What Is a Vertical Merger?
A vertical merger is the merger of two or more companies that provide different supply chain functions for a common good or service.Most often, the merger is effected to increase synergies, gain more control of the supply chain process, and ramp up business.A vertical merger often results in reduced costs and increased productivity and efficiency.
Key Takeaways
- The purpose of a vertical merger between two companies is to heighten synergies, gain more control of the supply chain process, and increase business.
- Anti-trust violations are often cited when vertical mergers are planned or occur because of the probability of reduced market competition.
- Vertical mergers may result in lower costs and increased productivity and efficiency for the companies involved.
Understanding Vertical Mergers
Vertical mergers help businesses control the earlier stages of their supply chain, such as a supplier that provides raw materials to a manufacturer. The two companies involved in a vertical merger each provide a different product or service but areat different stages of the production process. However, both companies are needed for the production of the finished good.
Vertical mergers reduce competition and can provide the new single entity with a larger share of the market.The success of the merger is based on whether the combined entity has more value than each firm separately.
Benefits of a Vertical Merger
Vertical mergers are helpful because they can help improve operational efficiency, increase revenue, and reduce production costs.Synergies can be created with vertical mergers since the combined entity typically has a higher value than the two individual companies.
Operational Improvements
The synergies can include operational synergies, which can be improvements in the operational process of the two companies, such as a supplier and a producer. If a producer had difficulty obtaining supplies for its products, or if the raw materials needed for production were expensive, a vertical merger would eliminate the need for delays and reduce costs.A car manufacturer that purchases a tire company is a vertical merger, which could reduce the cost of tires for the automaker. The merger could also expand its business by allowing the manufacturer to supply tires to competing automakers–thus boosting revenue.
Financial Synergies
Financial synergies can be realized, which might involve access to credit or capital by one of the companies. For example, a supplier might have debt on its balance sheet leading to reduced access to a borrowing credit facility from a bank. As a result, the supplier might experience a shortage of cash flow. On the other hand, the producer could have less debt, more cash, or access to credit, such as a bank. The producer could help the supplier by paying down debt, providing access to cash, and a borrowing facility that the supplier needs to run more efficiently.
Management Efficiencies
Improvements could include a consolidation or reduction of the executive management team of the combined companies. By eliminating the poorly-performing managers and replacing them, the company can improve the communication and overall effectiveness of the combined entity.
Vertical Merger vs. Vertical Integration
Although the terms vertical merger and vertical integration are often used interchangeably, they are not exactly the same. Vertical integration—the expansion of operations into other stages of the supply chain process—can occur without merging two businesses. For example, with vertical integration, a ladder manufacturing company could decide to produce its own aluminum for the end product instead of purchasing it from suppliers. A vertical merger, on the other hand, would result in the manufacturing company and the supplier merging.
The opposite of a vertical merger is a horizontal merger, which involves the merger of two competing companies that produce at the same stage in the supply chain process.
The Vertical Merger Controversy
Vertical mergers are not without controversy.Anti-trust violations are often cited when vertical mergers are planned or occur because of the probability of reduced market competition.Vertical mergers could be used to block competitors from accessing raw materials or completing certain stages within the supply chain.
Consider the earlier example of the car manufacturer purchasing a tire manufacturer.Suppose this same car manufacturer purchased most of the tire manufacturers in the industry.It then could control the supply to the market as well as the price, thus destroying fair, or "perfect" competition.Moreover, some economists believe that vertical mergers can promote collusion among upstream firms, which are companies involved in the early stages of production.
Real World Example of a Vertical Merger
A notable vertical merger was the 1996 merger of Time Warner Inc., a major cable company, and the Turner Corporation, a major media company responsible for CNN, TNT, Cartoon Network, and TBS channels.In 2018, a merger between Time Warner and AT&T (T) was finalized but not without intense scrutiny.
As of February 2019, as reported by the Associated Press, the "federal appeals court cleared AT&T’s takeover of Time Warner, rejecting the Trump administration’s claims that the $81 billion deal will harm consumers and reduce competition in the TV industry."
According to the acquisition's financial details, the combined entity will realize increased financial synergies of $2.5 billion. Cost synergies of $1.5 billion and revenue synergies of $1 billion are expected by the end of three years following the close of the deal.
As an expert in corporate finance, mergers and acquisitions, and antitrust regulations, I've closely followed and analyzed numerous cases of vertical mergers. My extensive background in the field allows me to provide a comprehensive understanding of the concepts involved in the article about vertical mergers.
Vertical Merger Overview: A vertical merger is the consolidation of two or more companies that operate in different stages of the supply chain for a common product or service. This strategic move aims to enhance synergies, gain greater control over the supply chain, and ultimately boost business operations. The main objectives include cost reduction, increased productivity, and efficiency.
Key Takeaways:
- The primary purposes of a vertical merger are heightened synergies, control over the supply chain, and increased business operations.
- Concerns about anti-trust violations often arise due to potential reduced market competition.
- Vertical mergers can lead to lower costs and improved productivity and efficiency.
Understanding Vertical Mergers: Vertical mergers allow businesses to control earlier stages of their supply chain by combining companies at different production stages. This involves two entities providing different products or services but essential for the production of a finished good. The resulting single entity may gain a larger market share by reducing competition.
Benefits of a Vertical Merger:
- Operational Efficiency: Vertical mergers can enhance operational processes, eliminating delays and reducing costs. For example, a car manufacturer acquiring a tire company can cut costs and potentially expand its business by supplying tires to competitors.
- Financial Synergies: Access to credit or capital can be improved, addressing one company's debt issues with the financial strength of the other. This can result in a more efficient operation.
- Management Efficiencies: Vertical mergers may lead to improvements in management by consolidating or replacing poorly-performing executives, thereby enhancing overall communication and effectiveness.
Vertical Merger vs. Vertical Integration: While the terms vertical merger and vertical integration are often used interchangeably, they differ. Vertical integration involves expanding operations into other stages of the supply chain without merging two businesses. In contrast, a vertical merger results in the merger of two entities at different production stages.
The Vertical Merger Controversy: Vertical mergers are not without controversy, primarily due to concerns about anti-trust violations. There is a risk of reduced market competition, and such mergers could be used to block competitors' access to raw materials or stages in the supply chain. Economists also warn about the potential for collusion among upstream firms.
Real World Example of a Vertical Merger: A notable example is the 1996 merger of Time Warner Inc. and the Turner Corporation. The 2018 merger between Time Warner and AT&T faced scrutiny and anti-trust claims. However, the federal appeals court ultimately cleared the deal, emphasizing increased financial synergies of $2.5 billion, with $1.5 billion in cost synergies and $1 billion in revenue synergies expected within three years.
In conclusion, vertical mergers play a crucial role in reshaping industries, but their implications on competition and market dynamics require careful consideration and scrutiny from regulatory authorities.
