Businesses seeking growth and cost reductions acquire other companies or product lines through horizontal and vertical mergers & acquisitions, resulting in the integration of two or more companies. An M&A process is known as horizontal or vertical integration, depending on the acquisition type and business strategy.
Horizontal vs Vertical Integration
Horizontal integration means you are moving “horizontally” in your industry of merging with competitors with similar customer levels, whereas vertical integration is when you move “vertically” up or down the production process of acquiring suppliers or distributors within your same vertical, so you can own more of the production process internally.
Horizontal integration is designed to help your company achieve new levels of growth, technology, geographic business expansion, and cost synergies. Vertical integration is designed to help bring production processes in-house to add internal capabilities and reduce costs in production, supply chain, or distribution channels.
What is Horizontal Integration?
Horizontal integration is an M&A strategy of merging with or acquiring companies in the same industry and sector of the supply chain to gain market share through product and geographic expansion and access to new technologies and to reduce costs through synergies from reducing duplicate operating costs and other strategies.
Companies with horizontal integration conduct similar business activities.
Examples of Horizontal Integration
Examples of horizontal integration as an expansion strategy include Microsoft – Activision Blizzard, a terminated JetBlue Airways – Spirit Airlines (proposed merger), and Baxter – HillRom M&A deals. Two of these M&A deals, excluding JetBlue Airways–Spirit Airlines, closed in 2022 and 2021. The acquiring company is named first in the pair of combining companies.
Microsoft – Activision Blizzard
Software company Microsoft acquired Activision Blizzard, an interactive gaming and entertainment experience company, in January 2022 through horizontal integration. The acquisition will expand Microsoft’s portfolio of product offerings and customer base and provide some “building blocks” for the Metaverse.
JetBlue Airways – Spirit Airlines
As a horizontal integration, in July 2022, JetBlue Airways Corporation submitted a winning bid to buy Spirit Airlines for $3.8 billion, subject to U.S. government antitrust regulatory approval. Both companies operate a fleet of passenger airlines and offer limited air freight service in the cargo hold of the planes.
On March 4, 2024, the proposed JetBlue-Spirit merger was abandoned by JetBlue and Spirit after a judge ruled against the Department of Justice lawsuit on January 16, 2024 that the deal was anti-competitive and unfavorable to consumers. Therefore, JetBlue Airways and Spirit Airlines will not merge. According to the proposed merger agreement deal terms, JetBlue will pay Spirit Airlines $69 million for deal termination.
Had the merger deal been completed between JetBlue and Spirit, their operations would have been combined to achieve expected synergies of between $600 million and $700 million. According to the original SEC Form 8-K company filing by JetBlue on July 28, 2002, if approved, the deal was expected to close in 2023 or 2024.
Baxter – HillRom
Baxter International Inc acquired HillRom in December 2021 with horizontal integration to provide customers with HillRom and Welch Allyn products and services in the medical industry. HillRom, a global company, is best known for its manufactured hospital beds. Baxter is also a global medical product and services company for hospitals, medical providers, and patients.
Besides expanding revenues with a larger product and services offering, entering new international markets, and achieving synergies, Baxter will gain connectivity technology expertise from HillRom.
Pros and Cons of Horizontal Integration
Horizontal integration has advantages and disadvantages (pros and cons).
Pros
The pros of horizontal integration include:
- Increasing revenues sooner than launching a new product in-house through organic growth
- Increasing sales force, geographic business expansion, and entering new markets
- Gaining technology and impressive talent for increasing competencies
- Achieving synergies and market power by combining companies
- Getting higher volume discounts in procurement
- M&A deal premium for stock of publicly-traded target companies acquired and the immediate vesting of stock options in the acquired company from change of control provisions.
Cons
The cons of horizontal integration include:
- Possibility of poor cultural fit of the companies in the M&A deal
- Uncertainty of pending layoffs and changes leading to poor employee morale in the acquired company
- M&A integration problems, including failed or delayed systems integration
- Potential lawsuits from disgruntled acquired company employees
- A downturn in the industry can result in higher losses
- Adding unprofitable business lines to the integrated company
- Anti-competitive DOJ rulings can terminate a proposed merger, with costs incurred by both companies and a possible termination payment by one of the parties of the merger agreement to the other party
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What is Vertical Integration?
Vertical integration is a merger and acquisition (M&A) strategy to purchase vendors (through backward integration) or distributors (through forward integration) in a company’s supply chain. Vertical integration can increase parts quality and timeliness, gain technology, reduce costs, and increase control over processes in manufacturing a product or providing a service to customers.
Vertical integration is achieved when companies are at different levels in the supply chain.
Vertical Integration Trend
In its analysis of Global M&A Industry Trends: 2022 Outlook, PwC Global believes vertical integration will increase to address supply chain issues and improve supply chain technology. Vertical integration benefits the value chain.
We expect 2022 will bring more vertical-integration deals, both upwards, to secure key raw materials or components, and downwards, to control how products are distributed. Many companies contending with raw material, input or labour shortages, port lockdowns, shortages of shipping containers—especially those in the manufacturing, pharmaceutical and medical devices sectors—are now focused on onshoring or nearshoring opportunities in order to reduce lead times and build greater resilience into their supply chains. We also expect strong investor interest in technology companies specialising in supply chain processes, particularly those able to capture and leverage data and analytics.
Examples of Vertical Integration
Vertical integration receives antitrust scrutiny from the Federal Trade Commission (FTC). The FTC’s goal is to ensure fair competition and avoid oligopoly dominance in an industry. U.S. Department of Justice & The Federal Trade Commission have jointly issued Vertical Merger Guidelines that provide information for corporations considering vertical acquisitions.
This FTC scrutiny may result in FTC rejecting corporate attempts to acquire a supplier or distributor to reduce production or supply chain costs. Such is the case with Lockheed Martin’s effort to acquire Aerojet Rocketdyne.
Other examples of vertical integration include the Walmart – JoyR
FTC – Blocked Proposed Lockheed Martin Acquisition of Aerojet Rocketdyne
Lockheed Martin Corporation terminated its attempted Aerojet Rocketdyne vertical acquisition of a supplier in February 2022 after the U.S. Federal Trade Commission challenged the merger. This is an example of a backward integration attempt to purchase a parts supplier.
FTC Bureau of Competition Director Holly Vedova issued this statement:
I am pleased that, for the second time in the span of a week, merging parties have abandoned an anticompetitive vertical transaction in the face of an FTC challenge. Lockheed Martin announced two days ago that it would terminate its attempt to acquire Aerojet Rocketdyne. The acquisition would have eliminated the country’s last independent supplier of key missile propulsion inputs and given Lockheed the ability to cut off its competitors’ access to these critical components. Simply put, the deal would have resulted in higher prices and diminished quality and innovation for programs that are critical to national security. The FTC’s enforcement action in this matter dovetails with the DoD report released this week recommending stronger merger oversight of the highly concentrated defense industrial base. I want to thank the FTC team for their fantastic work on this highly complex matter and their close collaboration with their counterparts at the U.S. Department of Defense during the investigation.
Walmart – JoyRun
To improve its last-mile delivery logistics, Walmart purchased select assets of JoyRun, a last-mile delivery platform, in November 2020 through vertical integration. This is an example of forward integration to buy a distributor.
According to TechCrunch :
Today, the Bay Area startup … becomes part of Walmart as Walmart has purchased select assets in a bid to enhance its supply chain. The mega-retailer announced today that it has acquired “select assets – including the talent, technology platform and IP” from the company, in a bid to incorporate its peer-to-peer food and drink delivery service into its own last-mile logistics.
NVIDIA – Bright Computing
NVIDIA acquired Bright Computing, a high-performance computing (HPC) software provider, through backward vertical integration in January 2022. According to Network World, NVIDIA’s M&A intent is in-house use of Bright Computing, although Bright Computing will continue to sell to other customers. Bright Computing had been a supplier to NVIDIA before the acquisition.
In its January 10, 2022 announcement of the Bright Computing acquisition, NVIDIA states:
Now we see an opportunity to combine our system software capabilities to make HPC data centers easier to buy, build and operate, creating a much larger future for HPC. NVIDIA’s partners will take Bright’s software to more markets. And Bright’s software and expertise will enhance our growing NVIDIA DGX and data center businesses.
Pros and Cons of Vertical Integration
Vertical integration has advantages and disadvantages (pros and cons).
Pros
The pros of vertical integration include:
- Increase control over the global supply chain, adding self-sufficiency
- Increase supplier stability to ensure parts availability when needed
- including procurement volume discounts and lower production costs from a higher level of production
- Gain access to technology
- Improve quality control
- Improve delivery of products to customers.
Cons
The cons of vertical integration include:
- Possibility of poor cultural fit
- Potential loss of key talent from the acquired company
- Potential underperformance by the acquired company
- Expected cost reductions may not be realized
- Tarnished reputation if poor customer performance by the acquired company.
Should You Use Horizontal or Vertical Integration?
Companies should consider using both horizontal and vertical integration. Horizontal integration expands market share by acquiring a similar company serving customers in the same industry. Vertical integration can improve supply chain control, cost, and quality, including acquiring parts vendors and distributors. Horizontal vs. vertical integration strategies aren’t an either-or decision.
How Horizontal and Vertical Integration Deals are Structured
Horizontal or vertical integration can be a stock, debt, or cash M&A deal for an entire company, subsidiary, division, or product line. The M&A transaction can be structured as an asset purchase for cash to avoid the assumption of that company’s debt and contingent liabilities.
Private equity firms provide debt financing for leveraged buyouts when companies are taken private or privately held at deal time. Management buyouts are one type of leveraged buyout deal.
When massive amounts of debt will be incurred in a leveraged M&A transaction, the cash flow and liquidity of the M&A candidate should be scrutinized in due diligence. Ensure working capital will provide adequate liquidity (measured by the acid-test ratio) and cash flow timing patterns are sufficient to service the debt financing.
Publicly traded companies can use their stock shares or cash proceeds from subsequent stock issuance to achieve significant growth through horizontal or vertical M&A. Going public, through an IPO or other methods, has advantages. One reason privately held companies consider going public is to participate in M&A deals to rapidly expand growth and market share.
When more than one company is combined in M&A, a business consolidation using a NewCo or successor company structure may be used to combine the companies.
Importance of Horizontal and Vertical Integration
Horizontal and vertical integration are important parts of a company’s M&A strategy to increase return on investment, attain rapid global growth, gain new technologies and talent, improve supply chain and product quality and timeliness, improve distribution, and find opportunities to reduce costs. With Tipalti AP automation software integrated with your multi-entity ERP, your business can reduce its invoice processing costs for these multiple entities, thereby increasing synergies with new systems. Learn more.
