Types of Mergers

What is a Merger?

A merger is an agreement between companies to combine operations into one company. Mergers have become a strategic tool for growth, market expansion, and competitive responses. 

There are various types of mergers, each motivated by numerous factors, including gaining competitive advantages, expanding market reach, and achieving economies of scale. From this, we can see different types of firms merging with others in manners specific to the situation.

We will discuss the different types of mergers, including horizontal mergers, vertical mergers, market-extension mergers, product-extension mergers, and conglomerate mergers, along with a few less common types.

Types of Mergers

There are five primary types of mergers:

• Horizontal mergers are mergers between competitors in a particular industry or product line. Combining forces will essentially eliminate one competitor and allow for a further combination of assets.
• Vertical mergers are mergers between companies along the same supply chain, feeding into operations. For example, a toy manufacturing company could buy a plastic manufacturer.
• Market-extension merger: These mergers are between two companies that sell similar products in different markets
• Product-extension mergers are mergers between companies in the same market but offer different products from one another.
• Conglomerate mergers are mergers between two businesses in unrelated business activities, such as a car company buying a clothing company.

Horizontal merger

A horizontal merger is a merger between companies operating in the same industry competing in the same market. The primary motive for horizontal mergers is gaining market power and allowing for more synergies through economies of scale.

Consolidation generally occurs in this stage, granting the merged company bargaining power and more favorable market positioning. By undergoing these mergers, big companies can become more extensive and compete in markets, challenging industry leaders.

Through economies of scale, lower operating costs will likely result from these mergers as companies can combine workforces, distributions, and other tangible and intangible assets.

Therefore, the primary motives and benefits include: 

• Increasing the company’s market share
• Reducing industry competition
• Realizing cost efficiencies through economies of scale

However, these merger types also have disadvantages. For example, the creation of a monopoly or oligopoly could have complications with:

• Harming the new company, as antitrust laws may have new regulatory implications 
• Merging complicated company cultures

A typical example is the $26 billion merger between T-Mobile and Sprint. Both cell-service providers offered the same service in the same marketplace. Still, they merged to gain economies of scale by merging cell-service equipment and market power by combining customer bases.

Vertical merger

A vertical merger is between two companies in different supply chain segments. It can involve two companies along a business's production, warehousing, or shipping process.

Companies usually perform these mergers to achieve quality control over the business, better information flows, and synergies in the supply chain.

A typical example is a car manufacturer merging with a radio company, so they have better synergies and high-quality radios to install in the vehicles.

Companies are critically motivated to pursue vertical mergers due to:

• Improved supply chain coordination. Eliminating the middleman in the supply chain, which allows for reduced costs and markups associated with dealing with third parties, is a primary benefit.
• Also, controlling more stages of the supply chain will grant a business more market power and control of its supply chain, allowing it to offer more high-quality products.

However, vertical mergers have disadvantages:

• Integrating the different levels of the supply chain is complex. 
• Firms may need help integrating upstream or downstream supply chain processes into their production process.

Most of the time, these deals are acquisitions rather than simple mergers between two corporations. A large company will typically acquire a smaller company that will streamline operations in the supply chain to make the existing large company’s operations operate more smoothly.

A real-world example would be the 2002 merger between PayPal and eBay. eBay’s acquisition of PayPal gave it the payment processing infrastructure that made online payments secure. 

Another prime example is the merger between Disney and Pixar. Disney's benign acquisition of Pixar allowed them to control more of the animation process in their movies, from the creation to the distribution of the products, and enhance their market position.

Market-Extension Mergers

A market extension merger is a merger between companies that sell similar products in different markets. Companies enter these agreements to gain a larger market share and customer base from the extension into new markets.

Market-extension mergers can also occur internationally if a firm wants to expand across country borders. These merger types most frequently happen in retail food distribution and banking operations. Rapid consolidations in these industries deter existing firms from expanding via wholly-owned subsidiaries.

This allows companies to:

• Expand their market reach by entering new markets and customer segments, potentially increasing sales from the new opportunity for growth. 
• Benefit the firm through synergies and cost savings.

However, disadvantages include:

• Cultural and operational integration challenges will surface from the companies' different market origins, which can also dilute their existing brands.
• Other regulations may govern different markets, posing a steep learning curve and a challenging operating environment.

A typical example would be a bank on the West Coast of the United States merging with a bank on the East Coast to grow its market share. Both banks offered the same services but operated in separate markets in different geographic regions. 

Another example is the merger between shipbuilding companies Wight Shipyard in the UK and OCEA in France, which allowed each firm new market access.

Product-Extension Mergers

Product-extension mergers are mergers between companies that sell related offerings in the same market. Companies will undergo this merger to combine products or services into a more excellent offering for the customer to make a better product and gain more customers.

Product-extension mergers are also known as ”congeneric” mergers. The overlap creates synergies between the two companies, where the bundled offerings have greater value than both products offered independently. For example, a car engine and a frame combined are worth more than those two items provided separately. 

The value created primarily arises from the following:

• Revenue synergies from selling the bundled products across customer bases
• Cost synergies, such as shared infrastructure or reduced duplication of efforts

This can help a company, as it will have a product offering that appeals to more consumers, creating more opportunities to cross-sell to them. It could also consolidate the firm's market position and gain more competitive power.

However, disadvantages exist in the:

• The complexity involved with merging different product lines and any associated brand dilution. 
• Integrating the product teams may pose challenges in efficiency and cultural implications. 

An example of this type of merger would be a Chicago software company offering marketing software combined with another company offering accounting software to create a comprehensive business management suite.

This combination would bundle the accounting and marketing software and capture more customers.

Conglomerate Mergers

Conglomerate mergers are between corporations that are unrelated in markets and operations. Two primary types exist:

1. Pure conglomerate mergers are mergers between unrelated companies operating in different markets
2. Mixed conglomerate mergers are between companies seeking product improvement and expanding into different markets

The most prominent risk in these mergers is the combination of operations between two big corporations that operate in different markets at a large scale. 

These mergers are usually a series of “bolt-on” mergers undertaken by large corporations to expand their product portfolio, service offerings, geographic reach, or market presence. Proctor & Gamble is an example of this, offering items from various consumer products.

The advantages of these mergers include:

• Diversifying firms' business risks
• Stable cash flows, as a booming market, can offset a struggling business unit.
• Access to new markets enables a more extensive customer base that allows companies to sell to more end-users; this will increase the total accessible market for firms and could increase sales.

Disadvantages surface from:

• The complexity involved in managing different business units 
• Requirement of new expertise and coordination with exciting business lines to function correctly in the conglomerate
• Neglecting existing successful units

Also, there is a risk of over-diversification that could lead to a business needing to be more efficient. If there are a large number of business units, there may be too many to keep track of, and the more units acquired, the less marginal benefit a firm will get from diversification

An example of a conglomerate merger is Amazon's 2017 acquisition of Whole Foods for $13.7 billion. Whole Foods is an organic supermarket, and Amazon is an online retailer. Both operate in different markets and offer various products.

However, the merger was mixed. Amazon could bundle its e-commerce capabilities with Whole Foods’ brand equity in the organic food space to make a compelling offering, potentially improving market share in online retail and supermarkets.

For example, a pure conglomerate merger would be a computer hardware company merging with Coca-Cola. The merger has no inherent reasons or benefits in product development or market consolidation. This is because no progress has been made in either market, and competition in both markets has not been affected.

Other Merger Types

Various other types of mergers also exist, and although they are less common, they are still utilized due to their business benefits. 

Reverse Merger

In a reverse merger, a private company typically merges with a public company, allowing the private company to become publicly traded without going through the traditional IPO process.

A famous example is the New York Stock Exchange acquiring Archipelago Holdings. 

SPAC Merger

A SPAC merger occurs when a SPAC (Special Purpose Acquisition Company) is traded publicly and uses public markets to raise the capital needed to acquire an existing private company. The existing company then becomes a public company. 

This is done to avoid the expensive IPO process for the existing private company, allowing for more accessible listings on public markets. These types of deals have become more popular over recent years. 

A prominent example of this type of merger is Diamond Eagle Acquisition Corp's acquisition of the DraftKings Sportsbook in 2019. At the time, Diamond Eagle had a market cap of $500 million, but it changed its name to DraftKings and went to market with a $3.3 billion market cap.

Acquisition Hire

The merger between two companies can also be motivated by acquiring top workplace talent in human capital. Talent and intellectual capabilities are growing in necessity, leading firms to acquire companies to ensure they possess the top industry talent.

This action is primarily undertaken in technology, as many technology companies need help hiring or maintaining top programming talent to stay relevant and produce quality products. 

An example would be Google’s 2012 acquisition of Milk, an app development company. Google undertook this acquisition solely to hire Kevin Rose, a famous entrepreneur. After this, Google shut down Milk and employed Rose and others to work on Google+.

Free Resources:

To continue learning and advancing your career, check out these additional helpful WSO resources:

• M&A Deal Structure
• Merger
• Merger Arbitrage
• Merger Monday
• Merger vs. Acquisition