Horizontal vs Vertical Integration

Horizontal integration refers to the expansion strategy adopted by the corporations, which involves acquiring one company from another company where both the companies are in the same business line and at the same value chain supply level. Conversely, vertical integration refers to the expansion strategy adopted by the corporations. One company acquires another company at different levels, usually at the lower level of its value chain supply process.

When a business kicks off into the market, it aims to grow its customer base and its capacity to deliver the best of its products and services to the customers. But easier said than done, this has never been a sprint but a marathon.

Such expansions in the business world require a lot of resources in terms of finances, human capital, and, most importantly, a business expansion strategy. As a result, companies employ many strategies to establish their place amongst their peers in the market. Still, one can group them into two at a high level, namely horizontal and vertical integration.

Horizontal integration is a business expansion strategy that involves a company acquiring other companies from the same business line or at the same value chain level to subside competition.

• Due to lesser competition, there operates an environment of consolidation and monopoly. However, it can also create an oligopoly if there are still some independent players in the market.
• The company can also diversify its products and services. A company's horizontal integration expansion grows its operational size and economies of scale due to increased production levels.
• It helps the company to reach a larger customer base and market. However, horizontal integration often raises antitrust concerns, as the combined firm will have a larger market share than either firm did before merging.
• Some recent examples of such a strategy would be Walt Disney Company's $7.4 billion acquisition of Pixar Animation Studios in 2006.

Vertical integration is a business expansion strategy comprising a company acquiring various entities engaged in different value chain stages.

• In vertical integration, two firms doing business for the same product but are currently at different levels of the supply chain process merge into a single entity, opting to continue the company on the same product line as before integration.
• Vertical integration is an expansion strategy used to gain control over the entire industry. There are mainly two forms of vertical integration: forward integration and backward integration.
• In a merger situation where the company acquires control over its distributors, it refers to downstream or forward integration. In contrast, it is upstream or backward integration when the company receives control over its supplier.

• Horizontal integration occurs between firms that are similar in product and production level. In vertical integration, the two firms to be merged operate at different supply chain stages.
• Horizontal integration brings synergy but not self-sufficiency to work independently in the value chain, while vertical integration helps the company gain independence.
• Horizontal integration helps acquire control over the market, but vertical integration helps gain control over the whole industry.
• Example:
  • The Heinz and Kraft Foods merger is an example of horizontal integration in producing processed food for the consumer market.
  • Target, which has its store brands, is an example of vertical integration. It owns the manufacturing, controls the distribution, and is the retailer, offering products at a much lower price by cutting out the middleman.

The firms mainly use integration strategy to:

• Minimize competition by taking over competitors
• Increase their market shares
• Become more diversified in operational presence
• Eliminate the cost of developing and making a new product available.

Horizontal integration can prove to be a successful strategy when: -

• Competitors are not in the capacity to go for head-on competition for long due to the limitation of resources at their disposal.
• A company is competing in a growing industry.
• Economies of scale or monopoly are beneficial for all the business stakeholders.

Though horizontal integration, as explained above, may appear to be a promising strategy, it may not work in all situations. It depends on the company’s value proposition and its resources and capabilities. The model provides a great recipe for success and leverage but is limited to factors such as the synergy created through horizontal integration to promote the products and services at the new scaled-up production levels and depends on the company's place in the entire value chain.

Vertical integration helps a company in: -

• Increasing entry barriers for new entrants.
• Absorbing both upstream and downstream profits
• Smoothening the supply chain.

But vertical integrations may also cause: -

• Fall in the quality of goods due to lack of competition
• Companies focus less on their core competencies and more on newly acquired businesses
• Reduction in flexibility to increase or decrease production levels.

Choosing between these inorganic strategies must involve considering short-term and long-term growth objectives. While horizontal and vertical integration mergers represent significant benefits, a company must remember that such a transaction is only successful if the new company integrates strategically and seamlessly. So, the merger should create some value in terms of synergy, market leadership, or cost leadership, which could then be translated into profits, promising a long-term customer base and a sustainable business environment.

Whether to employ horizontal or vertical integration has a long-term influence on a company's business strategy.

This article is a guide to Horizontal vs Vertical Integration. Here, we discuss the top differences between horizontal and vertical integration with infographics and a comparison table. You may also have a look at the following articles: -

• Mergers vs. Acquisitions
• Deal Origination
• Bootstrap Effect