Synergy

Benefits achieved by combining companies

What is Synergy?

Synergy is the concept that the whole is worth more than the sum of the parts. This logic is typically a driving force behind mergers and acquisitions (M&A) where investment bankers and corporate executives will use synergy as a rationale for the deal. In other words, by combining two companies in a merger, their new combined value will be greater than each of them are currently worth individually.

 

Synergy explained in diagram

 

What are the different types of synergy?

There are generally two types of synergy that can be achieved in an M&A process: (1) cost savings, and (2) revenue enhancements.

Cost saving synergy can be achieved by eliminating redundant costs, having better bargaining power with suppliers and vendors, and improving efficiencies. Redundant costs frequently relate to people, such as not requiring two CEOs and thus firing one of them. Bargaining power with supplies can be improved by forming a larger company that has more leverage and ability to negotiate better pricing and better terms. Lastly, operational efficiencies may be realized by sharing best practices and streamlining processes across both companies.

Revenue enhancements can be achieved by cross-selling complementary products to customers, having more pricing power with consumers, and expanding or being able to enter into new markets and new geographies.

 

Examples of synergy in M&A

A classic example of deal synergy in M&A is the merger of Kraft and Heinz, announced in 2015.

According to the press release from Heinz,

“The significant synergy potential includes an estimated $1.5 billion in annual cost savings implemented by the end of 2017. Synergies will come from the increased scale of the new organization, the sharing of best practices and cost reductions.”

News articles following the deal commented that the term synergy typically involves closing offices, combining manufacturing facilities, and reducing the number of warehouses, which frequently means a reduction of staff and job losses.  For this reason, many employees who worked at Kraft and Heinz were worried about layoffs.

At the time, the combined businesses had approximately $28 billion of revenue, so the total synergies represented 5% of that.

 

Can synergy be negative?

Synergies can be negative (dis-synergies) if a merger or acquisition is poorly executed.  In many cases, forecasted cost savings actually turn into higher costs as two businesses fail to integrate properly.

According to a study by McKinsey, more than 60% of transactions fall short of the stated synergies they hoped to achieve, and some not only didn’t achieve their targets but actually experienced dis-synergies.

Part of the reason for over-optimism may be the desire to “sell a deal” to the markets or investors and ensure that it looks attractive enough.  There are plenty of reasons for managers and executives to want to acquire companies, even if it doesn’t create value.  Common reasons include empire building, ego boosting, and the justification of larger compensation packages (bigger companies pay higher compensation).

 

Additional resources

Thank you for reading the CFI guide to synergy in M&A transactions. CFI is the official provider of the Financial Modeling & Valuation Analyst certification.  To continue advancing your career as an analyst, these additional resources will be helpful:

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