Horizontal Integration Definition
In the simplest terms, horizontal integration is the process of procurement of a commercial entity that has been functioning at a similar echelon. The entity may belong to a similar or a different industry. Unlike vertical integration, horizontal integration does not entail a business procuring another business entity that is in a dissimilar stage of production.
A Little More on What is Horizontal Integration
The primary objective of horizontal integration is to enhance production efficiency, create market domination in the production and distribution arenas, enhance product differentiation and explore newer horizons. Often, two business entities perform better in generating revenue as a merger than they would have been able to on their own. Yet, there is an inherent negative aspect to a successful horizontal merger that comes in the form of significant reduction or in some cases, a total obliteration of market competition. Horizontal integration within an industry will result in a company or a small number of companies controlling the industry, leading to either a market monopoly or an oligopoly. In fact, this institutional control of the market has led to the formation of antitrust laws to protect the consumer.
Advantages of Horizontal Integration
Horizontal integration not only reduces production cost, but also enhances the scope for marketing, facilitates better R&D, and strengthens the production and distribution chain of the new merger. For a merger occurring within an industry, horizontal integration also effectively introduces diversity in the product portfolio and potentially reduces marketing cost by integrating the separate portfolios of the merging companies into a single portfolio. Horizontal integration not only combines products; in fact, it potentially combines markets.
Marketing imperatives are a driving force behind horizontal integration. A business that procures another business entity that has an operational base in a country in which the parent business itself has had no prior exposure, not only gets immediate access to a new market, but also has at its disposal, ready marketing infrastructure to introduce its portfolio there.
Porter’s Five Forces model lists five competitive forces that essentially drive any industry
1. Horizontal competition from substitute products
2. Competition from new entrants in the market
3. Competition from rivals
4. Bargaining power of customers
5. Bargaining power of suppliers
Horizontal integration aims to address the first three competitive forces. Disadvantages of Horizontal Integration. We have already mentioned that horizontal integration has directly resulted in the formation of antitrust laws to deal with any unhealthy competition in markets. Even if the merger complies with the competition regulations of the market, horizontal integration does not always guarantee benefits. Inflexibility in management owing to the sheer size of the new merger and incompatibility of leadership of the two merging businesses can and will negatively affect the business value of the merger.
Examples of Horizontal Integration
Examples of horizontal integration in the 21st century include:
- Hewlett Packard’s acquisition of Compaq
- Fiat’s acquisition of Chrysler to form Fiat Chrysler Automobiles N.V
- Facebook’s acquisition of Instagram and WhatsApp
- Kraft Foods’ acquisition of Cadbury
- Pfizer’s acquisition of Wyeth
References for Horizontal Integration
Academic Research on Horizontal Integration
Why reputation favors joint ventures over vertical and horizontal integration A simple model, Garvey, G. T. (1995). Journal of Economic Behavior & Organization, 28(3), 387-397. This paper investigates the effect of reputation in a model where two parties make “non contractible” contributions to an economic undertaking. The paper shows that the optimal allocation of ownership between the parties is more similar in a repeated than in a one shot version of the model. The paper suggests that low discount rates and repeated investment decisions thus favor subcontracting and joint venture arrangements, while full integration is more likely to be optimal when reputational forces are weak.
Horizontal integration for bargaining power: Evidence from the cable television industry, Chipty, T. (1995). Journal of Economics & Management Strategy, 4(2), 375-397. This paper studies the hypothesis that large firms have more bargaining power with suppliers than do small firms, using data from the cable television industry. The paper uses techniques from the “new empirical lo” , where the effect of owner size on marginal costs is inferred from the effect of owner size on observable product market choices. The paper aims to show that scale economies, in the cable industry, are likely to stem from regional size, while bargaining power is likely to stem from national size.
Vertical vs. Horizontal integration: pre-emptive merging, Colangelo, G. (1995). The Journal of Industrial Economics, 323-337. This study explores the importance of pre-emption in a firm’s merger decision. The paper studies whether and under which circumstances pre-emptive merging occurs in vertically related industries. The paper finds that vertical mergers often preempt horizontal mergers and are dominant outcomes. It suggests that pre-empting the threat of a detrimental horizontal integration may be the main reason for vertically integrating.
Toward better horizontal integration among IoT services, Al-Fuqaha, A., Khreishah, A., Guizani, M., Rayes, A., & Mohammadi, M. (2015). IEEE Communications Magazine, 53(9), 72-79. This paper analyses the several divergent application protocols proposed for the Internet of Things (IoT) solutions. It explores the lack of a protocol that can handle the vertical market requirements of IoT applications, and examines how they have led to a fragmented market between many protocols. This paper, after articulating the major shortcomings of the current IoT protocols, outlines a rule-based intelligent gateway that bridges the gap between existing IoT protocols to enable the efficient integration of horizontal IoT services.
Strategic effects of private labels and horizontal integration, Tarzijan, J. (2004). The International Review of Retail, Distribution and Consumer Research, 14(3), 321-335. This paper examines the reason why retailers would want to introduce private labels in a given product category. The paper focuses especially on the effects of the emergence of private labels on the relative power of retailers vis à vis national brand manufacturers. The paper aims to show that retailers’ gain from introducing private labels increase with the concentration of the retail market both with linear and non-linear pricing.
Horizontal integration in the Dutch financial sector, Dietzenbacher, E., Smid, B., & Volkerink, B. (2000). International Journal of Industrial Organization, 18(8), 1223-1242. In this paper, the consequences of cross-shareholding in an n-firm industry are analyzed. The paper focuses on the case where firms have silent interests in each other. It analyzes the effects of cross-shareholding on the price–cost margins in a Cournot and a Bertrand setting. The Dutch financial sector is used as a case study.
Market power and vertical and horizontal integration in the maritime shipping and port industry, Van de Voorde, E., & Vanelslander, T. (2008). OECD/ITF Joint Transport Research Centre Discussion Paper. This literature examines the level of change in the maritime sector in recent years. The paper first examines the competitive shifts that have occurred in the port and maritime arena, the strategic behaviour exhibited by the main market players, and analyses their behaviours. It further presents the consequences of the strategies pursued in the context of the anticipated future scenarios.
Firm reputation and horizontal integration, Cai, H., & Obara, I. (2009). The RAND Journal of Economics, 40(2), 340-363. This paper explores the effects of horizontal integration on firm reputation in an environment where customers observe only imperfect signals about firms’ effort/quality choices. It highlights some of the positive and negative impacts of horizontal integration, and suggests that these effects give rise to a reputation‐based theory of the optimal firm size and derive its comparative statics.
The horizontal integration of the banking firm, credit rationing and monetary policy, Cukierman, A. (1978). The Review of Economic Studies, 45(1), 165-178. The purpose of this paper is to derive the implications of horizontal integration of functions within a banking firm for the equilibrium interest rate, the degree and structure of credit rationing and the operation of monetary policy. The paper also explores the implications of the existence of a positive dependency between the demand for banking services and the amount of credit granted to a customer, for the nature of equilibrium in the credit market and the effects of monetary policy.
Horizontal and vertical integration of organizational IT systems, Wangler, B., & Paheerathan, S. J. (2000). Information Systems Engineering. This paper investigates the need for better integration of systems by firm managers across functional boundaries and in line with business processes. The paper surveys and discusses methods and technique to achieve such horizontal integration as well as vertical integration between different operational and management levels in an organization.
Consolidating the water industry: an analysis of the potential gains from horizontal integration in a conditional efficiency framework, Zschille, M. (2015). Journal of Productivity Analysis, 44(1), 97-114. This paper investigates the fragmentation level of the German waters and presents the implications of its findings. The paper uses a cross-section sample of 364 German water utilities in 2006, applying Data Envelopment Analysis, to analyze the potential efficiency gains from hypothetical mergers between water utilities at the county level. The paper shows that the greatest efficiency improvement potentials turn out to result from reducing individual inefficiencies while pure merger gains are found to be low.