What is Vertical Merger?
The term “vertical merger” refers to the process of combining of two or more entities that operate in the same industry but offer different supply chain functions in that industry. Typically, a it takes place in order to gain more control on the supply chain, while leveraging synergy to ramp up business. By and large, as a result of vertical merger costs of operation decrease while operational efficiency and productivity increases. It is also popularly known as vertical integration.
Explanation
Companies intend to undergo vertical merger in order to gain better control of the different stages in the supply chain, which can include either the supplier that provides raw materials or the consumer that purchase its intermediate product. The acquisition of supplier is known as backward integration, while the acquisition of buyer / purchaser is known as forward integration.
Basically, a product manufacturing process may include multiple companies at different stages of the production right from raw procurement up to the finished good manufacturing, wherein each entity provides intermediate product at the end of its production process. Interestingly, all the entities are required for the production of the finished good. It intends to improve its profitability and operational efficiency by combining the operations of two or more entities operating at different stages of a certain end product.
Examples of Vertical Merger
Some of the major examples have been discussed below:
- In the year 1996, Time Warner Inc. merged with Turner Corporation in a $7.5 billion deal. It is an example given that Time Warner Inc. is a large cable company, while Turner Corporation is a major media company that owns CNN, TNT etc.
- Google’s acquisition of Android in the year 2005 is also an example as the acquirer was able to venture into the mobile operating industry with this transaction. The value of the acquisition was $50 million.
- Live Nation, owner and operator of entertainment venues, acquired Ticketmaster, a retail ticket seller, in the year 2010. This also an example as the acquirer can leverage the retail ticket seller’s market.
- In the year 2016, Dell Inc. acquired EMC in a $67 billion cash-and-stock deal. Dell was a manufacturer of personal computers, enterprise server and mobiles, while EMC was a data storage company. This transaction was part of backward integration for Dell.
Reasons of Vertical Merger
A vertical merger allows a manufacturing company to have better control on its entire production cycle, which includes purchase of raw material from the suppliers and then adding value to the process to produce the intermediate product to sell it to the next buyer in the supply chain. Having control on either the supply side or seller side or both results in better operational discipline that can boost profitability margins. Some of the major benefits include timely and optimal supply of raw material, more control on supply chain and greater output efficiency.
Vertical Merger vs Horizontal Merger
Some of the major differences between vertical merger and horizontal merger are as follows:
- It takes place among companies that operate in the same industry but at different stages of the supply chain, while horizontal merger means merger among companies that produce similar output and operate at the same level in the supply chain.
- It is effected with the intention to integrate the operations of downstream and upstream entities in order to gain more operational control without much variation in the scale of operation, while horizontal merger is carried out with the intention to increase of scale of production, expand market and grow business size.
- It results in improvement in profitability by eliminating the margins paid to the downstream companies, while horizontal merger results in gain of market share and elimination of competition.
- Its provides more control on certain parts of the supply chain, while horizontal merger results in bigger market share or expansion of product offerings.
Advantages and disadvantages of Vertical Merger
Below are the advantages and disadvantages:
Advantages
It has several advantages and some of them are as follows:
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- It helps in reducing the financial constraints of the weaker entity by providing funds of the stronger entity, which is required for higher debt capacity and increased credit limits for supporting potential of business expansion.
- It helps in eliminating some of the strata in the supply chain, which means that the new entity is not required to pay the mark-ups on the raw material and that results in reduction of costs of operation or higher profitability.
- It helps in improving management quality by replacing any weaker team members in the management with more effective and efficient members of the combining entity.
- It helps in building better administrative and operational capabilities by combining the strengths of each combining entity, while evading the problem areas.
- The combining entities can build a stronger team by leveraging the available resources.
Disadvantages
It has several disadvantages and some of them are as follows:
- In some cases, the additional costs due to some of the bureaucratic costs can outweigh the benefits of reduction in operating cost, which eventually leads to increase in overall cost.
- There is the possibility that some of the key personnel may not be willing to join the merged entity, which can be detrimental to the very cause of the merger.
- In some cases, it can be very difficult to merge two entities with difference in cultural background and management styles.
Conclusion
So, it can be seen that vertical merger takes place between two or more companies as a strategic move to improve profitability margin, operational efficiency and management control. In short, vertical merger focuses on the bigger goal of improving the overall operations of the company. So, by now you must have developed fair idea about the pros and cons.
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