Horizontal and vertical integration are two major corporate strategies. Both strategies offer different types of business growth and expansion opportunities to the parties involved.
Let us discuss what are horizontal and vertical integration strategies and their key differences.
What is Horizontal Integration?
Horizontal integration refers to a scenario when two or more entities in the same value chain merge. The merger can be in the form of a joint venture, acquisition, or partnership.
Horizontal integration is a market competitive strategy. It is used by companies to gain a competitive edge over rivals in the market.
It happens when a company merges or acquires another company in the same line or industry. It means both companies would be selling similar (or same) products and their base customer market will be the same.
How Does Horizontal Integration Work?
Horizontal integration is a growth strategy. It is considered by companies aiming to grow quickly through non-organic growth.
Horizontal integration would only succeed when two companies enjoy synergetic cultural values. It means they can harness more profits through integration than being working separately.
An acquirer company considers a suitable business in its value chain. It acquires the business or proposes a joint venture through a merger.
Horizontal integration happens when both companies are in the same industry. Their selling products and technology should also be similar. Moreover, their customer base should be the same.
This type of integration would also include the internal integration of activities and processes. The aim is to streamline the activities of the newly found company to harness the benefits of horizontal integration.
Objectives of Horizontal Integration
The main objective of horizontal integration is to achieve quick growth. It is a growth strategy that seeks non-organic business growth.
An entity seeks an increase in size through horizontal integration. It is a strategy to increase the worth of a business by acquiring another business in the same industry line.
Horizontal integration also results in the increased market power of the acquirer. The acquirer would acquire another entity in the same value chain, thus increasing control over suppliers and distributors.
It also aims to achieve economies of scale. The acquirer with more market power, control over supplies, and increased size would be able to generate more sales and profits.
Other key objectives of horizontal integration include capturing new market share or reducing market competition in the existing market.
Examples of Horizontal Integration
A real-world example of horizontal integration is the acquisition of 21st Century Fox by Walt Disney in 2019.
Walt Disney company used a horizontal integration strategy to increase its market power in the entertainment and content industry.
It aimed to increase the market share through global expansion. The acquisition included stakes and control over other subsidiary companies held by the 21st Century group.
Another real-world example of horizontal integration is the merger of Marriott hotels and Starwood hotels.
Although both chains had an international presence, it created a diversified portfolio for both companies. After the merger, both chains now own the largest hotel chain in the world.
Pros and Cons of Horizontal Integration
Horizontal integration comes with discrete pros and cons for all parties involved.
Pros of horizontal integration include:
- Combined entities enjoy greater market share after a successful merger.
- It helps new entities grab a larger customer share in the existing market.
- It creates synergetic benefits like shared cultural values, shared technology, and access to unique products/services.
- It is a quick method of non-organic growth for many businesses.
- It generates higher profits for merged entities when the merger is successful.
Cons of horizontal integration include:
- It may not be allowed by regulators if it creates a market monopoly.
- Achieving success through horizontal integration is difficult as synergetic gains are hard to realize in practice.
- The acquired entity may lose flexibility over its operations and strategic management.
What is Vertical Integration?
Vertical integration is a strategy where an entity acquires another within its supply chain. In other words, it acquires a company where its operations had been outsourced previously.
Vertical integration can be through internal development or by an external acquisition. It can be forward or backward integration depending on whether the acquired entity is a supplier or distributor.
In vertical integration, two or more entities merge where they produce similar products within the same supply chain. It means their target customer is the same.
How Does Vertical Integration Work?
Vertical integration can happen through internal expansion as well. An entity may decide to take control of its input (inventory supplies) or post-production process internally.
Internal vertical integration is often referred to as expansion or growth.
Externally, vertical integration can be of two types.
Backward integration happens when an entity acquires or merges with a supplier. It means the company takes control of its input and inventory supplies.
Forward integration is when an entity takes control of its post-production operations. These operations may include logistics and retail selling points.
In all types of vertical integrations, an entity tries to reduce its costs of operations and generate more profits through efficiencies in operations.
Either way, an entity would look to capture upstream or downstream profits that it would otherwise share with its trading partners.
Objectives of Vertical Integration
Objectives of vertical integration would lead to the type of integration. Therefore, it’s important to set clear goals with a vertical integration before execution.
The first objective of vertical integration is to create operational efficiencies. It can be achieved through internal expansion or external integration.
Control over input supplies is another main objective of backward integration. It also helps reduce costs of production and generate higher profits in turn.
Many companies set business expansion as an objective through access to retail outlets and distribution channels. It can be in the domestic or foreign market with the help of another entity through a merger or acquisition.
Control over supplies and improved quality are other important goals with vertical integration.
Examples of Vertical Integration
One of the famous backward integration examples is the purchase of forest lands in Romania by the world’s leading furniture manufacturer IKEA.
IKEA wanted to secure the inventory supply for the long term. It also aimed to produce furniture wood at reasonable prices and become more sustainable.
A good example of internal vertical integration is Netflix’s content production internally. Netflix is a media streaming platform that started producing its own content to generate more profits.
Pros and Cons of Vertical Integration
Some key advantages of vertical integration include:
- Reduced input costs result in reduced costs of production overall.
- It helps an entity improve operational efficiencies.
- It improves sales and helps in creating a bigger market share.
- It provides better quality control over the production process.
- It helps in keeping control over the supply chain.
Some disadvantages of vertical integration include:
- It is a costly strategy that requires immense financial and operational resources.
- It can be difficult to harness synergetic benefits.
- It increases risks for the acquirer.
- It concentrates resources and reliance on the acquirer.
Horizontal Integration Vs Vertical Integration – Key Differences
Horizontal and vertical integration are two important competitive strategies. Both strategies offer different types of advantages and some limitations.
Let us summarize the key differences between horizontal and vertical integration strategies.
Horizontal integration refers to a merger or acquisition of two entities in the same industry selling similar products.
Vertical integration is when one entity gains control over another entity in its value chain. It can be anywhere in the value chain from supplies to distributions channels.
The objectives of horizontal integration are:
- Capturing a larger market share
- Increasing the customer base
- Reducing competition in the market
- Creating entry barriers to new entrants
- Generating synergy benefits through mergers
The objectives of horizontal integration are:
- Increasing profit margins through control over value chain processes.
- Increased sales and profits.
- Improved product quality through control over the supply chain.
- Control over the production process.
- Increased operational efficiency overall.
Horizontal integration is the process of combining two entities in the same value chain. It means two companies appealing to the same customer base join hands.
Vertical integration can be achieved through internal expansion or external processes. It can be achieved through backward integration (merging suppliers) or forward integration (merging distributors).
Horizontal integration results in a larger market share for the combined new entity. It creates entry barriers to new entrants as well.
Horizontal integration also provides control over market competition.
Vertical integration results in control over the supply chain process. It results in improved upstream or downstream profits.
Horizontal integration is suitable for entities looking for non-organic and quick growth. It is used by companies looking to achieve a larger market share and increase the customer base quickly.
Vertical integration is suitable for entities looking to improve control over the supply chain process. It is used by companies to improve profits through reduced input costs and improved operational efficiencies.