When it comes to growing a business and expanding its market presence, there is essentially one of two methods carried out: organic growth and acquisition. When concerned with an acquisition there are essentially three approaches that can be carried out. Over the next few weeks we will discuss the vertical acquisitions and diagonal acquisitions, today I will discuss horizontal acquisitions, which are often referred to as mergers.
A merger is when two companies that are in similar stages in their growth and both usually obtain similar products or services – revenue generators, then those two companies combine their assets and liabilities creating one single company. This is beneficial for both companies because now they can eliminate inefficiencies by combining, which usually results in decreasing, overhead costs while maintaining the same level of revenue. This expansion also has the potential to dramatically increase economies to scale, which means that it can obtain greater cost advantages.
A merger allows the newly formed company to reach new markets as well as increase the presence within the market it already resided in. One recent example of a merger is a deal that is being featured by one of Deal Capital’s partners. This private equity group is seeking to acquire numerous IT consulting firms that all contain various specialties in serving their clients. While all are focused on consulting within one specific service in the IT market, each contains a niche focus within that service.
This partner sees the value that the IT consulting companies provide, however, it also sees the inefficiencies that are created due to the overhead of each company. By combining each of the companies together and acquiring the sum of the niche services provided while decreasing the excessive overhead costs, the resulting company is able to be much more profitable with the same level of revenues.
Although not all mergers are similar companies as was reflected in the merge between K-Mart and Sears, but that is just how I referred to it in the article. This week we will discuss a vertical acquisitions, also know as vertical integration.
Vertical acquisitions are typically when a company buys out one of its suppliers. For example, when if a manufacturing company purchases a product that is partly developed, and then continues to build that product before selling it further, if the manufacturer buys out its supplier that would be a vertical acquisition. This type of strategy is can have a number of benefits, especially when the acquiring company is afraid of its supplier raising prices.
This strategy contains many benefits because it allows continued decreases in the price of production due to the combination of various stages of production into one location, thus allowing a greater utilization of overhead costs and a decrease in transpiration costs. It can also allow information to flow more freely increasing efficiency. One last point I will emphasize, although there are many, is that it cuts the business-to-business costs increasing bottom line profitability for both entities.
When deciding whether to make a horizontal acquisition of a vertical acquisition it is important to consider what types of advantages you would like to pursue. Do you want to decrease your profits and increase efficiency at what you are doing, or do you want to increase the quantity and expand your reach by acquiring new geographic markets. It may be that one strategy is good for your business now and the other is good for your business later. If you have having troubles deciding which strategy is best our M&A consultants are more than ready to assist you in making that difficult decision.
If you are considering an acquisition strategy, or if you are looking for an exit strategy, Deal Capital and our experienced professionals tied with our widespread connections can assist you in identifying and executing the strategy that will be the most beneficial to you.