Horizontal Integration Growth Strategies

Concentration Growth – Horizontal Integration Strategy

***Horizontal integration strategy helps firms enter different geographic locations or increase the range of their offered products***

What is a Horizontal Integration Strategy?

Horizontal growth can be achieved by expanding the organization’s operations into other geographic locations or by increasing the range of products and services being offered to current markets. Essentially, firms grow horizontally by broadening their products lines.

Horizontal growth can be achieved through merging or acquisitions among competitors in the same industry. This allows firms to expand their presence in an industry without having to rely on their own efforts.

Horizontal growth results in horizontal integration, which is the degree to which a firm operates in multiple geographic locations at the same point on the value chain.

That is, horizontal integration refers to a strategy of seeking ownership of or increased control over a firm’s competitors. Horizontal integration is widely used at the corporate level to help firms compete better in the industry.

Reasons to Use Horizontal Integration Strategy

Horizontal integration can be attractive for 2 main reasons.

First, having expanded horizontally allows firms for increased economies of scale and enhanced transfer of resources and competencies. Some purchased firms are attractive because they own strategic resources such as valuable brand names. Some purchased firms have a market share that is attractive.

Horizontal integration can also provide access to new distribution channels.

Second, considering horizontal integration alongside Porter’s five forces model highlights that such moves also reduce the intensity of rivalry in industry and thereby make the industry more profitable.

Mergers and Acquisitions in Horizontal Integration

Horizontal integration is the process of acquiring or merging with industry competitors in an effort to achieve the competitive advantages that come with a large size or scale.

An acquisition is a transaction involving two corporations in which one corporation completely absorbs the other using its capital resources (such as stock, debt, or cash), transforms it into an operating subsidiary or division. Acquisition usually occurs between firms of different sizes and can either be friendly or hostile.

A merger is a transaction involving two or more corporations in which stock is exchanged but only one corporation survives. The corporations agree to pool their resources in a combined operation. Mergers usually occur between firms of similar size and are usually friendly.

Mergers or acquisitions between direct competitors are more likely to create efficiencies than between unrelated businesses, both because there is a greater potential for eliminating duplicate facilities and because the management of the acquiring firm is more likely to understand the business of the target.

The result of wave upon wave of global mergers and acquisitions has been to increase the level of concentration in a wide range of industries. This has occurred because horizontal integration can significantly improve the competitive advantage and profitability of companies whose managers choose to stay inside one industry and focus on managing its competitive forces.

Despite the potential benefits of mergers and acquisitions, their financial results often are very disappointing. In general, mergers and acquisitions erode shareholder wealth while fewer increases shareholder wealth. Some of these moves struggle because the cultures of the two companies cannot mesh.

Guidelines to Effective Horizontal Integration

There are 5 guidelines that indicate when horizontal integration may be an especially effective strategy.

They are as follows: (1) When an organization can gain monopolistic characteristics in a particular area or region; (2) When an organization competes in a growing industry; (3) When increased economies of scale provide major competitive advantages; (4) When an organization has both the capital and human talent needed to successfully manage an expanded organization; and (5) When competitors are faltering due to a lack of managerial expertise or a need for particular resources that an organization possesses.

International Expansion with Horizontal Integration

With current globalization, horizontal growth is increasingly being used by many organizations through international expansion.

A corporation can select several strategic options for entering a foreign market or establishing manufacturing facilities in another country.

Strategy 1 – Exporting: which is delivering goods produced in the home country of the organization to other countries. The company could choose to handle all critical functions itself, or it could contract these functions to an export management company.

Strategy 2 – Licensing: which is granting rights to another firm in the host country to produce and sell a product, and the licensee, in turn, pays compensation to the licensing firm for technical expertise. The strategy is also important if the country makes entry via investment either difficult or impossible.

Strategy 3 – Franchising: which is granting rights to another company to open a retail store using the brand of the franchiser and its operating system. The franchisee in turn pays a percentage of its sales as a royalty. Franchising provides an opportunity for a firm to establish a presence in countries where the population is not sufficient for a major expansion effort.

Strategy 4 – Joint venture: which is a partnership between a foreign corporation and a domestic company that combines the resources and capabilities needed to develop new products or technologies. A joint venture may also be an association between a company and another in the host country. This is a quick method of obtaining local management and reducing the risks of expropriation or harassment by the host country’s government.

Strategy 5 – Acquisition: which is purchasing another company already operating in a specific international area. Generally, a wholly-owned subsidiary is more successful in international undertakings than are strategic alliances, such as joint ventures. Synergistic benefits can result if the company acquires a firm with strong complementary product lines and a good distribution network.

Strategy 6 – Green-field development: which is when a company builds its own manufacturing plant and distribution system. In general, firms possessing high levels of technology, multinational experience, and diverse product lines prefer green-field development to acquisitions. This strategy is usually far more complicated than acquisition, but it allows a company more freedom in designing the plant, choosing suppliers, and hiring a workforce.

Strategy 7 – Product sharing: often called outsourcing, which is a process of combining the higher labor skills and technology available in developed countries with the lower-cost labor available in developing countries.

Strategy 8 – Turnkey operation: which is typically a contract for the construction of operating facilities in exchange for a fee. The facilities are transferred to the host country when they are complete.

Strategy 9 – BOT: stands for Build-Operate-Transfer, which is a variation of the turnkey operation. Instead of turning the facility over to the host country when completed, the company operates the facility for a fixed period of time during which it earns back its investment plus a profit. It then turns the facility over to the government at little to no cost.

Strategy 10 – Management contract: which offers a means through which a corporation can use some of its personnel to assist a firm in a host country for a specified fee and period of time. Management contracts are common when a host government expropriates part or all of a foreign-owned company holding in its country. The contracts allow the firm to continue to earn some income from its investment and keep the operations going until local management is trained.

Benefits of Horizontal Integration

Horizontal integration results in 4 major benefits.

They are as follows: it (1) lowers operating costs, (2) increases product differentiation, (3) reduces rivalry within an industry, and/or (4) increases a company’s bargaining power over suppliers and buyers.

Benefit 1: Lower Operating Costs

Horizontal integration lowers a company’s operating costs when it results in increasing economies of scale.

Achieving economies of scale is very important in industries that have high fixed costs because large-scale production allows a company to spread its fixed costs over a large volume, which drives down average operating costs.

A company can also lower its operating costs when horizontal integration eliminates the need for two sets of corporate head offices, two separate sales forces, and so on, such that the costs of operating the combined company fall.

Benefit 2: Increased Product Differentiation

Horizontal integration may also boost profitability when it increases product differentiation.

Firms do this by allowing the combination of product lines of merged companies in order to offer customers a wider range of products that can be bundled together.

Product bundling involves offering customers the opportunity to buy a complete range of products they need at a single, combined price. This increases the value that customers see in a company’s product line, because (1) they often obtain a price discount by purchasing products as a set, and (2) they get used to dealing with just one company. For this reason, a company may obtain a competitive advantage from increased product differentiation.

Benefit 3: Reduced Industry Rivalry

Horizontal integration can help to reduce industry rivalry in 2 ways.

First, acquiring or merging with a competitor helps to eliminate excess capacity in an industry, which, often triggers price wars.

By taking excess capacity out of an industry, horizontal integration creates a more benign environment in which prices might stabilize or even increase.

Second, by reducing the number of competitors in an industry, horizontal integration often makes it easier to use tacit price coordination between rivals.

In general, the larger the number of competitors in an industry, the more difficult it is to establish an informal pricing agreement, such as price leadership by a dominant firm, which reduces the chances that a price war will erupt. Horizontal integration makes it easier for rivals to coordinate their actions because it increases industry concentration and creates an oligopoly.

Benefit 4: Increased Bargaining Power

Horizontal integration can help firms achieve more bargaining power over suppliers or buyers, which strengthens their competitive position and increases their profitability at their expense.

By using horizontal integration to consolidate its industry, a company becomes a much larger buyer of a supplier’s product; it can use this buying power as leverage to bargain down the price it pays for inputs, and this also lowers its costs.

Similarly, a company that acquires its competitors controls a greater percentage of an industry’s final product or output, and so buyers become more dependent on it. Other things being equal, the company now has more power to raise prices and profits, because customers have less choice of suppliers from whom to buy.

When a company has a greater ability to raise prices to buyers or to bargain down the price it pays for inputs, it has increased market power.

Limitations of Horizontal Integration

Horizontal integration does have certain problems and limitations. The gains that are anticipated from mergers and acquisitions may not be realized for a number of following reasons.

Limitation 1: Unsuccessful Merger and Acquisition

First, mergers and acquisitions may not be successful because of different company cultures, high management turnover in the acquired company when the acquisition is a hostile one or the tendency for managers to overestimate the benefits of a merger or acquisition or underestimate the problems involved in such operations.

Limitation 2: Antitrust Laws and Regulations

Second, when a company uses horizontal integration to become a dominant industry competitor, an attempt to keep on using the strategy may bring the company into conflict with antitrust law.

Antitrust authorities are concerned about the potential for abuse of market power. They believe that more competition is better for consumers than less competition. For industry companies to keep making acquisitions may allow them to raise prices to consumers above the level that would exist in a more competitive situation.

Antitrust authorities wish to prevent dominant companies from using their market power to crush potential competitors by cutting prices whenever new competitors enter a market and so forcing them out of business, and then raising prices again once the threat has been eliminated.

Because of these concerns, the government may consider blocking any merger or acquisition that they decide will create too much industry consolidation and so increase the potential for companies to abuse their market power in the future.

Resources

Related Concepts

References

Hitt, M. A., Ireland, D. R., & Hoskisson, R. E. (2016). Strategic Management: Concepts: Competitiveness and Globalization (12th ed.). Cengage Learning.
Hitt, M. A., Ireland, D. R., & Hoskisson, R. E. (2019). Strategic Management: Concepts and Cases: Competitiveness and Globalization (MindTap Course List) (13th ed.). Cengage Learning.
Hill, C. W. L., & Jones, G. R. (2011). Essentials of Strategic Management (Available Titles CourseMate) (3rd ed.). Cengage Learning.

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