Business mergers can be tricky to navigate and understand. Read on to find out 5 things you should know about vertical mergers.
Did you know that 2017 was the third year in a row where more than 50,000 mergers & acquisitions deals were announced?
All mergers are complex, but vertical mergers have an upper hand in that department. They can be difficult to navigate, but with the right information, you’ll know what’s going on.
If you are here it means that you are involved in a vertical merger, or might’ve heard about one. And, you want to know a bit about them so you understand what’s going on.
Don’t worry! We have you covered.
The Basics of Mergers
Before we get into the 5 things you should know about these mergers, we’ve should start with the basics. You may have heard about mergers and acquisitions. These terms are sometimes used interchangeably, but they aren’t the same.
Their differences will come down to how the purchase was made or announced. This will be determined by the Board of Directors from the purchasing company. We’ll be telling you a lot about mergers, but you can read more about acquisitions to cover your bases.
So, what is a merger? A merger takes place when 2 companies similar in size agree to operate as 1 company.
This type of merger is called a merger of equals. Here the stocks from both companies are surrendered, and they issue a new company stock. Two CEOs agreeing on joining their companies in the best interest of the businesses is also known as a merger.
There are several types of mergers. The most common types are horizontal and vertical mergers. Horizontal mergers happen between 2 companies that are in direct competition and share the same markets and product lines.
Vertical mergers are becoming more common than they used to be. You might’ve been a bit lost when the media talked about the merger between AT&T and Time Warner Cable. But, that won’t happen to you anymore.
Here are 5 things you should know about this type of merger:
1. What Is a Vertical Merger?
A vertical merger happens between a customer and company or a supplier and a company. Here companies that sold or bought goods from each other decide to merge.
There have been many vertical mergers in different industries. Many of them happen in the supply chain industry. One of the most known mergers of this type was when America Online merged with Time Warner.
It’s famous because of how bad it was for Time Warner’s shareholders. These mergers can happen for many reasons; usually, it isn’t to increase revenue. Yet, companies merge to cut costs and work more efficiently.
2. Help Lower Costs
Many of these mergers don’t necessarily happen to increase revenue, but rather cut costs and realize a higher profit margin. A manufacturer may decide to do a vertical merger to secure the supplies needed for their production.
For example, a car manufacturer may do a vertical merger with a tire supplier to secure the tires needed for the cars they’re producing. By doing this, they’ll lower the costs, because they won’t have to “pay” the tire company for the materials.
Before, they had to pay the cost of the materials, and the profit markup charged by the supplier. Now the manufacturer will only pay the cost of the tires. Therefore they’ll have a higher profit margin on their cars.
3. Bring Supply Chain Stability
This type of merger brings supply chain stability to the company that’s making the purchase. After merging, the purchasing company will have increased their supply stability.
Before merging with the tire company, that car manufacturer had to shop the market for different suppliers, analyze costs, and negotiate the supply terms. A supplier could assure them that they would have the materials on time and not perform as expected in the middle of the production.
These situations turn into major nightmares in the manufacturing business. And, the worst part about it is that at the end of the day these turn into costly mistakes. That slows a manufacturer’s production and lowers their profit margins.
Owning their supplier will help the manufacturer make sure that they’ll have the materials they need on time, and at the best price.
4. Can Make Suppliers Go out of Business
One of the cons of vertical mergers is that they eliminate a competition in the market. That’s one of the major issues government authorities and experts alike have with this type of merger.
It will come down to the size of the companies involved in the merger. For example, if the car manufacturer was General Motors and they had contracts with different tire suppliers. They’ll stop having supply contracts with other suppliers once they complete their merger.
The contracts these suppliers lose might be the biggest or more important account they have. So if they lose them, this might cause them to go out of business. Unless they can fill the void with another account.
For most suppliers, this will be difficult because there aren’t that many big players in the industries. So when a vertical merger happens in an industry, it might cause many suppliers, and maybe even manufacturers to go out of business.
5. Can Cause Anti-Trust Issues in the Market
These mergers reduce competition in the market. This will depend on the size of the companies, and their role in the market, but it can create a monopoly.
Many countries including the United States have anti-monopolistic laws that regulate vertical mergers. You might’ve heard about the AT&T, Inc. and Time Warner Inc. merger. Currently, the trial of the US Justice Department case against this merger is taking place.
In this case, the Justice Department disputes that the merger between these companies is anti-competitive, and should be blocked. This case should set precedent for other mergers like this, because of the nature of the transaction.
Many times vertical mergers create a market where consumers don’t have many options. This is what the Justice Department aims to protect. In a free market, as the one we have today, competition is necessary for a healthy economy.
Wrapping It Up
Mergers are a difficult subject to navigate, but vertical mergers can be even a bit more complex to understand. Yet, if you look closely at the transaction you can know what’s going on. If the company is buying a supplier, eliminating competition, and lowering costs is their main goal; you can be certain a vertical merger is happening.
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