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What Is A Vertical Merger
A vertical merger is a term used in business to refer to the merger of two companies that are part of the same supply chain function for the production of goods and services.
In other words, a vertical merger allows a company to take greater control over its supply chain process, potentially reduce production costs and produce goods more efficiently.
Large companies planning vertical mergers should carefully assess their options to avoid violating antitrust laws.
In fact, when multinationals have significant control over the supply chain for the production of goods, they may use their market power to make it very costly for others to compete.
However, when a vertical merger is done right and in compliance with the law, companies hope to achieve greater profitability by having greater control over their supply chain.
Vertical Merger Definition
How do you define vertical merger?
The merger of two or more companies that provide different supply chain functions for a common good or service
The definition of vertical merger is also be presented as:
A vertical merger is a union between two companies in the same industry but at different stages of the production process
As you can see from these definitions, a vertical merger is when:
- A company mergers with another company
- Who is involved in a supply chain function
- For a common good or service
Vertical Merger Guidelines
The U.S. Department of Justice and the Federal Trade Commission in the United States have come up with a Vertical Merger Guidelines providing principal analytical techniques, practices, and enforcement policies related to vertical mergers.
When very large entities vertically merge, they may achieve significant market power within the supply chain, effectively preventing other companies from competing fairly.
In the United States, there are various anti-trust laws designed to prevent a company or group of companies from controlling an industry or having market dominance to such an extent as to destroy fair competition.
Section 7 of the Clayton Act prohibits mergers if “in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly”.
Vertical mergers are heavily scrutinized for compliance with anti-trust laws and companies considering a vertical merger should carefully assess the legal impact of the transaction beforehand.
Why Companies Merge Vertically
There are many reasons why companies may choose to merge vertically with other companies within their supply chain.
The most common reasons why vertical mergers are considered are to achieve greater operational efficiency, improve profitability, reduce production costs, and take advantage of synergies.
A company may achieve synergies when the combined value of the companies is greater than each company’s value considered individually.
One area where vertical mergers can help create synergies is through operational improvements.
When a company can vertically merge and reduce delays in purchasing raw material or eliminate inefficient supply chain processes, it can in return more effectively produce goods as planned.
Companies producing goods tend to heavily rely on their supply chain to provide them with the components, parts, and raw materials needed so they produce their goods.
By vertically merging with a supplier, you can reduce delays in the delivery of components, parts, and raw materials and eliminate inefficient procurement processes between the two firms.
A vertical merger can also be considered to take advantage of financial synergies.
Financial synergies allow the combined entities have access to greater cash, credit facility, or financing options than each entity alone.
For instance, one company in the merger may have access to credit facilities at very low rates of interest while the other entity may not have the ability to get the same rates.
The merger will allow the combined entity to take advantage of cheaper access to debt or credit facilities.
We can say the same thing with the amount of cash the companies have on hand.
Imagine that a company merges with a supplier having a lot of cash on hand.
Tapping into the supplier’s cash on hand can help fund the business and even pay down debt.
In a merger, there could be many financial synergies possible making the deal worth pursuing.
A key consideration in a merger is the ability to reduce costs.
Every company strives to be more efficient in producing their goods and offering their services.
By reducing production costs, a company can immediately boost its net income and create more value for its shareholders.
Merging with a supplier may offer many cost reduction opportunities.
Vertical mergers allow companies access to the raw material, components, and parts needed to produce goods.
Having direct access to the raw material needed to produce goods can potentially lead to significant cost savings.
Another way vertical mergers can reduce costs is by eliminating duplicate or redundant functions within the combined entity.
The post-merger entity may not need all the managers and executives that the two individual companies needed in the past.
Also, achieving operational efficiencies can lead to the elimination of manual tasks and functions allowing the company to reduce its workforce.
Vertical Merger Drawbacks
What are the main challenges or drawbacks of vertical mergers?
In theory, a company merging with a supplier involved in the production phase may sound beneficial in many ways.
And that’s true in many cases.
However, not all vertical mergers will produce the expected result.
In some cases, vertical mergers can produce the opposite impact and lead to greater losses or inefficiencies for the combined entity.
Here are some of the main drawbacks and challenges of vertical mergers:
- Culture clashes between the employees of each entity
- Inability to achieve operational efficiencies leading to increased production costs
- Loss of key personnel following the merger
- Inability to achieve financial, management, or operating synergies
Vertical Merger Example
What is an example of a vertical merger?
Let’s look at an example of vertical merger to better understand the concept.
Example 1: Car Manufacturing
Imagine that a car manufacturer relies on many suppliers to provide it with the parts and components it needs to build a car.
The car manufacturer realizes that it purchases most of its raw material from the same supplier.
If the car manufacturer acquires its raw material supplier, the transaction will be considered a vertical merger.
It’s a vertical merger as the car manufacturer is merging with a supplier within its supply chain.
Example 2: Computer Production
Let’s now look at a company that produces computers.
A computer manufacturer relies on many suppliers to produce a single computer.
One of its many suppliers is the producer of microchips.
If the computer manufacturer merges with its main microchip supplier, we’ll consider that acquisition to be a vertical merger.
The objective for the computer manufacturer is to have easy access to computer microchips allowing it to produce its computers faster and potentially at a lower cost.
Vertical Merger FAQs
Let’s look at some common questions related to the definition of vertical merger.
What Is The Difference Between Vertical Merger vs Horizontal Merger
Vertical mergers and horizontal mergers are two entirely different types of mergers.
A vertical merger is when a company merges with another entity directly involved in its supply chain.
For example, a car manufacturer acquires the company supplying it with tires.
A horizontal merger is a type of merger where a company is looking to acquire an important competitor within its industry.
The main objective of a horizontal merger is to acquire a larger market share, expand the company’s products and services, and generate more revenues.
What Is The Difference Between Vertical Merger vs Vertical Integration
The terms vertical merger and vertical integration may sound the same but they do not mean the same thing.
A vertical merger is when a company “merges” with another company within its supply chain.
In a vertical merger, the supplier and the manufacturer will unite and form one business entity following the merger.
For example, a coffee retailer will acquire its coffee bean supplier.
On the other hand, vertical integration means that a company will expand its own business operations to include functions within its own supply chain.
What this means is that a company will not acquire a supplier within its supply chain but invest its own money to include what its suppliers do within its own business operations.
For example, a coffee retailer may decide to invest its own money to produce its own coffee beans.
Vertical Merger Meaning Takeaways
So there you have it folks!
What Is A Vertical Merger?
In a nutshell, a vertical merger is when two or more companies within different stages of the production process merge.
A vertical merger is when two or more companies within the same industry and in the supply chain for the production of certain goods merge with the objective of exercising greater control over the supply chain process.
There are many reasons why companies consider merging vertically with a supplier such as to reduce operating costs, generate more profits, achieve higher quality control, achieve greater production efficiency, and find synergistic benefits.
From a synergy point of view, companies tend to strive for achieving operational, financial, and managerial synergies when undergoing a vertical merger.
Now that you know what is a vertical merger, how it works, and why it’s important, good luck with your research or even transaction!
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