Horizontal Integration - Coursework Example

?EXPANSION STRATEGIES Horizontal integration refers to firms merging or taking over those firms which are on the same level of the value chain of production. For example, if a retail store purchases or takes over another brand of retail store or reseller, it will be referred to as horizontal integration. Irrespective of what industry a firm or business operates in, if it is on the same value chain of production, any merger or take-over would be termed as a conglomerate as this would be an example of diversification. For example, if an apparel manufacturer buys an electronic chip manufacturing firm, it would be diversifying its presence in the corporate world. Moreover, if any firm buys or merges with any other firm which is at a different level of the value chain and the chain of production, it will be called vertical integration. There are two types of vertical integration namely: Backward vertical integration and forward vertical integration. Backward integration occurs when a firm merges with or takes over firms at an earlier level of the chain of production than itself. For example, when a big retail store such as Wal-Mart, purchases a factory or plant which processes and produces frozen food, it would be called backward vertical integration as Wal-mart is ensuring a stable and secure supply of frozen food. Backward vertical integration is helpful where the suppliers have a stronger network and a stronger negotiating power in the industry. On the other hand, forward vertical integration occurs when firms take over or merge with firms which are at a later level of the value chain of production. For example, if a raw material supplier buys a factory or when a clothes manufacturer opens up a retail outlet, it will be called forward vertical integration. Forward vertical integration opens doors of a steady revenue stream for firms. The supplier will no longer have to worry about the raw materials being unsold or unused as they can be utilized in the factory owned by the company itself. Likewise, through the factory’s own retail outlet, it does not have to worry about distributors and more so, more margins could be earned on the end product manufactured (Sandoe et al, 2001; Helpman, 1983; Blackmur,1990). Horizontal integration has both advantages and disadvantages over vertical integration and conglomerate mergers. ADVANTAGES OF HORIZONTAL INTEGRATION When a firm expands horizontally, it is likely to experience economies of scale from the increased output. Firms can increase their profitability as per unit cost decreases with the increased level of output. For example, if a huge retail store merges with another chain of retail store, it can achieve economies of scale in the form of more discounts from manufacturers owing to bulk purchasing. As the store would now technically be purchasing close to twice as much as it did before under one umbrella, it would receive large discounts from manufacturers as well. Similarly, if a manufacturing firm merges with another, not only this would be the merger of capital, assets and liabilities, but also the firm would now share each other’s competencies and specialties. This might even include more cost-efficient production processes, vendor relationships, discounts on bulk purchase of raw materials etc. Besides this, the business would also expand on its geographical reach to the market. For example, when the Royal Bank of Scotland merged with Faysal Bank in Pakistan, all of Royal Bank of Scotland’s network of branches and accounts spread throughout Pakistan came under Faysal Bank’s control and brand name. Unilever’s taking over of Polka ice-cream in Pakistan is another example of geographical expansion through horizontal integration. This gave them an easy access to the market of Pakistan. However, as opposed to vertical integration, firms might enter into businesses which are out of the scope of their operations and specialization. This could misallocate resources into less profitable ventures if not unprofitable and even lead to money being drained on the losses incurred from inefficient operations and the firm being amateur in the business environment (Tabrizi, 2007). Secondly, horizontal expansion can be used to create synergies amongst common resources used by the firm. Coming back to the example of the retail store merger, the store would now be carrying more brands in all categories and hence, would be required to place bulkier orders to keep all the stores stocked. These bulk purchases would help the firm avail more discounts than before. Likewise, the human resource can be reshuffled as per the employees’ skill set. More ideas could be generated by the business. Production processes and other operations could be made more efficient owing to focusing on strengths of the two firms’ operations and minimizing the adverse effect from the weaknesses. Vertical integration on the other hand involves entering the later or earlier stage of value chain. This would mean that all of the resources such as human resource, plant and machinery and even land in the case of agro-based products, do not have enough mobility to be used interchangeably and hence, help firms benefit from creating synergies (Harrigan, 2003; Broadway, 1966). Expanding through horizontal integration would give the firm more market share. Be it manufacturing or retailing, horizontal integration would widen the customer base of the business. Coming back to the example of the merger of Faysal Bank and Royal Bank of Scotland, all the accounts of the Royal Bank of Scotland automatically came under the flag of Faysal Bank. Besides this, if a manufacturer purchases another manufacturer, it would only be increasing its revenue as the customers of the business which will have been taken over, would involuntarily become the customers of the company which has taken over. With YouTube, being purchased by Google, has increased the share of users of the Google group on the internet. In case when the industry is small, such horizontal integration would give the firm a strong negotiating power both when it on the buyer end (in case of raw material or supplies) and as well on the seller’s end (in the form of an oligopoly). Horizontal mergers increase the firm’s share of voice in the market. However, vertical integrations tend to make the firm internally strong in its value chain. It does not open ground breaking access to the market for firms however it does create a channel of other revenue streams for the firm. For example, a plastic producing firm may purchase a petrochemical plant which supplies polymer and other raw materials which are used to make plastic. Now, this not only would ensure a steady supply of raw materials but would also create more revenue stream as the raw material factory would also be supplying to other plastic manufacturing firms. However, vertical integration, as stated above, does not have a direct impact on the market share of the firm as it is moving either back or forth on its value chain. In case of a manufacturer opening up its own retail stores rather than selling through distributors, it would again be called as entering a different market by deciding to cater to the end consumer. This would again take a lot of research along with experience to be able to successfully penetrate a new market with different customers (or consumers rather than just customers) (Blackmur,1990) . When firms take over or merge with those businesses which are on the same level of value chain, it not only gives them access to a wider market, but also becomes the source of global expansion. Johnson and Johnson’s prime strategy of expansion is taking over running businesses in different countries. Setting up a factory or a separate business unit independently would not only cost a fortune, but also expose the firm’s investment enormous risk of failure as the firm will not be used to or aware of the local business environment prevalent in the area. Horizontal integration in this scenario proves more fruitful as running firms are already operating in the industry and are well aware of all the norms. Therefore, not only a firm can expand in the global arena but also save on additional costs and protect itself from incurring losses. In the past, many conglomerates have involved mergers and acquisitions of running businesses rather than companies diversifying independently. One of the primary advantages of horizontal integration is that it saves the company, costs of international trade. For example, any product made in some other country will not have to shipped all the way to another country and make it expensive by additional transportation costs, customs duty, taxes etc. With presence in those countries which have a high demand of a product, firms can save extra costs and hence benefit fully from international trade. Vertical integration on the other hand does not expand the firm’s market on the same value chain therefore it is not capable of serving the purpose of international expansion where costs from international trade can be minimized (Broadway, 1966; Harrigan, 1983). DISADVANTAGES OF HORIZONTAL INTEGRATION Many critiques argue that horizontal integration does not create or add to the value. Achieving synergies in resources often is merely theoretical as each company operates in its own unique way and therefore, resources cannot be used interchangeably. Moreover, it may also increase costs for the business eventually as it may become difficult to manage to merge a diverse range of company values and established processes into one without compromising on the other. Moreover, workers might be laid off because of shuffling and most importantly, merging the higher management and the hierarchy levels of the two organizations would be a painstaking task as some levels will have to be eliminated. Vertical integration on the other hand, is bound to improve profitability of the business. When a manufacturer would take over a supplier, it can ensure a steady supply of raw materials and that too at lower prices. With this, per unit cost of the firm fall and hence, one unit would now be able to earn more profit for the firm. Similarly, when a clothing manufacturer would open up its own chain of stores, not only it would be ensuring a direct revenue stream, but would also be able to earn the retailers’ margin hence, making the value chain more profitable for the business (Nupponen, 1995; Gaughan, 1996). As stated above, implementing a horizontal strategy would be painstaking. Unlike Unilever, a corporate conglomerate, a pure horizontal integration would involve two separate brands, with their own set of values, practices, marketing techniques. Either brand may have to lose its identity to the either one. Or a whole new separate brand might be the outcome of the merger. In most cases, it is the one alpha brand which prevails and the business has to lose on the market which the other brand was targeting. The idea of expanding the market size through horizontal integration might not work altogether. In contrast to this, vertical integration strengthens a business internally. There are fewer complications as the acquired business has its separate ground. There is no clash of interest and the usual business process does not have to be revamped (Harrigan, 1983; Gaughan, 1996). Horizontal integration reduces competition on the market as one player would merge with another player to cater to the same market. If the industry is competitive with a large number of sellers and the consumers dominating the market, then the merger can take place without the authorities taking special interest. However, when the industry is comparatively small or when there a fewer players in the market, then the merger might even go against antitrust laws. Most economies discourage monopolies and would rather have a competitive environment in a mixed economy. Therefore, a merger would eventually lead to government taking steps to restrict the firm’s activities with anti-competition laws, taxes etc. Eventually, the firm would have been better off without the merger in the first place. Vertical integration on the other hand might also invite a few concerns from the government about the practices of the new merger. However, they will not be as restrictive as antitrust laws which would result from merging with a competitor (Nupponen, 1995; Broadway, 1966). CONGLOMERATE Conglomerate mergers are firms merging with those businesses which belong to a different industry altogether. For example, Samsung can be called a conglomerate as it has firms in the construction industry and is also globally known for its electronic items too. Besides that, Johnson and Johnson is another example of a conglomerate with its presence in personal care and hygiene products besides marking its presence in the pharmaceutical industry globally. Conglomerate mergers help firms diversify its range of operations. As opposed to being focused on only one business, conglomerates ensure that if one business of the group is not profitable, it will always have one or the other business making up for the lesser profitable one(Harrigan, 2003). CONCLUSION Diversification is considered healthy however a business may make sure that it has enough experience in the industry and in its related sub-sectors before it invests in them. It is always advisable for firms to expand in the sub-sector of the industry in which it has expertise. For example, Sony marks its presence in almost every category of electronic items. From cameras to LED TVs, from music systems to cell phones, Sony makes itself a perfect example of sensible diversification. The point is not which way of expansion to choose to gain more revenue. But it is to establish a corporation which will reap benefits in the long-run, be it gaining internal strength through vertical integration or by being more aggressive through horizontal integration (Sandoe et al, 2001; Helpman, 1983).  REFERENCES SANDOE, K., CORBITT, G., & BOYKIN, R. (2001).Enterprise integration. New York, Wiley. NUPPONEN, P. (1995). Post-acquisition performance: combination, management, and performance measurement in horizontal integration. Helsinki, Helsinki School of Economics and Business Administration. HELPMAN, E. (1983). The multiproduct firm: horizontal and vertical integration. Cambridge, Mass, Dept. of Economics, Massachusetts Institute of Technology. HARRIGAN, K. R. (1983). Strategies for vertical integration. Lexington, Mass, Lexington Books. BLACKMUR, D. (1990). The strategic management of vertical integration: theoretical perspectives and empirical evidence. [Brisbane], University of Queensland, Dept. of Economics. HARRIGAN, K. R., & HARRIGAN, K. R. (2003). Vertical integration, outsourcing, and corporate strategy. Washington, D.C., Beard Books BROADWAY, F. E. (1966). The management problems of expansion. London, Business Publications. TABRIZI, B. N., & TSENG, M. M. (2007). Transformation through global value chains: taking advantage of business synergies in the United States and China. Stanford, Calif, Stanford Business Books AAKER, D. A. (1992). Developing business strategies. New York, Wiley GAUGHAN, P. A. (1996). Mergers, acquisitions, and corporate restructurings. New York, John Wiley & Sons. Read More