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Vertical Mergers: The Ultimate Guide With Examples

Commercial & Corporate Law

updated:
12.7.21
Vertical Mergers Guide

A vertical merger can bring many benefits to a company. Learn about the features and advantages of vertical merger from this article.

What Is a Vertical Merger?

A general definition of 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 such a merger is to benefit the economics of both of the merged entities.

The Difference Between Horizontal and Vertical Mergers

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.

Which Type of Merger is Right for Me?

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 cut costs. 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.

What Is a Vertical Merger

The Benefits of Vertical Mergers

In a merger, whether vertical or horizontal, two companies integrate their operations. This is more than just a joint venture, however. The two companies merge 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.

Better Management

A vertical merger can improve the management structure of the surviving company, thereby improving management performance. When two companies merge, there are 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 higher profits. A merger increases a company’s competitive position in its market, resulting (ideally) in higher profits.

Cost Control/Cost Reductions

A vertical merger can result in better cost control. 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.

Synergy

“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

A vertical merger 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

A vertical merger creates financial synergy by increasing liquidity and free cash flow. It 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.

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 two 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 two companies merge, it is not at all uncommon for key personnel members to leave the company during or after the merger. This is especially likely when two 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?

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.

Examples of Vertical Acquisitions

Following are some high-profile 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.

All of the foregoing mergers were successful.

Contact Us Today

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!

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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