The term synergistic is derived from synergy, which refers to the benefit that results from the merger of two agents who want to achieve something that neither of them would be able to achieve on their own. The term is mostly used in mergers and acquisitions (M&A), where two companies merge to form one company that can generate more revenues or streamline the two companies’ operations and save on costs.
The potential synergy is considered when two companies are planning to merge or a large company is planning to acquire its smaller competitor and thereby increase the efficiency of its operations. The expected synergy is measured in terms of the potential to increase revenues, add technology, or to reduce costs.
Types of synergistic effects
Corporate synergy refers to the benefits that two firms are expected to gain when they merge or when one firm acquires another. The synergistic effect of such transactions often forms the basis of the negotiations between the seller and the buyer.
The following are the main types of synergies that corporations enjoy:
Marketing synergy refers to the marketing benefits that two parties in an M&A transaction may enjoy when promoting their products and services. These synergies include information campaigns, marketing tools, research and development, as well as marketing personnel.
For example, an IT company may acquire a smaller IT company that lacks infrastructure but has a strong marketing and PR department. The smaller company has qualified personnel, marketing tools, and experience in selling their products that can help the larger IT company boost its public image and formulate new marketing strategies to win more customers.
When two companies merge, they often become synergistic by virtue of generating more revenues than the two independent companies could produce on their own. The merged company may gain access to more products and services to sell through an extensive distribution network.
The company will also benefit from a larger number of sales representatives to sell more products than they previously owned before the merger. Also, the merged company will incur fewer costs of marketing and distribution due to the corporate synergies.
The combined entity also stands to benefit from various financial synergies such as access to debt, tax savings, and cash flow. A merged company achieves a strong asset base inherited from the former companies, which allows the company to access credit facilities and use the combined assets as collateral. It reduces the level of gearing since the company can use debt rather than equity that reduces the percentage of ownership stakes of the founders/owners.
Also, the merged company may enjoy more tax breaks and pay less tax than the two former companies before the merger. Lastly, when a cash-rich company acquires a cash-starved company, the former can invest in the revenue-generating projects of the latter.
When two companies merge, there is a reorganization of the management teams. Depending on the goals and character of the management team members, the synergistic effect may be positive or negative. When the management teams of both parties to the merger work in harmony, the company will experience better service delivery, proper utilization of resources, improvement in employee motivation, and more opportunities for growing the business. A merger can also reduce job duplication and multiple levels of management.
However, when the team members are in constant conflicts with each other, it can result in decreased quality of products and services, reduced efficiency of operations, and poor utilization of resources.
Example in Financial Modeling
Below is a screenshot from CFI’s M&A Modeling Course where you can see the synergistic impact of an acquisition.
Cost synergy is the expected cost savings on operating expenses from the merger of two companies. Typically, when two companies merge to form one company, the combined company will enjoy synergistic cost benefits brought by the parties to the merger.
Savings on human resources costs
One of the cost benefits is the amount incurred in paying employees’ salaries and wages. The merger process may make some roles redundant, and the company may lay off employees whose input is no longer needed or whose roles are duplicated. The move will result in cost savings, which will increase the amount of profits for the combined entity.
Costs incurred in acquiring technology
When contemplating a merger or acquisition, a company may prefer transacting with a company that owns a superior technology that will benefit it. Such a merger helps the company save on costs that it would’ve used to acquire the technology on its own. The company also benefits from increased efficiencies and streamlining the production process.
Companies that operate established distribution networks in specific geographical locations may enter into an M&A transaction with companies with distribution networks in other geographical markets. For example, assume that Company A has established strong distribution networks in North America, while Company B has established distribution networks in Europe.
The merger of the two companies can give Company A access to the European distribution networks while Company B will gain access to the North American distribution networks. This will result in cost savings since the new entity will be able to distribute more products using the existing networks. The company will also achieve strong bargaining power when sourcing products from suppliers.
How are synergistic impacts accounted for?
A combined company can record the amount of synergy resulting from a merger on its goodwill account, as well as in the balance sheet. Goodwill is defined as the value of intangible assets that cannot be attributed to other business assets. It occurs when a company acquires another company, and the goodwill represents the value of expected future growth as a result of the transaction.
The effect of the goodwill must reflect the expected future cash flows, growth rates, revenues, and lower cost of capital. The amount of goodwill is recorded on the balance sheet as a non-current asset.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:
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