What Are Horizontal and Vertical Mergers?

Horizontal and vertical mergers are two ways that one business firm can buy or otherwise acquire another. Horizontal mergers concern two businesses that compete with each other. Vertical mergers concern two businesses that operate within the same supply chain.

Here's what you need to know about these two types of mergers and how they affect markets.

What Are Horizontal and Vertical Mergers?

A merger takes place anytime one business is acquired by another. After the merger, the two businesses become one legal entity. The acquired business typically adopts the branding and business practices of the business that acquired it.

There are many different types of mergers, but two common types are known as horizontal and vertical mergers. A horizontal merger is defined as one business acquiring another that is in direct competition with it. A vertical merger is defined as one business acquiring another that belongs to the same supply chain.

How Do Horizontal and Vertical Mergers Work?

Mergers commonly involve one company buying another company, but there are a lot of variants as to how the transaction can play out. The purchase can be a cash deal, or it can be an all-stock deal, or it can be a mix of the two. A deal can be struck between upper management at the two companies, or one company can try to perform a hostile takeover of another company.

Since horizontal and vertical mergers are different types of mergers, it may help to break them both down separately.

Horizontal Mergers

Horizontal mergers are a type of non-financial merger. In other words, a horizontal merger is undertaken for reasons that have little to do with money, at least not directly. Instead, a business would conduct a horizontal merger to reduce its competition in the marketplace.

Examples of horizontal mergers are abundant in the banking industry. Deregulation during the '80s and '90s expanded what a single bank could do (for example, investment banks were granted the ability to offer commercial banking services) and allowed bank holding companies to conduct interstate bank mergers (as opposed to restricting the number of states in which a bank could operate).

As a result, many banks consolidated into single companies. For example, in 2000, J.P. Morgan and Chase Manhattan Bank merged into a single company—instantly creating the sixth-largest banking institution (as measured by assets).

Vertical Mergers

A vertical merger or vertical integration is a merger between two companies that produce different products or services along the supply chain toward the production of some final product. Vertical mergers are usually conducted to increase efficiency along the supply chain which, in turn, increases profits for the acquiring company.

Unlike horizontal mergers, vertical mergers never involve one business directly acquiring its competition. However, just like horizontal mergers, vertical mergers can result in anti-trust problems in the marketplace. Even though the acquisition in and of itself doesn't reduce competition, the impact of one company acquiring a greater share of the supply chain could effectively reduce competition.

For example, consider the automobile industry. If a car manufacturer were to buy up other businesses that exist along its supply chain, they might not directly reduce the ability of other car manufacturers to compete, but they would gain some control over those manufacturers. If the car manufacturer bought up seat belt manufacturers, it could effectively control the price that all car manufacturers pay for seat belts. It would profit off every car made with the seat belts, whether or not the car was manufactured by that company or not. The more aspects of the supply chain a single company owns, the more it reduces competition in that industry.