Question

When two firms in the same industry form one larger company, this is a __________ merger. (LO4) a) horizontal c) conglomerate b) vertical d) diversifying

Short answer

a) Horizontal Merger.

Step-by-step solution

Define merger types

First, let's go through the different types of mergers presented in the options so that we have a clear understanding of each one: a) Horizontal Merger: A merger between two firms in the same industry that are at the same level of production. In other words, they are competitors that produce similar products or services. b) Vertical Merger: A merger between two firms in the same industry but at different levels of production. For example, a manufacturer may merge with a supplier to streamline the production process. c) Conglomerate Merger: A merger between two firms that operate in completely different industries. These companies often merge to diversify their business operations and maximize profits. d) Diversifying Merger: This term is somewhat ambiguous, as it could refer to either conglomerate mergers or mergers within the same industry that aim to expand the company's product or service offerings. Now that we have a clear understanding of all the different types of mergers, we can identify which one best matches the description from the exercise.

Choose the correct option

Based on the given description in the exercise ("when two firms in the same industry form one larger company"), we can narrow down the options to two possible answers: a) horizontal merger and b) vertical merger. Since the description does not specify any information about the level of production, we can conclude that the answer is: a) Horizontal Merger.

Key concepts

Types of Mergers

Mergers are a way for companies to join forces, often to achieve greater efficiency or tap into a new market. Understanding the types of mergers is crucial for grasping business strategies.

• Horizontal Merger: This occurs when two companies in the same industry, typically competitors offering similar products or services, come together as one. This type of merger often seeks to increase market share and reduce competition.
• Vertical Merger: This happens when companies from the same industry but different stages of production merge. Think of scenarios like a car manufacturer merging with a parts supplier. Here, the goal is to improve efficiency and reduce costs by streamlining production.
• Conglomerate Merger: This is a merger between businesses that operate in entirely different industries. Companies often pursue conglomerate mergers to diversify risks by not putting all their proverbial eggs in one basket.
• Diversifying Merger: Sometimes used interchangeably with conglomerate mergers, these might also occur within the same industry to broaden a company’s product or service range.

Each type of merger serves a specific purpose, often driven by market dynamics and operational needs.

Vertical Merger

A vertical merger combines two companies that operate at different stages of a product's life cycle within the same industry. By joining forces, these companies aim to enhance the supply chain from production to distribution.

• Supply Chain Efficiency: By merging with suppliers or distributors, businesses can cut down on logistic costs and improve inventory management.
• Increased Control: Gaining control over the supply chain allows companies to have better command over pricing, quality, and production timelines.
• Barrier to Entry: Vertical mergers can create an entry barrier for competitors by controlling vital components of the supply chain.

For example, if a smartphone manufacturer merges with a chipmaker, the manufacturer could ensure a consistent supply of chips, potentially reducing costs and improving product reliability.

Conglomerate Merger

Conglomerate mergers involve companies from completely different industries. Unlike horizontal or vertical mergers, these do not result in the joining of similar or interconnected operational processes.

• Risk Diversification: By expanding into various industries, a company can mitigate risks associated with market fluctuations within a single sector.
• Market Power: Often, firms pursue conglomerate mergers to gain market power over a broader range of industries, allowing them to influence a diverse set of market conditions.
• Resource Utilization: These mergers can increase the efficiency of utilizing resources by sharing capabilities, technologies, or knowledge across different sectors.

An example of a conglomerate merger could be a food and beverage company merging with a clothing retailer. The two businesses are unrelated operationally, but their alliance might result in a stronger financial position and expanded market presence.