Horizontal Merger
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Table Of Contents
What Is A Horizontal Merger?
A horizontal merger refers to the union between organizations that operate in the same or similar industries. Generally, the competitors in the industry opt for such types of mergers for reasons like increasing the share in the market, bringing economies of scale, reducing competition, etc. Moreover, other smaller players in the market have a more difficult time gaining a share in the market.
Horizontal merger companies aim to create an oligopoly, where they have very little competition and significant freedom to operate and market their products the way they can collectively experience benefits. These mergers are popular in the type of markets that are saturated. Therefore, these unions of companies consolidate both their customer bases and increase revenue.
Table of contents
- A horizontal merger is an amalgamation of organizations working in similar industries.
- Usually, the competitors in the industry adopt these types of mergers for reasons such as increasing the share in the market, bringing economies of scale, diminishing competition, etc.
- Cultural integration difficulties, different management styles, monopolistic markets, and product cannibalization are the problems faced in a horizontal merger.
- Horizontal mergers help the merged entity regulate its expense ratio. Therefore, the companies’ blend of expenses and revenues reduces the expense ratio and enhances financial performance.
Horizontal Merger Explained
A horizontal merger is a merger between companies operating in a similar line of business or the same industry. In other words, it happens when companies that offer the same or similar products or services come together under single ownership. Most companies going for such a merger are competitors operating in the same industry.
Companies go for a merger for many reasons, both financial and non-financial. These mergers are usually considered for non-financial reasons. However, these types of mergers are more closely monitored by the government since they may decrease competition in the industry, and oligopoly.
A hypothetical example of a horizontal merger may be Hindustan Unilever Ltd. (HUL) and Patanjali. Though both operate in the FMCG market, they have different product ranges for different demographics. Thus, the merger may help them offer a wider range of products and substantially increase their revenue and market share.
Examples
Horizontal merger benefits include a bigger market share, better revenue, and little to no competition. Let us understand the concept better with the help of a few examples.
Example #1
Suppose ABC Ltd. sells steel products, and PQR Ltd. sells steel at the retail level to individuals.
In this example, there can be a horizontal merger between these two companies to create synergy and increase the revenues and market shares of the group.
ABC Ltd.
| Liabilities | Amount | Assets | Amount |
|---|---|---|---|
| Capital | $100,000 | Fixed Assets | $50,000 |
| Current Assets | $50,000 | ||
| $100,000 | $100,000 |
PQR Ltd.
| Liabilities | Amount | Assets | Amount |
|---|---|---|---|
| Capital | $50,000 | Fixed Assets | $20,000 |
| Current Assets | $30,000 | ||
| $50,000 | $50,000 |
ABC PQR Ltd (Combined Entity)
| Liabilities | Amount | Assets | Amount |
|---|---|---|---|
| Capital | $200,000 | Fixed Assets | $70,000 |
| Current Assets | $80,000 | ||
| Goodwill | $50,000 | ||
| $200,000 | $200,000 |
In the above example, by combining the two companies, the asset base of the combined entity has increased from $1,00,000 to $2,00,000.
Further, there is goodwill in the horizontal merger process, which has been recognized in the balance sheet as per the accounting norms.
Example #2
Suppose ABC Ltd. is into the manufacturing of plastic bags, and PQR Ltd. is into the business of manufacturing plastic packets. Then, there can be a horizontal merger between these two companies that can gain synergy in the following way: -
ABC Ltd. Profit & Loss Account
| Liabilities | Amount | Assets | Amount |
|---|---|---|---|
| Expenses | $100,000 | Fixed Assets | $150,000 |
| Net Profit | $50,000 | ||
| $150,000 | $150,000 |
PQR Ltd. Profit & Loss Account
| Liabilities | Amount | Assets | Amount |
|---|---|---|---|
| Expenses | $100,000 | Sales | $200,000 |
| Net Profit | $100,000 | ||
| $200,000 | $200,000 |
ABC PQR Ltd. Profit & Loss Account
| Liabilities | Amount | Assets | Amount |
|---|---|---|---|
| Expenses | $200,000 | Income | $350,000 |
| Net Profit | $150,000 | ||
| $350,000 | $350,000 |
ABC Ltd. and PQR Ltd. are in the same business, manufacturing plastic products.
- By combining the two companies, the merged company will have a diversified steel product base to sell to consumers.
- You will see that the combined entity turnover has increased from $1,50,000 to $3,50,000 ~ a 130% jump.
- By executing this merger, the company's net profit has risen from $50,000 to $1,50,000, a three-times growth in the net profit, increasing the per-share valuation.
Horizontal mergers will also help the merged entity control its expense ratio. As a result, the companies’ combined expenses and revenues will lower the expense ratio and improve their financial performance.
Example #3
Suppose ABC Ltd. manufactures helmets but has no infrastructure and heavily makes losses but has a very high distribution network. On the other hand, PQR Ltd. has an established infra set-up and is heavily making profits.
ABC Ltd. Profit & Loss Account
| Liabilities | Amount | Assets | Amount |
|---|---|---|---|
| Expenses | $100,000 | Sale | $50,000 |
| Net Profit | ($50,000) | ||
| $50,000 | $50,000 |
PQR Ltd. Profit & Loss Account
| Liabilities | Amount | Assets | Amount |
|---|---|---|---|
| Expenses | $100,000 | Sale | $200,000 |
| Net Profit | $100,000 | ||
| $200,000 | $200,000 |
ABC PQR Ltd. Profit & Loss Account
| Liabilities | Amount | Assets | Amount |
|---|---|---|---|
| Expenses | $200,000 | Income | $250,000 |
| Net Profit | $50,000 | ||
| $250,000 | $250,000 |
In this case, although ABC Ltd. is making losses at an individual level, by merging the company with PQR Ltd., they can absorb their losses and can even report positive profits in the long term.
- We can see that the net profit of the combined entity has absorbed the losses of ABC Ltd. and strengthened the group's financial positioning since it now has a full infra setup along with a wide distribution network.
- Thus, companies in the same business line have achieved synergy in the amalgamation process by using USPs and strong points to make a strong merged entity.
- This one company’s weakness can be another company's strength. It gives the merged entity the fuel to scale up the operations and build a strong base in the market by capturing the market share.
Advantages & Disadvantages
A process with intricate details such as a merger is bound to have perspectives and opinions of extreme nature. Let us understand the advantages and disadvantages of horizontal merger companies through the discussion below.
Advantages
#1 - Economies of Scale
A merger usually occurs when it is expected that the combined entity will have more valuation than the combined valuation of individual entities. The same is on account of synergies in M&A achieved between the two companies on the merger. Companies go for horizontal mergers to increase economies of scale by cost reduction. The cost reduction may occur by eliminating redundant processes, operations, or human resources costs. Thus, the company can offer a wider range of products or services more efficiently and cost-effectively.
#2 - Reduction in Competition
Companies may also go for this type of merger to reduce competition. Thus, it may also lead to the consolidation of a fragmented industry.
#3 - Increase in Market Share and Operating Revenue
A merger is an inorganic growth method for a company. When two companies providing the same or similar products or services have their market share and audience in the market combined to become a single entity, it increases market share and thus increases revenue.
#4 - Faster Growth
Inorganic growth is a faster growth method than organic growth. Therefore, companies looking for more rapid growth methods usually go for a Horizontal merger. On the other hand, if a company is looking to increase its product range, market share, or geographical reach without investing time and resources to develop it from scratch, it may go for such a merger.
#5 - Business Diversification
Companies may go for this merger to seek business diversification regarding product/service range and geographical presence. It may also help a company enter a new market and increase its reach demographically.
Disadvantages
#1. Cultural Integration Difficulties
Cultural issues are usually faced in all mergers but are especially evident in horizontal mergers. Since the two companies operate in a similar industry, they have similar processes and functions, but they might handle things differently. Thus, the diverse cultures of the two companies further make it difficult for them to co-exist.
#2. Different Management Styles
Both companies' management styles must be different. A merger may lead to clashes in both the management and an unsuccessful union.
#3. Might Create a Monopolistic Market
#4. Product Cannibalization
The merger of two companies operating in a similar industry also may lead to product cannibalization of either company. Let's consider the earlier example of the merger of Patanjali and Hindustan Unilever Ltd. People are becoming increasingly concerned about organic and natural products. Patanjali products like shampoo; may be eaten in the shampoos of Hindustan Unilever Ltd.
Frequently Asked Questions (FAQs)
The US government carefully monitors horizontal mergers to safeguard monopolies from formation. However, a monopoly may occur if one company or a few companies regulates a specific industry.
A horizontal merger happens a company acquires another company that is a direct competitor. A vertical merger occurs when a company acquires another company that is not a direct competitor but works in a similar supply chain.
Horizontal mergers are illegal because Article 7 of Law No. 4054 on the Protection of Competition (the “Competition Law”) prohibits mergers and acquisitions that (i) make or strengthen a dominant position and (ii) result in a compelling reduction of competition in a market for goods or services. Therefore, a horizontal merger that immensely increases the concentration of firms in a specific market is always against the law.
The companies that are horizontal mergers are Disney+ and Hotstar, unification of WhatsApp, Facebook, Instagram & Messenger, Frito Lay & Uncle Chips, and Pepsi Co and Rockstar.
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