Impact of Horizontal Integration on Performance

Does Horizontal Integration allow firms to achieve better performance?

Numerous research papers on horizontal integration have been written over the years but only in the last three decades had it gain traction and the attention of the wider community. Recent studies have consolidated the key issues of horizontal integration into namely, bargaining power (market power) and efficiency. Interestingly, both proponents and opponents of horizontal integration have used these two points in explaining their stand (2014, 1997). This review will adopt the definition of horizontal integration as “the strategy that a firm adopts by acquiring production units for outputs, either complementary or competitive and acquiring the power to exercise control” (Grossman, 1986). This review seeks to provide a concise analysis on the trade-off between the benefits and costs of horizontal integration.

The execution of horizontal integration by firms allows them to consolidate and anchor the firm’s position in the industry (Moatti, 2014). This reduces the number of competitors in the market and allows the newly integrated firm to play an influential role in the industry (1997). The will result in an increased of the bargaining power of the firms. Firms can wield their newly acquired power to renegotiate the terms of contracts with their suppliers and adjustment of retail prices that consumers pay. The threat of changing suppliers and reduction in choices for consumer further complements the increased in power the firms possess (Moatti, 2014). In addition, by anchoring the firm’s position in the industry, it allows them to navigate through undesirable changes or situations that are beyond their control. The pre-cursor of a horizontal integration is often the promise to existing shareholders of the anticipated increased in profits of the firm.

The economic rationale of horizontal integration stemmed from the opportunity to reduce costs through the increased in bargaining power. Firms are able to exploit economies of scale: reducing cost and maximising prices (Capron, 1999), resulting in an increased in profits. Capron (1999) continues to state that the improvement in cost efficiency contributes to an appreciation of firm’s value. In addition, the integration of firms provides an avenue for information sharing and transferring/redeployment of knowledge and skills (Moatti, 2014). Horizontal integration can also open up a firm’s access (preferential access) to resources that was not available before. Essentially, the transferring of knowledge and skills increased the efficiency of firms in generating revenues as well as boosting firm’s value.

Horizontal integration expands the geographical scope of the firms, increasing the firm’s consumer base. Integration opens up the firm’s access to foreign markets by acquiring rivals firms that originate from foreign countries. Firms can opt to retain the acquired rival’s brand to prevent disruption to consumers (Grossman, 1986). The increase of the firm’s global footprint leads to an increase in consumer base, which will translate to an increased in firm revenues and brand recognition globally. Studies by (1997) also reveal that the consolidation of firms helps in stabilising the industry structure and aid in the development and expansion of the industry while reducing adverse or undesired changes. Financial theories subscribe to the preference for stable growth in a firm and industry instead of constant fluctuation in the industry.

However, the exact reasons for horizontal integration: bargaining power and efficiency have also raise the arguments that this strategic move is not attractive and viable. Even though increased in bargaining power can boost the influential role of the firm, evidence have also surface suggesting that such benefits are only temporal and not permanent (Moatti, 2014). Opponents argue that rival firms will execute similar retaliation strategies to secure their position in the industries. Moatti (2014) classify such retaliation move as “herding behaviour”. When rivals retaliate, the initial benefits will be reduced and eventually saturating throughout the industry; cancelling out the benefits of increased bargaining power.

Furthermore, there has been no substantial evidence suggesting that newly integrated firms will engage in oligopolistic practices by exploiting their increased in bargaining power (Eckbo, 1983). There is also no significant evidence that conclude that such strategy have resulted in a fall in rival firm’s value. With this result, this review can conclude that integrated firms have not exploit their increased bargaining power or that the advantages have been diffuse away through rival’s retaliation; the latter appears more apparent.

The consolidation of assets (physical and intangible assets, knowledge) in the newly integrated firm may necessarily result in economies of scale. Firms may not have the required expertise and capacity to adjust their operations with the sudden expansion of firm’s size (Moatti, 2014). In addition, there is also the possibility of acquiring redundant assets, reducing rather than increasing efficiency of the firm. Other than acquiring redundant assets, the newly integrated firm may also inherit post-integration issues. Grossman (1986) suggests the inheritance of internal management issues, such as staff turnover and workforce disruption. Firms may need to spent considerable resources to re-organise the firm structure and management, which defeats the purpose of horizontal integration: improved efficiencies.

Lastly, all firms have the potential of being a targeted firm for horizontal integration. Any news or rumours of potential acquisition exposes the vulnerability of the firm and can reduce the share prices and value of the targeted firm. Whether the firm gets takeover eventually will not matter as the threat alone can caused a fluctuation in the firm’s value (1997).

The papers analysed have revealed that horizontal integration will impact firm’s performance through bargaining power and efficiency; both positively and negatively. Both variables reflect two of the fundamental factors of a firm market advantage. Pricing advantage through the increase in bargaining power with respect to both suppliers and consumers and a revenue maximising advantage resulting from greater efficiency. However much these advantages, opponents of horizontal integration have also raise serious doubts on this strategy. The cancellation effect of the gains through increased bargaining power as well as the prospect of internal management issues that the firm will experience. In view of this opposing stand, this review would like to acknowledge the deficiencies of the papers reviewed that those studies carried out were specific to an industry or a group of related industries. Further studies need to be carried out to further investigate the validity of the trade-off between size of the firm (horizontal integration) and the resulting effect of the firm’s performance. In addition, the study must be aware that different industries operate in different market conditions and structure. In view of the points raised, this review is inclined towards the hypothesis that in general, horizontal integration does not carry along significant improvement in firm’s performances.

Bibliography:

Capron L. 1999. The Long-Term Performance of Horizontal Acquisitions. Journal of Strategic Management. Vol 20. pp 987-1018.

Eckbo E. 1983. Horizontal Mergers, Collusion, and Stockholder Wealth. Journal of Financial Economics. Vol 11. pp: 241-273.

Grossman S and Hart O. 1986. The Costs and benefits of Ownership: A theory of Vertical and Lateral Integration. Journal of Political Economy. 94(4). pp: 691-719.

Moatti V, Ren C, Anand J and Dussauge, P. 2014. Disentangling The Performance Effects of Efficiency and Bargaining Power. Strategic Management Journal.

Pranger R. 1992. The Effects of Horizontal Merger on Competition: The Case of the Northern Securities Company. RAND Journal of Economics. 23(1). pp: 123-133.