UNDERSTANDING VERTICAL MERGERS
UNDERSTANDING VERTICAL MERGERS
Vertical Mergers
Vertical integration is a broader concept, referring to a business establishing control of multiple stages of the value chain. This can be achieved by either establishing a new business or gaining control of an existing independent business at a different level of the value chain. Vertical mergers are therefore a specific type of vertical integration. Examples of vertical mergers include a wholesaler acquiring a retailer of the same product; or a manufacturer of finished goods merging with a producer of raw materials used in the finished good’s production process. This article discusses the benefits of vertical mergers, the Competition and Tariff Commission’s approach to assessing such mergers and provides a practical case handled by the Commission involving a vertical merger that raised competition concerns and how these were addressed.
Benefits of Vertical Mergers
The primary strategic objective of vertical mergers is to achieve operational synergies, reduce costs and exert greater control over the production process. By establishing control over multiple stages of production within a single organizational structure, firms can optimize resource allocation, eliminate redundancies and enhance overall efficiency. This consolidation can streamline operations, improve productivity, and potentially increase profit margins. Despite these potential benefits, vertical mergers can pose competition risks. Controlling a downstream or upstream firm within the same value chain can lead to anticompetitive practices by the vertically integrated company, potentially harming competitors without such integration. The Commission thus becomes important in safeguarding competition when such mergers are proposed.
Assessment of Vertical Mergers by the Commission
Unlike horizontal mergers, vertical mergers are less likely to immediately remove a competitor from the market. However, they can still lead to anti-competitive effects such as input and customer foreclosure, and monopolistic behaviors that may stifle competition. To address these concerns, the Commission assesses vertical mergers for potential foreclosure of rivals at various levels of the value chain and reduced competition which ultimately leads to diminished consumer welfare. While vertical mergers may offer efficiency gains as discussed earlier, these types of mergers can also concentrate market power and a company’s control over multiple stages of production, potentially leading to reduced innovation, higher barriers to entry and decreased consumer choice. In practice, there are two types of foreclosures associated with vertical mergers namely input and customer foreclosure which the Commission assess.
Input Foreclosure
Input foreclosure arises when a vertically merged entity restricts access to or alters the supply terms and conditions of essential inputs or resources, thereby impeding competitors’ ability to operate effectively in the market. This type of foreclosure typically occurs when a supplier that is part of the integrated entity is a dominant firm and significant supplier in the market with considerable influence over the availability and pricing of essential inputs. There are two main types of input foreclosure: total input foreclosure where the upstream division of the merged entity completely ceases supplying inputs to its downstream rivals, and partial input foreclosure, where inputs are supplied to downstream competitors on less favorable terms than pre-merger. By foreclosing access to inputs, a dominant company can reduce competition, increase its market power, and lead to higher prices, reduced innovation, and higher barriers to entry for new entrants. Consequently, the Commission therefore assesses the ability of the merged entity to engage in input foreclosure post-merger.
Customer Foreclosure
Customer foreclosure occurs when a vertically merged entity’s downstream division sources inputs exclusively or on preferential terms from its upstream division, thereby limiting rivals’ access to customers. This can have detrimental effects, particularly when the firm is a significant or sole customer in the market, degrading competitors’ ability or incentive to compete due to a reduced customer base. Two main types of customer foreclosure exist namely total customer foreclosure where the downstream division ceases purchasing inputs from upstream rivals; and partial customer foreclosure, where the vertically integrated firm acquires products from rival suppliers at a lower price or sells products incorporating the upstream competitor’s input at less favorable terms to the final consumer. Consequently, customer foreclosure is a concern for the Commission, as it undermines firms’ ability to compete and may ultimately lead to reduced competition in the market.
Vertical Merger Case Handled by the Commission
In July 2022, the Commission received a merger notification of a proposed acquisition of 100% issued share capital in Charles Stewart Day Old Chicks (Pvt) Ltd by Shanksville Farming (Pvt) Ltd. The market affected by this merger was identified as the production and distribution of broiler chickens, as well as broiler and layer day-old chicks(DOC) in the whole of Zimbabwe.
The merger was categorized as vertical since the acquirer and target companies operate at different stages of the poultry value chain. Shanksville – the acquirer, is an investment holding company with interests in two subsidiaries namely Brand-Agro (Pvt) Ltd which manages a poultry out-grower scheme and procures inputs such as broiler DOC on behalf of farmers; and Sable Park Estates (Pvt) Ltd, which packages and distributes chicken products to retailers across Zimbabwe. The target company – Charles Stewart, is engaged in farming broiler and layer DOC, representing an earlier stage in the value chain.
Analysis by the Commission revealed that Charles Stewart is a dominant firm and market leader in the layer DOC market. It also showed that if the merged entity ventures into the business of rearing layer chickens to produce tables eggs post-merger, the merged entity will have access to layer DOCs that other players in the downstream market will not have. This will give an unfair competitive advantage to the merged entity thereby adversely affecting effective competition in the production of layer DOCs. Further, the proposed merger would limit access to layer DOCs by customers and may lead to price enhancement, and this may prejudice consumer interests.
In light of competition concerns that arose from that transaction, the Commission approved the transaction on the condition that Charles Stewart and its subsidiaries, shall continue to supply layer DOC to its customers on non-discriminatory terms and conditions that include inter-alia prices, quality and delivery terms. This ensured that foreclosure concerns raised in the examination are remedied. While vertical mergers generally pose less anticompetitive risk than horizontal mergers, they can still raise competition concerns, particularly input and customer foreclosure. The example of the Charles Stewart Day Old Chicks (Pvt) Ltd and Shanksville Farming (Pvt) Ltd merger has shown that the Commission applied conditions to remedy anticompetitive effects identified during the analysis.
