Horizontal Merger

Horizontal Merger Definition

Horizontal merger refers to the merger that occurs between the organizations that operate in the same or similar industries and generally the competitors in the industry opt for such type of mergers for reasons such as to increase the share in the market, to bring economies of scale, to reduce the level of competition, etc.

Explanation

A horizontal merger is a type of merger that happens between companies operating in the 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 type of 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 type of mergers is more closely monitored by the government since it may lead to a decrease in competition in the industry and may also to oligopoly.

Horizontal Merger

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A hypothetical example of a horizontal merger may be of Hindustan Unilever and Patanjali. Though both of them operate in the FMCG market, both of them have different product ranges aimed at different demographics of people. Thus, the merger may help them to offer a wider range of products, will increase their revenue substantially, and will lead to an increase in market share.

Why do Companies go for Horizontal Merger?

Horizontal Merger Reasons

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#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 2 companies on account of the merger. Companies go for the horizontal merger to bring in economies of scale by cost reduction. Reduction of the cost may occur by the elimination of redundant processes, operations, or manpower costs. Thus, the company can offer a wider range of products or services in a more efficient and cost-effective manner.

#2 – Reduction in competition

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

#3 – Increase in Market Share and Operating Revenue

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

#4 – Faster Growth

Inorganic growth is a faster method of growth than organic growth. Thus, companies looking out for faster methods of growth usually go for a Horizontal merger. If a company is looking out to increase its product range or market share or increase its 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 for business diversification both in terms of product/services range and geographical presence. It may also help a company to enter a new market and to increase its reach demographically.

Horizontal Merger Example

Example #1

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

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

Horizontal Merger Example1
Example1.1
Horizontal Merger Example1.2

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 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 Limited is into the business of manufacturing plastic packet. there can be a horizontal merger between these two companies can gain synergy in the following way :

Horizontal Merger Example0.2
Example2.1.0
Horizontal Merger Example2.2.0

In this, ABC Ltd and PQR Ltd are in the same line of business manufacturing plastic products.

  • By combining the two companies, the merged company will have a diversified steel product base which they can sell to the consumers.
  • You will see that the combined entity turnover has increased from $1,50,000 to$3,50,000 ~130% jump in the turnover.
  • By executing this merger, the net profit of the company has risen from $50,000 to $1,50,000, a 3 times growth in the net profit, thereby increasing the per-share valuation.

Horizontal Merger also will help the merged entity to control its expense ratio since the combined expenses of both the companies, along with the combined revenues, will surely lower down the expense ratio and improve the financial performance of the company.

Example #3

Suppose ABC Ltd is in the business of manufacturing of helmets but has no infrastructure and is heavily making loses but has a very high distribution network. On the other hand, there is PQR Ltd, who has an established infra set-up and is heavily making profits.

Example3
Horizontal Merger Example3.1
Example3.2

In this case, although ABC is making losses at an individual level, by merging the company with PQR, 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 strengthen the financial positioning of the group since it now has a full infra set up along with a wide distribution network.
  • Thus both the companies which are in the same business line has achieved synergy in the amalgamation process by using each other USB’s and strong points to make a strong merged entity.
  • This one company’s weakness can be other company strengths. 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 types of mergers but are especially evident in horizontal mergers. Since the 2 companies operate in similar or the same industry, they both have similar processes and functions, but might have different ways of handling things. Thus, the diverse cultures of the two companies further make it difficult for them to co-exist.
  • Different management styles: Since the management styles of both the companies must be different, a merger may lead to clashes in both the management and may lead to an unsuccessful merger.
  • Might create a Monopolistic Market: It may also create a monopoly in the market if two of the biggest players operating in that industry merge together. For example, if a company having a 35% market share merges with a company having a 15% market share, the combined entity will have a 50% market share, thus majorly reducing the competition. Any further increase in the market share of the combined entity will create a monopoly in the market, which may lead to unfair market practices.
  • Product Cannibalization: The merger of two companies operating in the similar industry may also lead to product cannibalization of either company. If we consider the earlier example of the merger of Patanjali and HUL, considering people are becoming more and more concerned about organic and natural products, products of Patanjali like shampoo may eat in the market of shampoos of HUL.

This article is a guide to Horizontal Merger and its definition. Here we discuss why companies go for horizontal merger along with examples and explanations. You can find out more about these articles-

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