What Is a Vertical Merger?

by Thomas Metcalf

Companies expand through internal growth or acquisition of other companies -- a process that can occur on the local, national or global basis. Mergers provide economic clout to the firms involved, and they sometimes have a negative impact on their competitors. The opportunities for growing a business make vertical mergers a powerful business tactic.

Types of Mergers

Mergers fall into three categories: conglomerate, horizontal and vertical. A conglomerate merger is one in which two firms selling unrelated products merge. General Electric, which has engaged in numerous conglomerate mergers, sells everything from light bulbs and toasters to jet aircraft engines. A horizontal merger occurs when two competitors such as Exxon and Mobil combine to form a single firm, ExxonMobil. A vertical merger involves firms that are at different levels of the supply chain. Google’s acquisition of DoubleClick was a vertical merger between an Internet search firm and an Internet advertising firm, each in different levels of the same industry.

Rationale for Vertical Mergers

Companies engage in vertical mergers to take advantage of economies of scale. As a larger overall firm -- even though there is no apparent change in competition at any level -- the merged company can reduce transactions costs and benefit from the financial strength that comes from being a larger enterprise. If a firm acquires a supplier, it benefits by having an assured source of resources. Conversely, if a firm acquires a retailer, it is guaranteed to have a distribution outlet. A vertical merger may be undertaken to prevent others in the industry from exercising their economic strength. After UPS acquired Mail Boxes, Etc., now The UPS Stores, Federal Express responded by purchasing Kinkos, which is now renamed FedEx Office.

Anti-Competitive Aspects

Even though companies that are parties to a vertical merger do not compete directly, changes can occur in affected markets. As part of a larger enterprise, a merged firm gains greater economic strength, access to better credit terms and greater marketing power. A vertical merger may close competitors out of a segment of the market. If an automobile manufacturer purchases a tire producer, for example, it may choose not to sell tires to competing car manufacturers. Even if it does, the price to the competitor will be higher, while the company that owns the tire producer can have them at cost. If a manufacturer acquires a retailer, that retailer may not carry competitive brands.

Brown Shoe v. United States

A landmark Supreme Court decision in 1962 involved the merger between Brown Shoe Company, a manufacturer, and Kinney, a retail shoe store. Even though the impact of the merger on a national level was negligible, the Court ruled that it would have an impact on “an economically significant submarket” since competition would be significantly reduced in smaller cities across the nation. The Court ruled that this vertical merger caused a “clog on competition” and that it deprived other firms of “a fair opportunity to compete." In spite of rulings like Brown Shoe v United States, vertical mergers are commonplace in an increasingly global market.

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