Mergers and acquisitions continue to help the big get bigger in an effort to reduce costs, reach more customers and expand their product lines.

Big companies are getting even bigger, mainly through mergers and acquisitions (M&A), which is resulting in continuing fast-paced consolidation in various industries. The main driver for M&A has become achieving economies of scale, which means that companies look to earn higher margins on each additional unit produced or sold. Economies of scale are most prominent when an industry has high input costs, which easily diminish when inputs are bought in bulk or if a company integrates vertically with its suppliers. Although consolidation involving vertical integration has been occurring for many years, (and continues to occur), this article will focus on the significant increase in horizontal integration – the integration between companies that produce similar products within the scope of a single industry.

In addition to economies of scale, other factors that encourage horizontal integration include:

  • brand alignment
  • market reach expansion
  • globalization
  • downstream consolidation.

Companies seek to acquire brands that fall into their portfolio naturally, either to diversify or to narrow in on a specific market. Meanwhile, growth through market reach expansion is particularly enticing to brick-and-mortar industries. A quick review of how some industries have evolved over the last several years can provide an interesting perspective to demonstrate the effect of strategies initiated and deployed in furthering horizontal integration via each of these areas.

Economies of Scale

Food Service Contractors specialize in facility management for organizations that demand regular food services, including hospitals, schools, nursing homes and stadiums. The top four companies are all global players and generate 93.2% of all industry revenue, having increased market share by more than 14% since 2007. Recently, major company Aramark merged with RMK Acquisition Corporation, and industry leaders Compass and Sodexo have also been very active in acquisitions. Consolidation in this industry is occurring because of significant returns to scale for large operations, which are able to purchase food in bulk and centralize costs like insurance and human resources. This industry is experiencing increasing globalization, which is also driving M&As.

Also the trend in Warehouse Clubs and Retail Supercenters (which include stores that sell general line of grocery products and merchandise items) are consolidating. In Canada, the acquisition by Loblaw of Shoppers Drugmart / Pharmaprix is an example where low prices and large scope of merchandise is one of the main reasons retail industries like grocery stores and larger scale pharmacies are consolidating. Consumers prefer to shop at large supercenters for products rather than specialized retail shops because of low prices and access convenience.

Other stores such as Wal-Mart are expanding their Supercenters and Costco continues opening new retail outlets as consumers increasingly demand the products they retail and the low prices they offer. Larger companies increase their buying power by buying in bulk, and then lower prices are then passed on to consumers. Larger retailers are also better able to control product distribution as economies of scale tends to produce increased efficiency, and bigger companies are able to improve profit margins and their ability to control inventory on hand.

Branding Alignment

The four largest distilleries have increased their market share by more than 20% over the past five years, mainly through acquisitions. These companies now generate almost 90% of the entire industry revenue. Pernod Ricard used to be a relatively smaller player and only controlled about 10% of the US market in 2006, led the field in acquisition. Pernod’s strategic purchase of Vin & Spirits in 2008 boosted its market share to 12.5% despite some divestitures at the very same time. Shifts in company market share are mainly the result of branding strategies, which are the drivers for distiller M&A activity.

The number of companies in the Cigarette & Tobacco Manufacturing industry decreased by an estimated 14 firms over the last five years. This industry is extremely competitive with high profit margins, which incentivizes companies to expand market shares. While consumers have shied away from certain tobacco products because of their negative public perception and the negative health effects of smoking, larger firms have merged and acquired smaller firms. Large firms buy smaller companies because having a variety of branded products is extremely important for survival in this industry. With a variety of tobacco products, industry players can better adjust to changes in consumer preferences.

Larger firms have a competitive advantage in that they can use sales revenue from well-known products to promote emerging brands. Price and quality are tied together in such a way that many similar-quality products are often priced in a certain range. This nature intensifies competition in the arena, giving major players yet another advantage because they face decreasing costs per each additional unit produced and because they can buy inputs at cheaper bulk prices.

Expanding Market Reach

The Hobby and Toy Stores industry includes companies that sell a broad range of toy and hobby goods, such as traditional dolls and toys, electronic toys & games, hobby kits and craft supplies. In this highly competitive market, industry concentration horizontal consolidation has been on the rise and over the last 5 years, large players have grown market share considerably. With the increased pressure of revenue being taken by mass merchandisers and department stores, many companies have struggled with generating organic growth, and found it advantageous to increase their size through acquisition. For instance struggling Toys ’R’ Us acquired KB Toys and certain business assets of FAO Schwartz.

High market share is important in this industry because larger firms are more able to stock a wide range of products. By having a variety of merchandise, these stores may become more of a one-stop shop for families with toy and craft needs. In addition, larger stores are capable of having exclusive sales contracts with specific suppliers. Having exclusive rights to sell certain toys or games can be a large advantage in attracting more customers and by increasing their size, hobby and toy stores can offer lower prices by buying in bulk and provide a product range that is more diverse than external competitors, such as Target and Wal-Mart.

Future Consolidators

Although Urgent Care Centers and Vitamin and Supplement distributors are examples of industries not heavily participating in M&As currently, they represent two examples of industries that are more than ripe for M&A activity. Both these industries have strong growth potential and are not far behind the ones discussed above. The aging population will likely increase and encourage the acceptance of dietary supplements and a greater inclusion of alternative practitioners in healthcare. A shortage of primary doctors is expected to intensify in the next ten years, which could mean more limited access to healthcare and longer wait times for patients, which will likely result in a greater share of patients using urgent-care facilities.

Along with a strong growth potential, these two industries are ideal for M&A activity, as they have low concentration, moderate to high entry barriers and high profit margins. A straightforward way to gain market share in these profitable industries is to acquire competitors. Through acquiring other companies, vitamin and supplement manufacturer/distributors can increase their branding and their economies of scale. Through merging, urgent-care centers can also increase their branding exposure across geographical footprints along with their reach. Look for these industries to experience a greater degree of consolidation in the next five years.