Horizontal Merger Definition Examples How It Works

Horizontal Merger Definition

Explanation

A horizontal merger is a merger between companies operating in a similar line of business or the same industry. In other words, it happens when companies that offer the same or similar products or services come together under single ownership. Most companies going for such a merger are competitors operating in the same industry.

Companies go for a merger for many reasons, both financial and non-financial. These mergers are usually considered for non-financial reasons. However, these types of mergers are more closely monitored by the government since they may decrease competition in the industry, and oligopolyOligopolyAn oligopoly in economics refers to a market structure comprising multiple big companies that dominate a particular sector through restrictive trade practices, such as collusion and market sharing. Oligopolists seek to maximize market profits while minimizing market competition through non-price competition and product differentiation. read more.

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A hypothetical example of a horizontal merger may be Hindustan Unilever Ltd. (HUL) and Patanjali. Though both operate in the FMCGFMCGFast-moving consumer goods (FMCG) are non-durable consumer goods that sell like hotcakes as they usually come with a low price and high usability. Their examples include toothpaste, ready-to-make food, soap, cookie, notebook, chocolate, etc.read more market, they have different product ranges for different demographics. Thus, the merger may help them offer a wider range of products and substantially increase their revenue and market share.

Why do Companies go for Horizontal Mergers?

#1 – Economies of Scale

A merger usually occurs when it is expected that the combined entity will have more valuation than the combined valuation of individual entities. The same is on account of synergies in M&A achieved between the two companies on the merger. Companies go for horizontal mergers to increase economies of scale by cost reduction. The cost reduction may occur by eliminating redundant processes, operations, or human resources costs. Thus, the company can offer a wider range of products or services more efficiently and cost-effectively.

#2 – Reduction in Competition

Companies may also go for this type of merger to reduce competition. Thus, it may also lead to the consolidation of a fragmented industry.

A merger is an inorganic growth method for a company. When two companies providing the same or similar products or services have their market share and audience in the market combined to become a single entity, it increases market share and thus increases revenue.

#4 – Faster Growth

Inorganic growth is a faster growth method than organic growthOrganic GrowthOrganic growth is the rate of growth that a company achieves by increasing sales revenue by increasing volume of products sold or by achieving greater operational efficiency leading to a reduction in the cost of production or any other internal improvement.read more. Therefore, companies looking for more rapid growth methods usually go for a Horizontal merger. On the other hand, if a company is looking to increase its product range, market share, or geographical reach without investing time and resources to develop it from scratch, it may go for such a merger.

#5 – Business Diversification

Companies may go for this merger to seek business diversification regarding product/service range and geographical presence. It may also help a company enter a new market and increase its reach demographically.

Horizontal Merger Example

Example #1

Suppose ABC Ltd. sells steel products, and PQR Ltd. sells steel at the retail level to individuals.

In this example, there can be a horizontal merger between these two companies to create synergy and increase the revenues and market shares of the group.

ABC Ltd.

PQR Ltd.

ABC PQR Ltd (Combined Entity)

In the above example, by combining the two companies, the asset base of the combined entity has increased from $1,00,000 to $2,00,000.

Further, there is goodwill Goodwill In accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company’s net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company’s net identifiable assets from the total purchase price.read more in the horizontal merger process, which has been recognized in the balance sheet as per the accounting norms.

Example #2

Suppose ABC Ltd. is into the manufacturing of plastic bags, and PQR Ltd. is into the business of manufacturing plastic packets. Then, there can be a horizontal merger between these two companies that can gain synergy in the following way: –

ABC Ltd. Profit & Loss Account

PQR Ltd. Profit & Loss Account

ABC PQR Ltd. Profit & Loss Account

ABC Ltd. and PQR Ltd. are in the same business, manufacturing plastic products.

Horizontal mergers will also help the merged entity control its expense ratio. As a result, the companies’ combined expenses and revenues will lower the expense ratio and improve their financial performance.

Example #3

Suppose ABC Ltd. manufactures helmets but has no infrastructure and heavily makes losses but has a very high distribution network. On the other hand, PQR Ltd. has an established infra set-up and is heavily making profits.

In this case, although ABC Ltd. is making losses at an individual level, by merging the company with PQR Ltd., they can absorb their losses and can even report positive profits in the long term.

We can see that the net profit of the combined entity has absorbed the losses of ABC Ltd. and strengthened the group’s financial positioning since it now has a full infra setup along with a wide distribution network.Thus, companies in the same business line have achieved synergy in the amalgamationAmalgamationAmalgamation is the consolidation or combination of two or more companies, known as amalgamating companies, usually in the same or similar line of business, to produce a new legal entity, known as the amalgamated company, with the same shareholders, assets, and liabilities.read more process by using USPs and strong points to make a strong merged entity.This one company’s weakness can be another company’s strength. It gives the merged entity the fuel to scale up the operations and build a strong base in the market by capturing the market share.

What are the Issues Faced in the Horizontal Merger?

Cultural Integration Difficulties: Cultural issues are usually faced in all mergers but are especially evident in horizontal mergers. Since the two companies operate in a similar industry, they have similar processes and functions, but they might handle things differently. Thus, the diverse cultures of the two companies further make it difficult for them to co-exist.Different Management Styles: Both companies’ management styles must be different. A merger may lead to clashes in both the management and an unsuccessful union.Might Create a Monopolistic Market: It may also create a monopoly if two of the biggest players operating in that industry merge. For example, if a company with a 35% market share merges with a company with a 15% market share, the combined entity will have a 50% market share, thus majorly reducing the competition. In addition, any further increase in the combined entity’s market share will create a monopoly in the market, which may lead to unfair market practices.Product Cannibalization: The merger of two companies operating in a similar industry also may lead to product cannibalization of either company. Let’s consider the earlier example of the merger of Patanjali and Hindustan Unilever Ltd. People are becoming increasingly concerned about organic and natural products. Patanjali products like shampoo; may be eaten in the shampoos of Hindustan Unilever Ltd.