Types of mergers
/What is a Merger?
A merger occurs when two companies combine into a single new business. The owners of the original entities continue to be the owners of the merged entity. There are four types of mergers, which are vertical mergers, horizontal mergers, market extension mergers, and conglomerate mergers. These general types are expanded upon below.
Vertical Merger
A company may want to have complete control over every aspect of its supply chain, all the way through to sales to the final customer. This control may involve buying the key suppliers of those components that the company needs for its products, as well as the distributors of those products and the retail locations in which they are sold. The following are all examples of vertical integration:
A utility buys a coal mine in order to assure itself of raw materials for its power plants.
A consumer electronics firm buys an electronics website store in order to secure a retail channel for its products.
A furniture company buys a hardwood forest in order to assure itself of having sufficient raw materials.
An automobile manufacturer wants to use the just-in-time manufacturing system, under which component parts are delivered to its factory just as they are needed. To assure itself of a dependable source of supply for this system, it acquires a manufacturer of car seats.
A company does not normally engage in a comprehensive vertical integration strategy, but instead focuses on those suppliers who control key raw materials and production capacity, as well as those sales channels that generate the most profit.
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Horizontal Merger
A company acquires a direct competitor in a horizontal merger. By doing so, it can combine the product lines and locations of the two entities, resulting in more robust offerings to customers. This approach can be anti-competitive, especially if the two parties had previously been engaged in a price war, since the acquirer can then raise prices. A downside is the possibility of government intervention if competitiveness has been severely impacted. Such intervention usually only occurs when the buyer is a significant industry player.
An example of a horizontal merger was between The Walt Disney Company and 21st Century Fox. Both companies operated in the same industry (entertainment and media), producing movies, TV shows, and other content. This qualifies as a horizontal merger because they were direct competitors in the media space. Disney sought to strengthen its position in the entertainment industry by acquiring Fox's extensive film and TV assets, including franchises like X-Men and Avatar, as well as a significant stake in Hulu. The deal also enhanced Disney's ability to compete with streaming giants like Netflix and Amazon. This merger is a classic example of a horizontal merger because it involved two companies in the same industry aiming to consolidate their market share and expand their offerings.
Market Extension Merger
A market extension merger occurs when two companies sell the same general types of products, but compete in unrelated markets. Businesses that engage in market extension mergers want to develop a larger client base, which they achieve by essentially acquiring customers in new markets. This approach also gives the acquiring firm a larger sales upside, since its total addressable market has now increased. A potential problem is rationalizing the two sets of product lines to make them look as though they are being produced and serviced by a single, unified business.
Conglomerate Merger
A conglomerate merger is a catchall for all other types of mergers, which may involve acquisitions in completely different industries, or brand extensions, or geographic extensions within the current industry. Several variations are:
Geographic expansion. This involves finding another business that has the geographic support characteristics that the company needs, such as a regional distributor, and rolling out the product line through the acquired business. Under this approach, an acquirer would likely need to find an acquisition in each area in which it plans to conduct a geographic expansion.
Product supplementation. An acquirer may want to supplement its product line with the similar products of another company. This is particularly useful when there is a hole in the acquirer’s product line that it can immediately fill by making an acquisition.
Diversification. A company may elect to diversify away from its core business in order to offset the risks inherent in its own industry. These risks usually translate into highly variable cash flows which can make it difficult to remain in business when a bout of negative cash flows happen to coincide with a period of tight credit where loans are difficult to obtain.
Product Extension Merger
A product extension merger involves two businesses that compete in the same market, but which have somewhat different product offerings. By combining their offerings, the combined entities can cross-sell to each other’s customers, and possibly upgrade customers from the lower-priced offerings of one of the companies to the higher-priced offerings of the other. The main concern with this type of merger is making the combined product line look as seamless as possible, so that customers have an incentive to transition between the products without being tempted to switch away to a competitor’s offerings.
An organization may engage in several of these types of mergers, but tends to specialize in just one, since it takes time to build up expertise in how each type of merger is negotiated and priced.