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Vertical Merger Definition How It Works Purpose and Example

Vertical Merger Definition How It Works Purpose and Example

Vertical Merger: Definition, How It Works, Purpose, and Example

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. The merger is often done 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.

Understanding Vertical Mergers

Vertical mergers help businesses control the earlier stages of their supply chain. For example, a supplier that provides raw materials to a manufacturer. 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 can help improve operational efficiency, increase revenue, and reduce production costs. Synergies can be created since the combined entity typically has a higher value than the two individual companies.

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Operational Improvements

Synergies can include improvements in the operational process of the two companies, such as a supplier and a producer. A car manufacturer that purchases a tire company is an example of a vertical merger, which could reduce the cost of tires for the automaker. The merger could also expand its business by supplying tires to competing automakers–boosting revenue.

Financial Synergies

Financial synergies 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 credit. The producer could help the supplier by paying down debt, providing cash, and a borrowing facility to run more efficiently.

Management Efficiencies

Improvements could include consolidating or reducing the executive management team of the combined companies. By eliminating poorly-performing managers and replacing them, the company can improve communication and overall effectiveness.

Vertical Merger vs. Vertical Integration

Although the terms vertical merger and vertical integration are often used interchangeably, vertical integration can occur without merging two businesses. For example, a ladder manufacturing company could decide to produce its own aluminum 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.

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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 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.

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.

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