Advantages and Disadvantages of Vertical Mergers

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Advantages and Disadvantages of Vertical Mergers
Vertical mergers allow the parent corporation to internalise the supply chain (Felipe Dupouy/Lifesize/Getty Images)

A vertical merger is where a firm acquires a supplier or distributor. By definition, two companies involved in a vertical merger do not produce the same good nor do they directly compete in the market (as differentiated from horizontal mergers). For instance, if an auto manufacturer acquired a tire company, it would be a vertical merger.

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Advantage: Lower Cost

After a corporation merges with one of its suppliers, it no longer has to pay the supplier for the material, as they are essentially now one entity. Previously, the distributor would have had to pay the supplier the cost of the material in addition to the markup cost charged by the supplier to make a profit. After the merger, the parent corporation can obtain materials at cost.

Advantage: Supply Chain Stability

Once suppliers are absorbed into a parent corporation, that corporation has increased stability in terms of supply. Whereas before the company would have had to worry about negotiating the lowest cost and choosing between various competitors, the post-merger company has essentially one less thing to worry about. If these vertical mergers extend into various areas of supply, the corporation is more stable as the supply chain is internalised.

Disadvantage: Force Suppliers Out of Business

As far as market competition goes, vertical mergers can have a negative effect. Depending on the size of the corporation in question, a vertical merger can rob the suppliers market of significant business, potentially putting smaller suppliers out of business.

Disadvantage: Anti-Trust Issues

Vertical mergers essentially reduce competition in the market and, depending on the size of the companies involved and their place in the market, can lead to monopolistic practices. For this reason, the governments of many developed nations have laws prohibiting vertical mergers if they contribute to monopolistic domination of the market by a single corporation. One instance of this was in the merger of Time Warner and the Turner Corporation. The Federal Trade Commission was concerned that this would allow Time Warner to control a very large chunk of television programming. The merger, though scrutinised, was ultimately allowed to go through.

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