Does a Vertical Merger Signal a Golden Age of Profits?

A vertical merger is a transaction that sometimes takes place with companies that are in a manufacturing industry. A vertical merger occurs when a company purchases another company that manufactures a critical part of their end product. For example, if you had a computer manufacturer purchase the company that makes the processors that they use in the computers, this would be a vertical merger. This type of transaction can greatly affect the profitability of the company and the investors in that company. Here are a few things to consider about the vertical merger and how it can impact shareholders.

Purpose

The major objective in a vertical merger is typically to reduce costs and increase overall profitability. By purchasing a company that has economies of scale in a certain component of your business, you are potentially going to be able to save a lot of money. By doing this, you are going to be able to eliminate the markup that is between you and your supplier. Many times, by doing this, you are going to be able to gain a competitive edge over others in the industry.

With your knowledge in the industry, you might also be able to help the company that was acquired perform more efficiently. You might have just enough resources to put into the company that it will help them a great deal. By doing this, you are going to be able to improve the parent company and the company that was purchased. 

Many times, companies rely on a particular supplier a great deal. Because of this, their business is directly impacted by the decisions that are made by another company. This tends to handcuff the company, and it makes it very difficult to run their business. If the company can come up with enough money to purchase the supplier, they can cut down on the amount of control the other company has over them. This will allow them to freely make business decisions without worrying about what another company is going to do.

Shareholder Impact

When there is a merger or acquisition, shareholders are usually going to like it because the price of the stock is going to increase in most cases. When you are dealing with a vertical merger, this is even more favorable for the shareholders. You are potentially going to be invested in a company that is much more efficient than it once was, which means more profits. Although it does not always work out perfectly, most of the time, shareholders are going to appreciate this move.

Example

One well-known example of a vertical merger was when Time Warner purchased Turner Broadcasting. This amounted to a cable company purchasing a company that owns several of the networks and comes up with a lot of the programming that is on them. When this happened, the FTC was a little skeptical, thinking that this could create a monopoly. The FTC went ahead and allowed it, but they did put stipulations on what the companies could and could not do.

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