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Economics

Study Notes

Advantages and Drawbacks from Horizontal Integration

Level:
AS, A Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Horizontal integration is between two businesses in the same industryat the same stage of production.

Some recent examples include:

Horizontal mergers in the betting industry: Ladbrokes and Gala Coral, Betfair and Paddy Power

The parcels / logistics multinational FedEx bought rival TNT in 2015 for £3.4bn. Read more here.

Sports Direct purchased Jack Wills in 2019 as well as House of Fraser. Read more here.

The fast-food retailer Pret bought Eat in 2019. Read more here.

Advantages of horizontal integration

  1. Exploit internal economies of scale including bulk-buying, technical economies and financial economies.
  2. Cost savings from the rationalization of the business – however, this often this involves heavy job losses.
  3. Potential to secure revenue synergies by creating and selling a wider range of products - (i.e. diversification) – this creates opportunities for a larger business to benefit from economies of scope.
  4. Reduces competition by removing key rivals – this increases market share and lifts a firm’s pricing power.
  5. Buying an existing and well-known brand can be cheaper in the long-run than organically growing a brand – this can then make entry barriers higher for potential rivals and lead to higher long-run monopoly profits.

Disadvantages of Horizontal Integration

  1. Risk of diseconomies of scale from the enlarged businesses especially if there are clashes of management style and culture, and wider problems with integrating businesses that operate in very different ways
  2. Reduced flexibility– the addition of more personnel and processes means the need for more transparency and therefore, more accountability and red tape which can slow down the rate of innovation / getting new products to market
  3. Mergers risk destroying shareholder value rather than creating it: This often happens because the synergies never materialize despite the potential benefits of the horizontal integration. Most large-scale mergers fail to achieve the gains in shareholder value that were forecast before it happened
  4. Risk of attracting investigation from the competition authorities who might be worried that a horizontal merger might lead to a substantial lessening of competition in a market which could then lead to a fall in consumer welfare. A horizontal merger such as Sainsbury and Asda can be blocked on competition grounds.

Key exam context:

Not every proposed horizontal merger goes ahead. In 2019, the proposed merger between Sainsbury’s and Asda in the UK was blocked, as competition authorities feared it would leave consumers worse off due to restricted choice and higher prices. Two huge German banks Deutsche Bank and Commerzbank abandoned their merger talks in 2019, as they thought it would lead to higher risk for the combined business. The CMA recently blocked the merger between JD Sports and Footasylum. In contrast, the competition authorities allowed the merger between Liberty Global, which owns Virgin Media, and Spain's Telefonica, which owns O2. At European Union level, the EU competition commission is investigating a proposed merger between Google and Fitbit.

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