Vertical mergers refer to a situation where a product manufacturer merges with the supplier of inputs or raw materials. In can also be a merger between a product manufacturer and the product's distributor.
Vertical mergers may violate the competitive spirit of markets. It can be used to block competitors from accessing the raw material source or the distribution channel. Hence, it is also known as "vertical foreclosure". It may create a sort of bottleneck problem.
As per research, vertical integration can affect the pricing incentive of a downstream producer. It may also affect a competitors incentive for selecting input suppliers. Research studies single out several factors, which point to the fact that vertical integration facilitates collusion. Vertical mergers may promote collusion through an outlets effect. A corollary of vertical integration is that integrated business structures are able to perform better in crisis phases.
There are multiple reasons, which promote the vertical integration by firms. Some of them are discussed below.
The prime reason being the reduction of uncertainty regarding the availability of quality inputs as also the uncertainty regarding the demand for its products.
Firms may also enter vertical mergers to avail the plus points of economies of integration.
Vertical merger may make the firms cost-efficient by streamlining its distribution and production costs. It is also meant for the reduction of transactions costs like marketing expenses and sales taxes. It ensures that a firm's resources are used optimally.
Bird's Eye View of US Laws Pertaining to Vertical Mergers
In USA the vertical mergers abide by the 'Clayton Act (15 U.S.C.A. § 12 et seq.)'. The transactions conducted here fall under the purview of antitrust acts.
It is interesting to note that vertical mergers do not lead to a fall in the number of operating economic agents at a particular market level. However, it may result in a change of industry behavior pattern.
At its worst suppliers might be faced with a loss of product market. The retail chains may run out of stock. Competitors may also face blockages for supplies as well as outlets.
Vertical mergers by virtue of their market power may effectively block new firms from entering the market thereby violating the competitive flavor of the market.
The Supreme Court of USA has given a ruling on just 3 cases pertaining to vertical merger under the “Clayton Act ( section 7 )” as per the latest available information.
In the first case the Court contradicted the general assumption that section 7 was not applicable for vertical mergers.
In the following vertical merger case the US Supreme Court observed that the primary disadvantage of vertical merger lies in the throttling of the spirit and essence of competition. Business rivals may be denied a fair chance at competition.
The Court observed that regarding vertical mergers two areas need close scrutiny and regulation.
One concerns the purpose and nature of the vertical merger arrangement. The other parameter concerns the industry concentration trend in that specific sector.
In the third judgment passed on vertical merger US Supreme Court quashed Ford's claim that its acquisition of Autolite had made the latter a better competitor.
Thus a vertical merger is a situation where a firm acquires a product supplier or a customer. Vertical mergers may at times violate the US federal antitrust laws.
Gist of European Commission Guidelines on Vertical Mergers
In 2007 the European Commission released a new set of guidelines for non-horizontal mergers. It can be noted that vertical merger is a type of non-horizontal merger. The Commission is the regulatory body overseeing the compliance aspect of firms going for vertical mergers.
The guidelines cited instances where conglomerate and vertical mergers significantly affected the competitive nature of the market.
The European Commission normally is not bothered about 'competition concerns' in what is commonly known as 'safe harbors'. The guidelines sets benchmarks for market share levels and concentration levels below which comes the 'safe harbors'. Market analysts consider this 'safe harbor' aspect of the new guidelines to be an innovative one.
Seen in overall terms the new guidelines from the European Commission aims at providing a transparent regulatory guideline framework for the business community as well as the legal fraternity.