A company determined to take advantage of and control another firm’s assets employs an acquisition strategy that enables them to tap into that target company’s existing strengths and to overcome weaknesses. Through the acquisition, the target company’s ownership–with all its rights, privileges, and responsibilities–transfers to the acquiring company.
Most acquisitions fall into either of two basic categories: horizontal or vertical. Most business owners cannot distinguish between the two and struggle when deciding which type of acquisition will best meet their unique needs.
Let’s eliminate this confusion by understanding the factors that differentiate between horizontal and vertical Acquisitions.
The intention behind the business combination sets horizontal and vertical acquisitions apart.
A horizontal acquisition occurs when one company acquires another from the same business line or at the same value chain level. The intent is to acquire a company that offers the same products and services and is at the same production level.
In a horizontal acquisition, the target and acquiring companies are usually direct competitors in the same market space. The acquisition enables the acquiring company to eliminate its competition. A horizontal acquisition by eliminating direct competition yields benefits such as cost reduction, a rise in revenue and profits, and increased market share.
An example of horizontal acquisition is the Walt Disney Company’s acquisition of computer animation leader Pixar to further its delivery of outstanding creative content. The acquisition combined the preeminent creative and technological resources of Pixar with Disney’s portfolio of family entertainment, characters, theme parks, etc.
Another example is when AstraZeneca acquired ZS Pharma to strengthen its metabolic and cardiovascular drug portfolio. The transaction gave AstraZeneca access to the potassium-binding compound ZS-9, a treatment for hyperkaliemia, a condition associated with increased mortality in chronic kidney disease and chronic heart failure.
In both examples, the acquiring and target companies were in the same industry and operated at the same level.
A vertical acquisition occurs when one company acquires another company from the same industry and within the supply chain. A vertical acquisition does not immediately enhance revenue but works to reduce costs and increase profit. Its objective is to secure the supply of essential goods, avoid disruption in supply, restrict collection to competitors, strengthen the acquiring company’s supply chain, reduce production costs, improve production efficiency, reduce delays in delivery and transportation, or access new distribution channels.
For example, Google acquired smartphone producer Motorola in 2012. Google was doing great at software, and Motorola Mobility had expertise in devices. The combination of the two made sense and guaranteed faster innovation. Also, Motorola Mobility’s complete commitment to the Android operating system meant that the two companies were a natural fit.
Another example is when technology giant Apple acquired Florida-based firm AuthenTec. The target company developed the touch ID fingerprint sensor, a technology to secure networks and mobile devices using fingerprint sensors and identity management. Apple incorporated that technology into the iPhone.
In both examples, the acquiring and target companies were in the same industry but operated at different levels.
So, when choosing which acquisition type to adopt, acquiring companies need to focus on the intention behind the business combination.
Related: Benefits of M&A.
Level of Self-sufficiency
The level of self-sufficiency, which the acquiring companies wish to achieve, also distinguishes a horizontal acquisition from a vertical one.
In the case of horizontal acquisition, the acquiring company plans to assemble its products using an outside vendor; therefore, it wants to acquire such a company which will help to increase its market share.
With the vertical acquisition, the acquiring company wishes to manufacture its products in-house and targets a company to help reduce costs and strengthen the supply chain.
The vertical acquisition gives the acquiring company more control over the entire production and distribution process and helps increase profit by eliminating outsourcing. It allows the acquiring company to customize production and enjoy lower production costs, reduce waste, and better utilize resources.
Having complete control over the production and distribution process can be very time-consuming and expensive. Experts caution that companies opting for vertical acquisition should be sound financially, organizationally, and operationally.
A horizontal acquisition helps achieve great synergy but does not provide much self-sufficiency. Here, the acquiring company relies on multiple outside vendors for production. The company reduces risks and develops a safety net for itself so that if something goes wrong with one vendor, another can do the job.
When considering an acquisition, companies need to decide:
- Do they wish to have greater self-sufficiency with complete control over their manufacturing and distribution process (vertical acquisition)? Or,
- Do they want to have greater synergy, and are they ready to let go of self-sufficiency (horizontal acquisition)?
Diversification and Concentration Level
Horizontal and vertical acquisitions also differ by the diversification and concentration the acquiring companies wish to attain.
With a horizontal acquisition, the acquiring company can diversify its business by extending its product range by combining both companies’ existing inventories of products and services. The horizontal acquisition helps the acquiring company tap into new market sectors and expand into the broader geographical markets.
A vertical acquisition helps the acquiring company concentrate on refining its product range. The company can have control over the industry, not merely on the market, by acquiring a company on the same production path at a different stage along that path.
When choosing between horizontal and vertical acquisitions, companies need to determine if they want to diversify their product range or strengthen their hold on their existing product range.
Cost of Revenue
Horizontal and vertical acquisitions differ by the potential for cost savings and the enhancement of revenue.
With the horizontal acquisition, the acquiring company intends to grow the revenue by diversifying its product range and increasing market share. Vertical Acquisition helps the acquiring company reduce costs by eliminating procurement costs and improving the efficiency of the supply chain.
Companies selecting between horizontal and vertical acquisition need to evaluate what they want: increased revenue or cost savings.
Advantages and Disadvantages
The advantages and disadvantages of horizontal and vertical acquisitions also highlight the difference between them.
The horizontal acquisition offers several advantages, such as:
- Reduced direct competition,
- Focus on improving the product range,
- Significant effect of economies of scale,
- Ease of management due to similar products and processes,
- Lower costs from producing more products,
- Increase in market share,
- Better hold on suppliers and distributors,
- Exposure to new markets and distribution channels.
The horizontal acquisition also has its share of downsides:
- Limited flexibility in introducing innovations,
- Possibility of legal repercussions (e.g., antitrust),
- Possibility of a decentralized structure,
- Hindered productivity,
- Destroyed value if expected synergies do not materialize.
The vertical acquisition provides many benefits, including:
- Increased control over the value chain,
- Lower transportation costs,
- Reduced delivery turnaround times,
- A decrease in costs via economies of scale,
- Enhanced sales and profitability,
- Ability to get products to customers directly and quickly,
- Improvement in supply chain coordination,
- Creation of a company-owned brand,
- Restricted access of competitors to scarce resources or critical markets.
The advantages of vertical acquisition are immense, but even this acquisition strategy is not without its drawbacks:
- Difficulty in managing a large company,
- Outsourcing to suppliers and vendors could prove to be more efficient,
- Purchasing a supplier company could turn out to be very expensive,
- Increased debt, if capital expenditures require borrowing of funds,
- Lower production volume,
- Difficulty in building products at scale,
- Possibility of confusion within the business,
- The requirement to get acquainted with a new sector.
Acquiring companies should carefully analyze the advantages and disadvantages of both horizontal and vertical acquisitions to choose the option that suits them best.
Choose the Best Option
So, which one is better, a horizontal acquisition or a vertical acquisition? It depends upon your company’s goals and growth plan. Carefully analyze the unique pros and cons of both the acquisition strategies to make an informed decision.