Different companies all over the globe implement strategies of merger and acquisition at a certain time for growth expansion. In the process of merger or acquisition, companies undergo some type of change in their management or structure. Also, it consists of expansions, consolidations, restructuring, etc. So, we can say that every organization possesses a need for expansion and growth and that doesn’t depend upon the size or nature of the organization. The way through which companies do all such exercises to grow and expand is known as Integration.
Some sort of strategic integration is required for mergers or acquisitions. In simple terms, integration referred to a combination of activities or tasks related to an organization’s current activity. When a single business entity is formed after the merger of two separate businesses then there are chances of mismanagement. Integration is the right growth strategy in such cases. Integration strategy is beneficial for the companies in the following ways:
- Take over competitors to minimize competition
- Enhance market shares of companies
- Eliminate the cost of new product development and ensure its availability in the market
The two main types of integrations are there i.e. Horizontal integration and Vertical integration.
Before understanding the differences between these two integration strategies, let’s have a brief on what exactly these strategies are all about and their role in a business.
This is an expansion strategy in which a firm acquires another firm or business of the same line or at a similar level of the supply chain in order to remove the competition from the industry up to a larger extent. Few key aspects of horizontal integration are as under:
- Companies may adopt horizontal integration to enhance their size, reduce competition, gain economies of scale, or diversification of their products and services offerings. Also, this strategy is helpful to tab new markets or customers, including the global market. For example, a retail chain may merge with the same one in an international country to expand its operations.
- The successful horizontal integration may bring more profit together as compared to if the firms compete with each other independently. Also, the newly merged firm may experience cost-cutting by sharing core capabilities such as R&D, distribution, technology, marketing, and production.
Wherein, an integration strategy that is implemented by companies to cover all or most of the aspects of the supply chain is considered as vertical integration. Basically, in this expansion or integration strategy, a firm acquires another firm who is at the different supply chain level. In this integration, different entities are involved in different stages of the chain of distribution or value chain. Vertical integration is further categorized as Forward integration and Backward integration.
- Backward integration:
A company that has a great number of options may experience lower pressure but it is not always happening. Therefore, the companies that have very limited options of suppliers or looking to their supply chain control along with cost reduction in production would prefer to take the raw materials in a direct way rather than depending on suppliers.
For instance, a shoe retail company may acquire a supplier of raw material that is required to make shoes and starts its own manufacturing unit of making shoes along with selling. This type of upward movement in the supply chain process is termed as backward integration as it works by moving backward in the process of the supply chain. This can be helpful for companies as they need not depend on suppliers completely. Raw material can be obtained at reduced costs and the benefits can be given to customers by giving them products at fewer prices. This results in an increase in sales and a stable market position. Moreover, companies are able to ensure raw material availability on time with improved quality by reducing dependability on suppliers.
- Forward integration:
This type of integration includes the forward movement in the supply chain process in which companies get more involved with their customers by expanding operations into the downward areas of the supply chain i.e. retail and distribution. So, in this sense, forward integration can be viewed as an opposite integration strategy of backward integration. This integration provides much better control over the distribution channels of products. Direct customer selling may reduce distribution costs. Mediators can also be eliminated between the company and its customers and higher profit margins can be switched to them. There are various brands that have their own retail stores such as Apple, Dell, etc.
Below are some key aspects of vertical integration:
- In the case of vertical integration, two companies that are into the same product development business but operating at different stages of the supply chain, merge into one. This single company which is the result of the merger chooses to do the same business on a similar product line as it was operating before integration.
- This strategy is considered as an expansion strategy that is implemented by firms to gain control over the whole market or industry.
- Vertical integration is a competitive strategy by which a company takes complete control over one or more stages in the production or distribution of a product.
DIFFERENCE BETWEEN HORIZONTAL AND VERTICAL INTEGRATION (COMPARISON TABLE)
Key differences between horizontal integration and vertical integration as per the above comparison chart are explained below in detail:
When a firm acquires a similar type of product at a similar production level or marketing process then it is considered horizontal integration. This is basically an expansion strategy of businesses in which a firm merges with its competitor’s product line of the same level. This also refers to the combining of the business activities of two competitors.
Wherein, vertical integration is an ownership of a firm related to downward or upward activities in which the firm takeovers the full control of more than one area of the value or supply chain. In this integration, both companies participating in a merger operate at different levels of the value chain. This involves firms that carry the relationship of upward and downward or buy-sell.
2. Type of acquisition
As horizontal integration includes integration of similar types of products, so, most of the time both companies that participate in the merger process i.e. acquired and acquiring company are into the same businesses. In fact, even the products may also be the same.
On the other side, in vertical integration, a firm that takes over the business of another firm is not occupying a similar type of business of another one. In this, the acquired firm would come up as a helping hand for acquiring a firm for managing its business in a much better way.
Both business integration types are different from their purpose point of view too. The aim of horizontal integration is to merge two firms that provide similar products or services and have the same production level. In this, both acquired and acquiring firms are direct competitors to each other. So, the main aim of horizontal integration is to remove competition. Various benefits can be obtained by a firm through the elimination of direct rivals such as reduced costs, higher profit margin, increased market share, etc.
For example, a firm that is into the manufacturing of mobile devices acquires another firm that also makes mobile devices then it would be horizontal integration as the industry of both firms are the same and their operation level is also similar.
Whereas, vertical integration is aimed at gaining better hold to the customers of its competitor’s products or to provide much surety in supplies in case of purchase of supplier. Also, it works towards cost reduction, enhance profits and efficiency. The basic objective of this integration is to provide security in the supply of compulsory goods, create barriers in supply to rivals, and remove any disturbance in supply.
For instance, the acquisition of a textile manufacturing unit by a clothing firm is vertical integration. The former one is a supplier of goods or services to businesses and the latter one makes finished products from raw materials.
4. Capital requirement
The requirement of capital is usually lower in horizontal integration as it permits firms to hold distribution and production-related assets.
But in the case of vertical integration, it requires comparatively higher capital as the firm requires funds for the purpose of developing and managing elements of the final product.
5. Revenue or Profit margin
Horizontal integration facilitates a higher profit margin by providing the firm more power of pricing by removing competition.
Vertical integration facilitates the increase in profit margin by lowering down the excess cost.
The self-sufficiency level is also considered as a major difference between vertical and horizontal integration.
In vertical integration, a firm may have much hold over the whole distribution and production process and enables the firm to raise its profit by removing mediators. It facilitates firms to be self-sufficient by reducing their dependency on suppliers. Also, this integration permits the firm to develop its own specialized custom components for products.
On the contrary, self-sufficiency is not much there or totally absent in horizontal integration due to a firm depends upon outside suppliers for manufacturing and production. Dependency on more suppliers or vendors creates fewer risk factors.
There are two types of vertical integration i.e. backward and forward integration. No categorization is there in horizontal integration.
The level of concentration and diversification is also an element for differentiating horizontal and vertical integration.
Diversification of a firm’s business is possible in horizontal integration through expanding range of products i.e. by clubbing the existing stock of products and services of a firm with a competitor’s products and services. This way, a firm can enhance the diversity of its goods, introduce into new markets, and enlarge its presence in bigger geographical market segments.
On the other side, if a firm is looking to concentrate on the restructuring or improving its current range of products then a vertical integration is considered as a much better appropriate strategy.
In vertical integration, the profitability of all firms (acquiring and acquired) depends on the success factor of the final products and services. Wherein, each firm’s success factor in the supply chain supports other firms in horizontal integration.
10. Manufacture and Assemble
In vertical integration, a firm is required to develop most of the things on its own. But in horizontal integration, a firm brings elements from outside suppliers in order to assemble them to create the end product.
11. Customized tools
Vertical integration demands a larger need for custom elements and interfaces. The reason behind this is to make sure that the complete work of machinery is done in a firmly integrated way. To achieve this, most of the elements should be a custom build.
Wherein, horizontally integrated product’s characteristic is the standard interface. This facilitates companies in vendor negotiation and risk reduction.
Scaling is fast in horizontal integration i.e. both for companies and their competitors. The reason behind this is the benefit of acquisition in increasing the size of companies. However, in vertical integration, the potential of scaling is limited as compared to horizontal integration.
The more focus in horizontal integration is on operations, supply chain, and procurement. But in vertical integration, Research & Development (R&D) is the key focus area so that the best elements for the product can be ensured.
14. Customer experience
Horizontal integration may lead to less customer experience due to less customization. Wherein, vertical integration includes more customization levels and so, the optimized product can be produced that supports the enhancement of customer experience.
15. Risk level
There is a tendency of higher risk in vertical integration due to more disruptions. Horizontal integration contains comparatively less risk.
A vast ecosystem is there in horizontal integration due to the presence of lots of competitors selling the same products. Wherein, vertical integration carries a smaller ecosystem as it allows a firm to sell products in a limited amount.
Horizontal integration provides synergy but self-sufficiency is not there for independent working in the supply chain. On the other side, vertical integration supports the firm in gaining both self-sufficiency and synergy.
18. Market or industry control
Horizontal integration facilitates to gain market control, but to gain whole industry control is possible only in vertical integration.
Vertical integration supports a firm in the smooth supply chain process, creating entry barriers for firms that are new in the market, gaining both downstream and upstream profits.
Horizontal integration supports a firm in its expansion into new market territories by avoiding the higher costs involved in starting from basic because generally, it is less costly to add a profitable existing business rather than starting a new setup with a greater cost. It also provides economies of scale. Once a company obtains a certain size then the growth in its operating costs is at a much low rate as compared to the profits generated from activities.
Vertical integration may bring disadvantages such as poor quality of products due to less competition, less focus of firms on core competencies, and more on businesses that are newly acquired, less flexibility in increasing or decreasing the level of production.
The disadvantages of horizontal integration may include harm to the reputation of companies and goodwill may effect in the new market. Antitrust issues may arise.