Definitive Guide to Horizontal IntegrationFebruary 4, 2020
Horizontal integration occurs when separate companies within the same or similar industry combine to create a single company. When done correctly, horizontal integration can provide a company with several competitive advantages to help them increase their market power and be more successful within their industry. However, you also need to be aware of the challenges associated with horizontal integration to properly prepare for the process and to ensure the process is successful. In this article, we discuss everything you need to know about horizontal integration including what horizontal integration is, how it works and provide an example.
What is horizontal integration?
Horizontal integration is the process in which one company merges, acquires or takes over another company within the same value chain. Horizontal integration is a competitive business strategy that can be used to increase a company's overall market power, expand the company's product or service offerings, expand its current market or enter a new market, create economies of scale, minimize competition and increase revenue.
Why is horizontal integration important?
Businesses need to understand horizontal integration because it is a business strategy that can help a company strengthen its position in its industry. It is also important for individual consumers to understand horizontal integration because of the impact that a merger or acquisition of two companies can have on an industry and the overall market.
How does horizontal integration work?
The process of horizontal integration works through a company merging, acquiring or taking over another company that is in the same production stage within the same or a similar industry. A merger is the process of two independent companies of a similar size joining to create a new single joint entity. An acquisition is the process of one company purchasing another company. A takeover is the process of one company acquiring another company that does not want to be purchased.
Advantages of horizontal integration
There are several different advantages horizontal integrations can have on a business. Advantages of horizontal integration include:
- Economies of scale
- Increased differentiation
- Increased market power
- Access to new markets
- Reduced competition
Economies of scale
One major advantage of horizontal integration is the potential it gives a company to create greater economies of scale. An economy of scale exists when a company is successfully able to increase their level of production and proportionately increase revenue or decrease output costs. Because horizontal integration combines two companies into a single larger company, the new company should be able to produce more products and services more efficiently, which creates a greater economy of scale.
Another advantage of horizontal integration is the potential it provides a company to offer a wider variety of products and services to its customers. Although the two companies combining are within the same industry and production stage, each individual company usually has different products or service features they offer to customers. The combination of the two companies into one larger company allows the new resulting company to increase their product differentiation by combining the product and service offerings of each individual company.
Increased market power
Another major advantage of horizontal integration is that it helps a company increase its market power. By two companies combining to become one larger company, the resulting larger company receives greater power of its suppliers and distributors within the market.
Access to new markets
In addition to increasing market power, horizontal integration also gives a company the advantage of being able to expand their existing customer base and to access new markets the company was not capturing prior to the merger or acquisition. This occurs when a company merges or acquires another company that produces the same goods or services but operated in a different region or served a different market segment. The combination of the two companies gives the new company access to the markets that each individual company had already captured.
One of the most obvious advantages horizontal integration has for a business is the reduction of competition within the company's market and industry. By combining with another company that was previously a competitor, a merger or acquisition allows the company to reduce its competition within its industry. While reduced competition is a major benefit for companies, the company needs to be careful during the process of a merger or acquisition to ensure it is compliant with the Federal Trade Commission's (FTC) regulations restricting monopolies.
Disadvantages of horizontal integration
While there are several advantages of horizontal integration, there are also some disadvantages. Disadvantages of horizontal integration include:
- Regulatory scrutiny
- Firms becoming too large to manage
- Decreased value
One of the largest disadvantages of horizontal integration is the strict regulatory scrutiny of the FTC. The FTC closely monitors horizontal integrations because of the potential they have to enable a company to increase its market share and gain monopoly power. A monopoly exists when one company dominates the market. The FTC has created strict regulations to prevent a company from gaining monopoly power of an industry because it causes a lack of competition.
Firms becoming too large to manage
Another disadvantage that can occur with horizontal integration is that the resulting firm becomes too large and more challenging to manage. Differences in the managerial opinions that can occur when combining two companies can create unexpected inefficiencies and may limit the company's ability to innovate and offer new products to the market.
Finally, sometimes companies are not able to achieve the results they anticipated from a horizontal integration. If a company is unable to achieve the expected synergies of a merger or acquisition, it will also have difficulty yielding the value they expected to gain from the horizontal integration. Sometimes, a company even loses overall value because of the inability to realize the anticipated synergies.
Horizontal integration vs vertical integration
Horizontal integration and vertical integration are similar because they both involve one company acquiring or taking over another company. However, there is a difference between horizontal integration and vertical integration. While horizontal integration occurs when a company acquires or takes over another company that operates at the same level within the value chain of an industry, vertical integration occurs when a company acquires or takes over another company that is in the same industry but operates either before or after the acquiring company within the supply chain process.
Horizontal integration example
Here are two real-world examples of horizontal integration:
1. Disney and Pixar
Walt Disney Company acquired Pixar Animation Studios for $7.4 billion in 2006. While the Walt Disney Company originally began as an animation studio, the company was challenged with market saturation and creative stagnation when it acquired Pixar Animation Studios. Pixar had a unique vision and the most up-to-date technology available at the time. Disney's acquisition of Pixar helped the company expand its market share and increase profits. Because both companies were animation studios whose target audience was families and children, this is an example of horizontal integration.
2. Facebook and Instagram
One of the larger, more recent real-world examples of horizontal integration is Facebook's acquisition of Instagram for $1 billion in 2012. Facebook and Instagram both operated within the same industry of social media and had similar target audiences for their photo-sharing services. Facebook recognized Instagram as a competitor and viewed the acquisition as an opportunity to reduce competition, increase its market share and gain access to a wider audience base. While Instagram is now owned by Facebook, the two platforms continue to operate as separate social media platforms.