What this lesson teaches
I can define horizontal, vertical and conglomerate mergers and weigh their advantages and disadvantages.
Syllabus K343, 3.4.2. Mergers: definitions, examples, advantages and disadvantages of different types of mergers: horizontal, vertical and conglomerate
Make a guess
A coffee chain buys the roasting company that supplies its beans. What type of merger is this?
- A conglomerate merger of firms.
- A backward vertical merger.
- A horizontal merger of rivals.
Show the answer
A backward vertical merger.
The firms are at different stages of the same industry, and the coffee chain is buying its supplier.
A merger joins two firms: at the same stage (horizontal), different stages (vertical), or in unrelated industries (conglomerate).
A merger is when two firms join to form one. Firms merge to grow faster, cut costs, gain market share or reduce risk.
A horizontal merger joins firms at the same stage of production in the same industry, such as two airlines. It can create economies of scale and remove a rival, but may reduce choice and raise prices for consumers.
A vertical merger joins firms at different stages of the same industry. Backward vertical means buying a supplier, such as a car maker buying a battery maker. Forward vertical means buying a customer or outlet, such as a brewer buying bars. It secures supplies or outlets, but the firm may become less efficient without competition.
A conglomerate merger joins firms in unrelated industries. It spreads risk across different markets. But managers may lack knowledge of the new business.
Sort these
A bubble tea chain is planning a merger. Sort each deal by its type.
Groups: Horizontal, Backward vertical, Forward vertical, Conglomerate.
- It buys a travel agency.
- It buys a tea plantation in Taiwan.
- It buys a property developer.
- It merges with another drinks kiosk brand in malls.
- It buys a chain of food courts where it sells drinks.
- It buys the factory that makes its tapioca pearls.
- It buys a delivery app that brings drinks to homes.
- It buys a rival bubble tea chain.
Show the answer
Horizontal
- It merges with another drinks kiosk brand in malls. The two sell the same kind of product to the same customers.
- It buys a rival bubble tea chain. Both firms are at the same stage of the same industry, so this is horizontal.
Backward vertical
- It buys a tea plantation in Taiwan. It is buying a supplier at an earlier stage of production.
- It buys the factory that makes its tapioca pearls. Taking over an input maker moves the chain back down the supply chain.
Forward vertical
- It buys a chain of food courts where it sells drinks. It is buying an outlet closer to the final customer.
- It buys a delivery app that brings drinks to homes. The app gets the product to customers, a later stage than making it.
Conglomerate
- It buys a travel agency. Holidays and bubble tea are unrelated markets, which spreads risk but needs new know-how.
- It buys a property developer. Property has nothing to do with making or selling drinks, so the industries are unrelated.
- Horizontal merger
- Same stage, same industry; e.g. two airlines.
- Vertical merger
- Different stages; backward (supplier) or forward (customer).
- Conglomerate merger
- Unrelated industries; spreads risk.
Worked example: Classifying mergers
Decide which type each merger is.
- A ride-hailing app buys a rival ride-hailing app: horizontal. In 2018 Grab bought Uber's Southeast Asian business.
- A chocolate maker buys a cocoa farm: backward vertical.
- A clothing maker buys a chain of clothes shops: forward vertical.
- A property developer buys a food delivery firm: conglomerate.
Watch out for this
A vertical merger is when a firm buys a rival in the same business.
That is horizontal. A vertical merger joins firms at different stages of production, such as a supplier and a manufacturer.
Check your understanding
Two rival bubble tea chains combine into one firm. How would an economist classify this?
- Backward vertical, as one firm supplies the other.
- Horizontal, as both firms are at the same stage.
- Conglomerate, as the firms are in different industries.
Show the answer
Horizontal, as both firms are at the same stage.
Right. Both sell bubble tea to customers, so they join at the same stage of production.
Check your understanding
Which kind of merger takes place when a chocolate maker takes over a chain of sweet shops selling its bars?
- A forward vertical merger
- A horizontal merger
- A backward vertical merger, joining a supplier
- A conglomerate merger
Show the answer
A forward vertical merger
Right. The maker joins with a firm nearer the customer, at a later stage of its own production.