Economic theory classifies mergers into three broad categories: 1. Horizontal 2. Vertical 3. Conglomerate
Horizontal mergers are combinations between two competitors. When Pfizer acquired Warner Lambert in 2000, the combination of these two pharmaceutical companies was a horizontal deal. The deal is an excellent example of the great value that can be derived from acquisitions, as Pfizer was able to acquire Lipitor as part of the package of products it gained when it acquired Warner Lambert. Lipitor, the leading anticholesterol drug, would become the top-selling drug in the world, with annual revenues in excess of $11 billion by 2004. This helped Pfizer maintain its position as the number-one pharmaceutical company in the world. This transaction was actually part of a series of horizontal combinations in which we saw the pharmaceutical industry consolidate. Such consolidations often occur when an industry is deregulated, although this was not the case for pharmaceuticals as it was for the banking industry. In banking this consolidation process has been going on for the past two decades. Regulatory strictures may prevent a combination that would otherwise occur among companies in an industry. Once deregulation happens, however, the artificial separations among companies may cease to exist, and the industry adjusts through a widespread combination of firms as they seek to move to a size and level of business activity that they believe is more efficient.
Increased horizontal mergers can affect the level of competition in an industry. Economic theory has shown us that competition normally benefits consumers. Competition usually results in lower prices and a greater output being put on the market relative to less competitive situations. As a result of this benefit to consumer welfare, most nations have laws that help prevent the domination of an industry by a few competitors. Such laws are referred to as antitrust laws in the United States. Outside the United States they are more clearly referred to as competition policy. Sometimes they may make exceptions to this policy if the regulators believe that special circumstances dictate it. We will discuss the laws that regulate the level of competition in an industry later in this chapter.
Sometimes industries consolidate in a series of horizontal transactions. An example has been the spate of horizontal M&As that has occurred in both the oil and pharmaceutical industries. Both industries have consolidated for somewhat different reasons. The mergers between oil companies, such as the merger between Exxon and Mobil in 1998, have provided some clear benefits in the form of economies of scale, which is a motive for M&As that we will discuss later in this chapter. The demonstration of such benefits, or even the suspicion that competitors who have pursued mergers are enjoying them, can set off a mini-wave of M&As in an industry. This was the case in the late 1990s and early 2000s as companies such as Conoco and Phillips, Texaco and Chevron merged following the Exxon-Mobil deal, which followed on the heels of the Amoco-BP merger and occurred at roughly the same time as the PetroFina-Total merger.
Vertical mergers are deals between companies that have a buyer and seller relationship with each other. In a vertical transaction, a company might acquire a supplier or another company closer in the distribution chain to consumers. The oil industry, for example, features many large vertically integrated companies, which explore for and extract oil but also refine and distribute fuel directly to consumers. An example of a vertical transaction occurred in 1993 with the $6.6 billion merger between drug manufacturer Merck and Medco Containment Services—a company involved in the distribution of drugs. As with horizontal transactions, certain deals can set off a series of other copycat deals as competitors seek to respond to a perceived advantage that one company may have gotten by enhancing its distribution system. We already discussed this concept in the context of the oil industry. In the case of pharmaceuticals, Merck incorrectly thought it would acquire distribution-related advantages through its acquisition of Medco. Following the deal, competitors sought to do their own similar deals. In 1994 Eli Lilly bought PCS Health Systems for $4.1 billion, while Roche Holdings acquired Syntex Corp. for $5.3 billion. Merck was not good at foreseeing the ramifications of such vertical acquisitions in this industry and neither were the copycat competitors. They incorrectly believed that they would be able to enhance their distribution of drugs while gaining an advantage over competitors who might have reduced access to such distribution. The market and regulators did not accept such arrangements, so the deals were failures. The companies simply could not predict how their consumers and regulators in their own industry would react to such combinations.
Conglomerate deals are combinations of companies that do not have a business relationship with each other. That is, they do not have a buyer-seller relationship and they are not competitors. Conglomerates were popular in the 1960s, when antitrust enforcement prevented companies from easily engaging in horizontal or even vertical transactions. They still wanted to use M&As to facilitate their growth, and their own alternative was to buy companies with whom they did not have any business relationship. We will discuss this phenomena more when we review merger history. Also, we will discuss diversifying deals in general in Chapter 2 on merger strategies. We will find that while some types of diversifying mergers promote shareholder wealth, many do not. We will also see that even those companies that have demonstrated a special prowess for doing successful diversifying deals also do big flops as well. General Electric (GE) is a well-known diversified company or conglomerate, but even it failed when it acquired Kidder Peabody. Acquiring a brokerage firm proved to be too big a stretch for this diversified corporation that was used to marketing very different products. The assets of brokerage firms are really their brokers, human beings who walk in and out of the company every day. This is different from capital-intensive businesses, which utilize equipment that tends to stay in the same place you put it. With a brokerage firm, if you do not give the “asset” a sufficient bonus, it takes off to one of your competitors at the end of the year. If you are not used to dealing with such human assets, this may not be the acquisition for you. It wasn’t for GE.
Click Here To Purchase This Book