Firms: Types, Mergers & Scale
Microeconomic Decision Makers
Two firms can join together in a merger, which makes the combined firm larger. The syllabus expects the three types of merger, with definitions.
A horizontal merger is a merger between two firms in the same industry and at the same stage of production (for example, two car manufacturers, or one supermarket chain buying another).
A vertical merger is a merger between two firms in the same industry but at different stages of production. Backward vertical means joining with a supplier earlier in the chain (a car maker buying a steel producer); forward vertical means joining with a distributor later in the chain (a car maker buying a dealership).
A conglomerate merger is a merger between two firms in completely different industries (a food company merging with an electronics firm), usually to diversify and spread risk.
Common exam question
Naming the type of merger
Question: Name the type of merger two firms are making, or pick the main reason for a merger of unrelated firms (1 mark, multiple choice).
Set in 5 of the 13 multiple-choice papers. Place both firms on the chain from raw material to consumer. Two firms making the same product at the same stage merge horizontally. Firms at different stages of one chain merge vertically: forward when the buyer takes over a firm nearer the consumer (a timber company buying a furniture maker), backward when it buys a supplier. So a manufacturer joining a retailer of the same product is vertical, not horizontal, and a bakery buying the app its customers order through is forward vertical, not conglomerate. Firms in unrelated industries make a conglomerate merger, whose main gain is diversification (spreading risk), not economies of scale or market share.
| Merger type | Main advantage | Main disadvantage |
|---|---|---|
| Horizontal | Larger market share and economies of scale | May create monopoly power and reduce competition |
| Vertical (backward) | Secures and controls the supply of inputs | The firm must manage an unfamiliar stage of production |
| Vertical (forward) | Secures outlets and control over how the product is sold | The firm must run retailing it may not be skilled at |
| Conglomerate | Spreads risk across different markets | Managers may lack expertise in the new industry |
Common exam question
Benefits and drawbacks of a merger
Question: Identify or explain a merger's benefits, explain why it may raise prices, analyse why one may be blocked or fail, or discuss encouraging mergers (2–8 marks).
Asked in 5 of the 11 structured papers. Credited benefits are economies of scale and lower costs, lower prices, higher quality when the firms pool their strengths, extra capital, higher profit and international competitiveness; higher revenue is not accepted. For the economy, take each a step further: lower prices raise output and jobs, better quality raises exports.
The drawbacks are monopoly power, so higher prices because consumers cannot switch, less choice and innovation, jobs lost through rationalisation, and diseconomies of scale from poor coordination, control or cooperation. Link any cost rise to those diseconomies or to the merger's own cost, not just to the firm being bigger. Asked why a government may block a horizontal merger, define it first: the mark needs both the same industry and the same stage of production.