a horizontal merger is the combination of companies at the same level of the supply chain — in the context of the above example, a horizontal merger would be the combination of two different automobile manufacturers into one company. While a horizontal merger often aims to reduce competition, the goal of a vertical merger is to reduce the number of separate players along the supply chain.

Vertical mergers serve to make the supply chain process more efficient, cut costs for raw materials, and combine the profits of two separate companies into one. Depending on the extent to which vertical mergers allow for the combination of production and distribution costs, it’s possible to significantly cut overhead costs while increasing profits at the same time, leading to an undeniable economic advantage for the companies involved.

Examples of Vertical Acquisitions

Following are some of the biggest vertical mergers in recent history:

  • In 1984 Mobil (now ExxonMobil), which was strong in oil refining and marketing, acquired Superior Oil, which was strong in oil and gas exploration and drilling.
  • In 1996 Time Warner, a cable company merged with Turner Corporation, a media company.
  • In 2006 Walt Disney acquired Pixar. Disney gained an animation studio, while Pixar gained access to Disney’s distribution network.
  • In 2017 Inditex, one of the largest fashion retailers in the world, acquired Indipunt, its primary textile supplier.  
  • In 2005 Google acquired Android. The $50 million vertical merger allowed Google to expand into the mobile operating industry.
  • In 2002 eBay acquired PayPal. The vertical merger streamlined the online payment process for eBay and popularized the use of PayPal, increasing profit for both.

All of these vertical merger examples were successful. One thing that successful examples of vertical mergers all have in common is intelligent business strategy. Effective M&A planning can bring lasting economic benefits to companies that merge vertically.

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A vertical merger involves two different elements of the supply chain combining into one company to cut costs, increase efficiency, and ultimately experience increased profits.

Vertical mergers allow companies to streamline their business practices and focus on improving performance as a whole. Horizontal and vertical mergers can differ significantly in their objectives. Part of a sound business strategy is to consider both competitors and other actors in your supply chain to identify which type of merger might best serve your business goals.

If your company is on the verge of a vertical merger and you are afraid of making mistakes in the process, contact Sequoia Legal by calling at 303-993-0932 or by contacting us online for a free consultation. We are waiting to hear from you!

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Power Your Growth with Confidence: Business Law at Sequoia Legal

Schedule your consultation today and get expert legal guidance for your business in Denver.

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