Understanding Horizontal and Vertical Mergers | Hilton Smythe

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Understanding Horizontal and Vertical Mergers

In the UK, M&A deals are chugging along at a reasonable pace, and horizontal and vertical mergers are the most common. Here is a complete explanation of both merger types.

Mergers and acquisitions are often mentioned in the same breath, but are not the same. Typically, mergers involve a merger of equals. In other words, both parties are of a similar size and stature.

In the UK, M&A deals are chugging along at a reasonable pace, with 450 transactions in Q2 2023. Regarding mergers, horizontal and vertical mergers are the most common. If the terms mystify you as you plan your long-term business strategy, here is a complete explanation of both merger types.

What is a horizontal merger?

Horizontal mergers occur when two companies in the same or a similar merger decide to combine and create a new entity. Larger horizontal mergers can reduce market competition by pooling resources.

Often, smaller companies may combine to take on a market giant eventually. Due to the impact on competition, these types of mergers are commonly reviewed by the UK Competition and Markets Authority (CMA).

For example, Glaxo Wellcome and SmithKline Beecham conducted a successful horizontal merger in 2000 to create the pharmaceutical giant GlaxoSmithKline. It made sense for these companies because they operated in the same markets.

The effect put the new company in a powerful position to expand its operations. For example, the European Commission approved the acquisition of Pfizer’s Consumer Health Business by GlaxoSmithKline in 2023, providing it a further competitive edge.

In recent years, horizontal mergers have grown in popularity due to the benefits for all involved parties.

Why would you choose a horizontal merger?

Opting for a horizontal merger makes sense when you are on friendly terms with a competitor or complementary business of a similar size. Otherwise known as a merger of equals, they enable you to pool your collective power to grow.

Some of the reasons managing directors might opt for this merger type include:

Increase Market Share – Combining product sales when both companies sell similar products reduces competition and instantly increases market share.

Wider Product Range – Coordinated mergers can allow companies selling different products to produce a more comprehensive product range and target a broader customer demographic.

Eliminate Competition – If two companies compete with each other, horizontal mergers can break the deadlock. Both companies can bring different skills and resources to the table, thus boosting innovation.

However, there are obstacles to horizontal mergers. Bringing together different cultures, management styles and work processes can complicate establishing a successful partnership.

These mergers work best when you are working with a company that you can cooperate with; otherwise, you risk damaging the value of both companies. Remember, no merger is a guaranteed recipe for success.

Example of a horizontal merger

The Exxon-Mobil merger in 1999 to create ExxonMobil is one of the most well-studied cases of a horizontal merger worldwide.

Unlike most horizontal mergers, this was a rare case of both companies possessing the exact same output. It made sense for these organisations to combine for this reason.

The merger was the largest-ever merger on the planet at that time. Today, ExxonMobile is one of the foremost global oil and gas industry leaders. The combined entity now generates hundreds of millions of dollars in cost synergies that would have never been possible without the merger.

What is a vertical merger?

Vertical mergers are the opposite of horizontal acquisitions – in these cases, a company will merge with a company at a different production or supply chain level.

For example, a company may decide to merge with its primary supplier. It can also work in the opposite direction. The key characteristic of a vertical merger is that it involves companies that already do business with each other.

In reality, vertical mergers are extremely rare these days. Instead, they usually take the form of an acquisition, whereby the buyer absorbs the seller into their existing operations, and no new entity comes to fruition.

For example, IKEA purchased 83,000 acres of forestland in Romania to gain more control over its forestry operations and guarantee long-term sustainable access to managed wood for its furniture production operations.

They would repeat this in 2021 when they purchased over 10,000 acres of property in Georgia from The Conservation Fund. In this case, it also helped them to support their goal of becoming carbon neutral.

As you can see, it’s typical for vertical mergers to take the form of acquisitions instead.

Why would you choose a vertical merger?

Vertical mergers have similar benefits to horizontal mergers in that they pool skills and resources to achieve greater goals. The difference here is the motivation behind these mergers usually revolves around cost reductions and improved efficiencies.

For example, an automaker may purchase a steelmaker because they can pay less for their steel supply and guarantee uninterrupted supply. It also often means that the steelmaker becomes tied to a single supplier, thus forcing their competitors to go elsewhere.

Like horizontal mergers, you can also enjoy an increased market share, reduced competition and further synergies.

However, it’s wise to consider that making a success from a vertical merger tends to be more complicated. Horizontal mergers are relatively easy to combine because both parties already share many of the same functions.

On the other hand, vertical mergers are more challenging to make a success out of because the businesses are usually so different. It can quickly create headaches because management may struggle to collaborate due to their lack of experience in other parts of the supply or production chain.

Example of a vertical merger

UK supermarket Iceland is well-known for specialising in frozen foods at relatively low prices. In 2012, the supermarket announced the vertical acquisition of Loxton Foods, one of its largest suppliers.

In the Iceland-Loxton acquisition, this was essential because, as their largest supplier, Loxton was facing bankruptcy at the time. Through this move, Iceland could secure the future of its most prominent supplier and prevent disruptions to its business.

Iceland benefited because it could acquire the raw materials to make its products at a much lower cost. Interestingly, Iceland also mentioned that it saw product innovation as the deal’s largest benefit.

With Loxton integrated into their business, Iceland could change its products more efficiently since it now had access to data elsewhere in the supply chain.

How do I know which merger is right for my business?

Knowing which merger is right for your business can enable you to avoid costly mistakes further down the line. No type of merger is better than another. It’s all about planning, deployment and execution.

Whether horizontal or vertical, UK business history is littered with failed mergers in every category.

Here are some aspects to consider when deciding whether a merger is right for your business:

Purpose – Why do you want to conduct a merger in the first place? A horizontal merger makes more sense if you aim to eliminate a competitor or grow your market share. If you are worried about cost increases of raw materials or the stability of your supply chain, a vertical merger could be the better option.

Budget All mergers come with costs, including integration. Vertical mergers require much larger cash reserves to execute than horizontal ones because the former may involve little cross-over, making their integration more complex.

Competition – It’s vital to consider the impact of any merger on the overall market. If a prospective merger may threaten a monopoly, it makes little sense to proceed because the UK CMA will likely shoot it down instantly.

Timing – Sometimes, lousy timing can derail an otherwise smart move. If you or the other party is experiencing times of turbulence, you may not have the resources to complete the move or subsequent integration.

Whatever your reasons, all mergers require effective research and due diligence. Any experienced managing director will tell you that professional support is essential to overcome various obstacles.If you need merger support, Hilton Smythe is there for you. To learn more about making your merger a success, speak to the team and find out what we can do.

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