Horizontal acquisition

What Is Horizontal Acquisition?

A horizontal acquisition occurs when one company purchases or merges with another company that operates in the same industry and at the same stage of production. This strategy falls under the broader umbrella of Mergers and Acquisitions (M&A), a key aspect of corporate finance. The primary goal of a horizontal acquisition is often to expand market share, reduce competition, and gain market power. The acquiring company and the target company typically produce similar goods or services and directly compete with each other.²⁰

History and Origin

The concept of horizontal integration, which a horizontal acquisition embodies, has been a core strategy in business expansion for centuries, evolving significantly with the advent of large-scale industrialization. Historically, companies sought to consolidate their positions within an industry to gain efficiencies and control supply. As industries grew and companies expanded across regions and nations, the potential for one company to acquire a direct competitor became a powerful tool. However, this growth also led to concerns about the concentration of economic power and the potential for reduced competition, giving rise to antitrust laws in the late 19th and early 20th centuries.

In the United States, significant legislative actions, such as the Sherman Antitrust Act of 1890 and the Clayton Antitrust Act of 1914, were enacted to prevent the formation of monopoly or oligopoly structures that could harm consumers. These laws necessitate rigorous review of horizontal acquisitions by regulatory bodies like the Department of Justice (DOJ) and the Federal Trade Commission (FTC). The most recent iteration of guidelines for such reviews, the 2023 Merger Guidelines, jointly issued by the DOJ and FTC, outline the factors and frameworks these agencies use to evaluate whether a merger or acquisition threatens anticompetitive harm.¹⁹

A prominent modern example of a horizontal acquisition is The Walt Disney Company's acquisition of 21st Century Fox, completed on March 20, 2019. This deal brought together two major entertainment conglomerates, significantly expanding Disney's content library and global footprint, while facing extensive regulatory scrutiny.¹⁷, ¹⁸

Key Takeaways

• A horizontal acquisition involves one company acquiring another in the same industry and at the same stage of production.
• The primary motivations include increasing market share, reducing competition, and achieving economies of scale.
• Such transactions are heavily scrutinized by antitrust regulators due to potential impacts on market competition and consumer welfare.
• Successful horizontal acquisitions can lead to increased revenue and profit, but also carry risks related to integration and regulatory challenges.
• The Herfindahl-Hirschman Index (HHI) is a key metric used by regulators to assess market concentration resulting from a horizontal acquisition.

Formula and Calculation

While there isn't a direct financial "formula" to calculate a horizontal acquisition itself, regulatory bodies, particularly antitrust agencies, use specific metrics to evaluate the potential impact on market competition. One of the primary tools is the Herfindahl-Hirschman Index (HHI).

The HHI is calculated by squaring the market share of each firm in an industry and summing the results:

$\text{HHI} = \sum_{i=1}^{N} (S_i)^2$

Where:

• ( S_i ) = the market share of firm i (expressed as a whole number, e.g., 25 for 25%)
• ( N ) = the number of firms in the market

For evaluating a horizontal acquisition, regulators calculate the pre-merger HHI and the post-merger HHI. The change in HHI ((\Delta \text{HHI})) is crucial. The 2023 Merger Guidelines indicate a presumption of illegality for mergers that significantly increase concentration in a highly concentrated market. For instance, a merger resulting in a post-merger HHI greater than 1,800 with an increase of 100 or more points is likely to face intense scrutiny.¹⁵, ¹⁶

Interpreting the Horizontal Acquisition

Interpreting a horizontal acquisition primarily involves assessing its strategic rationale and potential impact on both the acquiring firm and the broader market. From the acquiring firm's perspective, a successful horizontal acquisition can lead to enhanced market power, allowing for better pricing strategies and increased sales volume. It can also unlock synergy through cost reductions by eliminating redundancies in operations, such as duplicate administrative functions or overlapping distribution networks.

From a market perspective, a horizontal acquisition can result in fewer competitors, which may lead to reduced innovation, higher prices for consumers, and less product variety.¹³, ¹⁴ Regulators closely monitor these transactions to ensure they do not substantially lessen competition. The analysis considers the size of the combined entity's market share and the overall market concentration, often measured by the Herfindahl-Hirschman Index (HHI).

Hypothetical Example

Consider two hypothetical soft drink companies, "QuenchCo" and "FizzCorp," which both produce and distribute carbonated beverages. QuenchCo, a larger entity, decides to acquire FizzCorp, a smaller but well-established competitor with a loyal regional customer base. This would be a horizontal acquisition because both companies operate in the same industry (soft drinks) and at the same stage of production (manufacturing and distribution of finished beverages).

Before the acquisition, QuenchCo holds 30% of the market share, and FizzCorp holds 10%. After the horizontal acquisition, the combined entity, now operating under the QuenchCo brand, would command a 40% market share. This increased presence could allow QuenchCo to negotiate better deals with suppliers for ingredients and packaging due to increased volume, achieving greater economies of scale. It also reduces direct competition in certain segments, potentially leading to higher profits for the merged company. The new QuenchCo would then need to ensure smooth integration of FizzCorp's operations and employees.

Practical Applications

Horizontal acquisitions are prevalent across various industries as companies seek to consolidate their position, expand capabilities, and improve profitability.

• Technology Sector: Large tech companies frequently acquire smaller startups or direct competitors to gain access to new technologies, talent, or user bases, thereby enhancing their product offerings and reducing competitive threats.
• Retail and Consumer Goods: Companies in these sectors often engage in horizontal acquisitions to expand their geographic reach, acquire popular brands, or streamline supply chains, leading to a larger customer base and cost efficiencies.
• Media and Entertainment: As exemplified by the Disney-Fox acquisition, media companies combine forces to create extensive content libraries and distribution networks, aiming to dominate entertainment consumption across various platforms.¹²
• Banking and Financial Services: Banks often acquire other banks to expand their branch networks, grow their customer deposits, and increase their loan portfolios. Such mergers are closely reviewed by financial regulators like the Federal Reserve, which considers the impact on local banking markets using similar antitrust principles.⁹, ¹⁰, ¹¹

The strategic rationale for horizontal acquisition generally includes gaining greater market power, diversifying product lines, and increasing efficiency. However, these transactions are subject to rigorous regulatory oversight to prevent anti-competitive practices.⁸

Limitations and Criticisms

Despite the potential benefits, horizontal acquisitions are not without limitations and criticisms. A major concern is the potential for reduced competition within an industry. When direct competitors merge, it can lead to higher prices, fewer choices for consumers, and a decrease in innovation as the merged entity faces less pressure to differentiate or improve its offerings.⁶, ⁷ Regulatory authorities, such as the Department of Justice and the Federal Trade Commission, actively review these mergers precisely for these anti-competitive effects. The 2023 Merger Guidelines reflect a more aggressive stance, lowering the thresholds at which a merger is presumed to be anticompetitive.⁴, ⁵

Another significant challenge lies in the integration of two previously independent companies. Differences in corporate culture, operational processes, and management styles can hinder the realization of anticipated synergies. Poor integration can lead to employee turnover, decreased productivity, and a failure to achieve the desired financial outcomes, potentially resulting in a poor return on investment.³

Furthermore, the complexity and cost of a horizontal acquisition can be substantial, requiring extensive due diligence, legal review, and financial structuring. Even after completion, the merged entity might struggle to adapt quickly to market changes if its increased size leads to reduced flexibility. Regulators, including the U.S. Securities and Exchange Commission (SEC), also monitor acquisitions for potential misconduct, such as misleading disclosures, ensuring accountability in the financial markets.²

Horizontal Acquisition vs. Vertical Acquisition

The key distinction between a horizontal acquisition and a vertical acquisition lies in the relationship between the acquiring and target companies within the industry value chain.

While both strategies fall under Mergers and Acquisitions (M&A), the strategic rationale and regulatory implications differ significantly. Horizontal acquisitions are often focused on consolidating market presence and power, whereas vertical acquisitions aim to enhance operational efficiency and control over the production or distribution process.¹

FAQs

What is the main benefit of a horizontal acquisition?

The main benefit of a horizontal acquisition is typically the increase in market share and reduction of direct competition. This can lead to greater market power, allowing the merged company to benefit from economies of scale, streamline operations, and potentially increase revenue and profits.

Why are horizontal acquisitions often scrutinized by regulators?

Horizontal acquisitions are closely scrutinized by antitrust regulators because they have the potential to reduce competition in a market. If a merger creates an entity with too much market power, it could lead to higher prices for consumers, less innovation, and fewer choices, which are deemed harmful to a free market economy. Regulatory bodies use tools like the Herfindahl-Hirschman Index (HHI) to assess these risks.

Can a horizontal acquisition lead to job losses?

Yes, a horizontal acquisition can sometimes lead to job losses. When two companies merge, there are often redundancies in departments like human resources, finance, or even production. The newly combined entity might streamline operations to achieve greater efficiency, which can result in layoffs as duplicate roles are eliminated.

What are some challenges in a horizontal acquisition?

Challenges in a horizontal acquisition often include integrating different corporate cultures, systems, and processes. Mismanaged integration can lead to employee dissatisfaction, loss of key talent, and operational inefficiencies that undermine the anticipated benefits of the acquisition. Overpaying for the target company is also a significant risk.