Horizontal Integration

Abstract

Horizontal integration is the expansion of a business, often through acquisition of other companies, in order to increase its production at a specific part of the supply chain, in contrast with vertical integration, which diversifies a company’s production along the supply chain. Both types of integration involve antitrust concerns, as they provide a means by which a business can control an anticompetitive share of the market. Mega-mergers among especially large companies have been a trend seen in many industries in the twenty-first century.

Overview

Horizontal integration is a process by which a business increases its production in the same part of the supply chain, typically through acquisitions or mergers of other similar companies. The supply chain is the system of activities implicated in delivering a product or service from the supplier to the end customer, for example, the purchasing of ingredients, rental of real estate, baking, and delivery of pizza to a customer. In this hypothetical supply chain, horizontal integration would consist of buying more pizza restaurants or expanding one’s own chain by opening more locations. Alternatively, horizontal integration could mean a third-party delivery service expanding to deliver pizzas from more restaurants, or a commercial real estate developer buying more shopping centers from which to rent storefronts to restaurants. One of the major trends in horizontal integration in the twenty-first century has been the increased concentration of media ownership.

Horizontal integration contrasts from vertical integration, which is when one business controls multiple stages of the supply chain in order to “eliminate the middleman” and increase productivity. In our pizza delivery example, this would mean the same company owning the land on which its restaurants are located, owning the restaurants, and running its own delivery service, or owning the food service wholesaler that provides the pizza dough and pepperoni, or the meat products company that makes the pepperoni, or the farms that raise the pigs and cows that are slaughtered to make the pepperoni. Vertical integration was especially associated with the rise of the industrial tycoons in the nineteenth century. Both horizontal integration and vertical integration allow a company to benefit from economies of scale, and both kinds of integration can lead to monopolies.

A monopoly is a condition of the market wherein a single company controls all or nearly all of the supply or trade of a specific product or service. In most countries, including the United States, monopolies are illegal except in special circumstances (providing water service to customers’ homes, for instance, is generally a monopolistic public utility), and certain actions that risk creating a monopoly require legal approval. For instance, buying out most of one’s competitors would not, by itself, create a monopoly, but the reduced competition could result in a single major player in the market driving prices down and making it too expensive for the remaining businesses to continue, causing their failure or dissolution and resulting in a monopoly subsequent to, but as a result of, those mergers and acquisitions. In the United States, the Department of Justice enforces antitrust (anti-monopoly) law at the federal level, and most states have some antitrust laws of their own. As a condition of the merger of Bayer and Monsanto, for example, Bayer was forced to sell parts of its business——seeds and pesticides—where bringing those products under the same corporate umbrella with those of Monsanto would create monopolistic conditions in the market.

Horizontal integration need not mean expanding business of the exact same type. For instance, the aforementioned pizza tycoon may decide that it makes more sense to open (or acquire) a number of hamburger or fried chicken restaurants rather than opening more and more pizza restaurants. Both businesses operate in the same part of the supply chain—providing food to the end customer—and in a similar part of the market (fast food/drive-through/delivery), but do not compete as directly with each other, provided there is a limit to how often most customers will buy pizza and that many of them will buy hamburgers or fried chicken for some of those non-pizza meals. Yum! Brands is a restaurant conglomerate that originated as the fast food division of PepsiCo before being spun off in 1997. Yum! owns Kentucky Fried Chicken (KFC), Pizza Hut, Taco Bell, and WingStreet, and at one time also owned D’Angelo Sandwich Shops, A&W Restaurants, Pasta Bravo, and Long John Silver’s. All of these restaurants occupy a similar fast food niche but offer different kinds of food. An ancillary benefit of this particular horizontal integration was the opening of locations that offer both Taco Bell and Pizza Hut, both Pizza Hut and KFC, or other combinations. Furthermore, PepsiCo’s original acquisition of these restaurant chains was itself an act of horizontal integration, as the soft drink manufacturer diversified its business concerns to include other parts of the food and beverage industry—PepsiCo also owns Naked Juice, Aunt Jemima, Tropicana, and Quaker, among other brands.

In the twenty-first century, mergers or proposed mergers of large companies seeking horizontal integration have included Heinz and Kraft Foods, in the processed foods market; Sysco and US Foods, a food service merger that was rejected by the federal courts over antitrust concerns; AB Inbev’s acquisition of SAB Miller to create the largest beer company in the world; Exxon and Mobil, and BP with Amoco and Atlantic Richfield, in the oil sector; Ford and Volvo, in the automobile industry; Alcoa and Reynolds Metals, in the aluminum industry; and Dow Chemical and Dupont, in the chemicals industry. A number of high-profile mega-mergers have resulted in consolidation of media.

The benefits of horizontal integration include economies of scale as well as efficiencies in overhead, as redundancies and areas non-essential to the new company are eliminated. Bayer Monsanto’s reorganization plans, for example, included a workforce reduction of 12,000 and the closing of an administrative office in Pennsylvania. A merged company also spends less on market research, research and development, and advertising than the sum of spending by its constituent parts. Should Taco Bell be interested in what new flavors Americans are interested in seeing in fast food restaurants, for instance, Yum! Brands can conduct research and focus grouping and simultaneously uncover information useful to developing products for Pizza Hut and KFC, rather than conducting the same extensive study three times.

While horizontal integration has advantages for companies’ bottom lines, industry consolidation can result in higher prices—due to lack of competition—and shrinking consumer choices. Further, ever-growing companies pose concerns beyond those of anti-monopolists. Critics concerned with the policy-making influence of giant corporations such as Bayer Monsanto point out that consolidating businesses also consolidates political spending and streamlines lobbying efforts.

Applications

After a federal court overruled the Department of Justice, telecom giant AT&T was approved in the summer of 2018 to take over media conglomerate Time Warner, whose assets included HBO, Warner Bros., Turner Broadcasting System, CNN, Cartoon Network, DC Comics, Otter Media, and stakes in Hulu and the CW. The conglomerate was subsequently renamed WarnerMedia. The purchase of Time Warner kicked off a round of bids by media giants seeking to acquire a group of assets sold off by 21st Century Fox. The package of assets included Fox’s cable networks (FX, FXX, the National Geographic Channel, and Fox’s regional sports networks), the 21st Century Fox and Fox Searchlight film studios, Fox television production, and stakes in Sky plc and Hulu. The remaining Fox media assets—Fox News, Fox Business Channel, and the sports networks Big Ten, FS1, and FS2—would be spun off into a new company. Intellectual property transferred with the Fox assets would include the film and television rights to X-Men, The Fantastic Four, and Deadpool, and Avatar, and hit TV shows The Simpsons, Modern Family, and This Is Us, among others.

The leading bidders for the Fox assets were Comcast and Disney. Both Comcast and Disney already owned parts of Hulu; the Fox buyout would give either of them a sufficient share to either attempt a takeover or be forced by other shareholders into a divestiture. Disney had, over the previous twelve years, acquired Pixar, Marvel, and Lucasfilm, giving them control of many of the most venerable franchises in American entertainment: not only the Disney and Pixar animated characters, but most of the Marvel comic book characters, the Muppets, Labyrinth and the Dark Crystal, the Star Wars universe, and the Indiana Jones franchise. These acquisitions had in part been a way to protect itself from the “Netflix effect,” an across the board drop in both ratings and subscribers from traditional and digital television services credited to the growing number of cord-cutters drawn away by streaming services, primarily Netflix.

Disney made the first official offer, with Comcast making a counter-offer. An agreement between Disney and Fox shareholders was reached in July 2018, with the merger expected to be on track for the middle of 2019, pending regulatory approval of various governments. Science fiction and comic book fans hailed the merger, because it potentially reunited the separate movie universes of the X-Men and the rest of the Marvel characters (Spider-Man having already joined the Avengers through a deal struck between Sony and Disney), not to mention the potential for crossovers among other properties—the Muppets versus Deadpool, or the like. But serious monopolistic concerns were raised. The AT&T acquisition of Time Warner was viewed as vertical integration, but the acquisition of the Fox assets by either Comcast or, especially, Disney, involves a great deal of horizontal integration, by putting numerous content creators, broadcasters, and streaming assets under control of the same company. In addition to the Fox film and television assets, Disney already owns considerable film assets as well as ESPN Networks (of which the Fox sports networks are the only significant competition in sports television) and the Disney-ABC Television Group, which includes ABC, half of A&E Networks (A&E and its sister networks, The History Channel and its sister networks, the Lifetime channels, and a number of international channels), ABC Family, BVS Entertainment (which controls a good deal of children’s television properties, from the Pink Panther to Marvel animation), the Disney family of cable channels, ABC’s television production assets, and nine ABC-owned television stations.

Advocates of such mega-mergers promote them as corporate reorganizations that cost a few executive-level jobs but ultimately benefit the consumer by reducing overhead costs and streamlining production (like the aforementioned Marvel rights situation). However, concentrated control has monopolistic effects even when an actual monopoly is not present, and reducing competition reduces quality and risk-taking. Movies provide a simple example. Many of Hollywood’s great successes were grounded in risk—Avatar (2009) and The Matrix (1991) required expensive new special effects, Ghostbusters (1984) was a strange blend of buddy comedy, action, and horror, Die Hard (1988) and Speed (1994) depended on audiences accepting as action heroes two actors who at the time seemed unlikely candidates for the role, the Lord of the Rings trilogy (2001–2003) and the Avengers movies (2012–) depended on a great deal of audience patience and investment, as well as costing an extraordinary amount of money to produce. When there are fewer competitors and less audience choice, risk taking is harder to justify from a bottom-line perspective.

In the case of the Fox acquisition, those hypothetical Marvel movies are offset by other likely developments: The acquisition enlarges Disney’s library to where its own streaming service may be viewed as a “Netflix killer”—that is, Disney may decline to license out Marvel, Star Wars, and other properties so that they are no longer available for streaming except through Disney’s own service. After acquiring Fox, Disney owned the films responsible for a full 50 percent of the 2018 box office, and the future availability of all these films will lie with Disney. Such a precedent was set by CBS in moving its new Star Trek series to its streaming service exclusively, using it as the carrot to attract subscribers. Netflix and other streaming services responded to the potential withdrawal of content by the media giants by investing heavily in new proprietary content, but Disney’s substantially deeper pockets could afford to pursue the same agenda for a long time.

Issues

Disney’s acquisition of Fox is an example of a horizontal mega-merger. It was preceded not only by the AT&T/Time Warner horizontal mega-merger, but the acquisition of NBC Universal by Comcast in 2013. Comcast’s purchase took over three years, from late 2009 until March 2013 when GE divested its remaining stake in NBC Universal, and resulted in Senate hearings to evaluate the antitrust implications of the deal. Comcast was at the time (and remains) the largest Internet service and cable television provider, and a condition of the acquisition was that they offer a low-cost, low-usage Internet service subscription, in order to avoid pricing low-income households out of service. Fewer than 1 percent of the eligible households took advantage of the offer.

Media companies can be broadly grouped according to whether they are content providers (movie and television studios, television networks), distributors (theater chains, cable companies, pay television networks like HBO, satellite television services like Dish), media-related tech companies (Apple, Amazon, Netflix), and wireless/telecom companies (Verizon, T-Mobile). A round of media mega-mergers, both proposed and actual, was inspired in the 2010s by the success of Netflix, the transition to digital television, declining movie theater attendance, smartphone ubiquity, and other tech-driven changes to the media landscape.

Mega-mergers are one contributor to the increased concentration of media ownership in the United States, which has transpired across industries. In radio, for instance, Clear Channel Communications (now iHeartMedia) aggressively acquired radio stations across the United States, eventually owning more than 1,200. While not considered a monopoly because of the local reach of such stations, these acquisitions nevertheless had a powerful effect on both the radio industry and the music industry; the latter by increasing Clear Channel’s leverage with record labels, and the former because Clear Channel programs were distributed to many local stations, standardizing radio programming across the country at the cost of local character and local jobs.

In 2013, two of the largest publishers in the United States merged to form Penguin Random House: the Penguin Group, the consumer publishing arm of Pearson PLC, and Random House, the largest paperback publisher in the world. The resulting company is owned 47 percent by Pearson and 53 percent by Random House’s parent company Bertelsmann, and controls about 25 percent of the book publishing business. Just as the aforementioned television media mergers were motivated by threats from Netflix, the Penguin Random House merger was motivated by changes to the bookselling and publishing landscape wrought by the success of Amazon and the decreasing sales in local bookstores.

Terms & Concepts

Conglomerate: A conglomerate is a large company consisting of numerous smaller subsidiaries operating in different industries, often formed in order to diversify a corporation’s financial interests or to create synergy among separate but interdependent business entities.

Economies of Scale: Economies of scale are advantages that accrue as the result of an increased scale (size, scope) of business operations; a simple analogy is the difference in profit from re-selling at $1.50 cans of soda purchased for $1 each versus by the case at $10 for 24 cans.

Horizontal Integration: Horizontal integration is a process by which a business increases its production at the same part of the supply chain, especially by mergers or acquisitions.

Mega-merger: The merger of two large corporations resulting in an entity large enough that the transaction must be approved by the federal government to assure that a monopoly does not result.

Merger: A merger is an agreement between two business entities to reorganize into a single new entity.

Monopoly: A company has a monopoly when it has complete or near-complete control of the supply or trade of a specific good or service. Monopolies result in practices that are damaging to consumers in the absence of rigid and comprehensive legislation, because in the absence of competition, businesses raise prices and can reduce quality without consequence. Monopolies are illegal under U.S. law except in specific circumstances (public utilities, for instance, and public services like the police and fire departments), though in practice mega-mergers and other business practices lead to circumstances that are monopolies in practice, or nearly so.

Vertical Integration: In contrast with horizontal integration, integrates different stages of production within the same company.

Bibliography

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Pellinen, J., Teittinen, H., & Järvenpää, M. (2016). Performance measurement system in the situation of simultaneous vertical and horizontal integration. International Journal of Operations & Production Management, 36(10), 1182–1200. Retrieved January 1, 2019 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=118451326&site=ehost-live

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Suggested Reading

Han, A., Ge, J., & Lei, Y. (2016). Vertical vs. horizontal integration: Game analysis for the rare earth industrial integration in China. Resources Policy, 50, 149–159. Retrieved January 1, 2019 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=120146643&site=ehost-live

Martín-Herrán, G., Sigué, S. P., & Zaccour, G. (2014). Downstream horizontal integration and multiunit dealership. International Transactions in Operational Research, 21(1), 81–101. Retrieved September 15, 2018, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=92764938&site=ehost-live

Tomanek, R. (2008). Strategies of transport horizontal integration and their influence on the competition. Journal of Economics & Management, 4, 137–148. Retrieved September 15, 2018, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=44109953&site=ehost-live