Synergy in Mergers and Acquistions – Synergy is the concept that allows two or more companies to combine together and either generate more profits or reduce cost together. These companies believe that combining with each other gives them more benefits than being single and doing the same.
In this article, first, we will understand synergy first and then we will talk about the main emphasis of the article, i.e. types of synergies.
Let’s get started.
What is Synergy?
Let’s talk about synergy in mergers and acquisitions in a different manner. We will directly take an example and illustrate how synergy works.
Let’s say that Company A and Company B decides to go for synergy. Since when we talk about synergy, we talk about mergers and acquisitions; let’s say that Company A and Company B merges with each other because they believe that the decision to combine will enable them to reduce cost as well as to increase profits.
The reason they decide to merge with each other is that Company B produces the raw materials Company A uses to prepare the finished products Company A sells.
If they merge, Company A doesn’t need to look for a vendor and sourcing raw materials would be seamless.
On the other hand, as a result of the merger, Company B doesn’t need to worry about the sales and marketing. All they need to do is to improve their processes to produce better raw materials for Company A.
In this case, the sum of Company A and Company B is better than individual Company A and Company B. And that’s why we can call this a synergy in mergers and acquisitions.
Types of Synergies
There are usually three types of synergies in mergers and acquisitions that occur among companies. Let’s look at these different types of synergies so that we can understand how synergy works in different situations –
#1 – Revenue Synergy
This is the first of the three types of synergy in mergers and acquisitions. If two companies go through revenue synergy, they happen to sell more products.
For example, let’s say that G Inc. has acquired P Inc. G Inc. has been in a business of selling old laptops. P Inc. is not a direct competitor of G Inc. But P Inc. sells new laptops quite cheap. P Inc. is still very small in profit and size, but they have been giving a great competition to G Inc. since it is selling new laptops in much lesser price.
As G Inc. has acquired P Inc., G Inc. has increased its territory from selling only used laptops to selling new laptops in a new market. By going through this acquisition, the revenue of both of these companies will increase and they would be able to generate more revenue together compared to what they could have done individually.
And here lies the significance of revenue synergy.
Revenue Synergy Example
We note from the above example that Alaska Air acquired its smaller rival Virgin America for $2.6 billion. Alaska’s Air management estimates the revenue synergies at $240 million.
#2 – Cost Synergy
The second type of synergy is the cost synergies. Cost synergy allows two companies to reduce costs as a result of the merger or the acquisition. If we take the same example, we took above; we would see that as a result of the acquisition of P Inc., G Inc. is able to reduce the costs of going to a new territory. Plus, G Inc. is able to get access to a new segment of customers without incurring any additional cost.
Cost reduction is one of the most important benefits of cost synergy. In the case cost synergy, the rate of revenue may not increase; but the costs would definitely get reduced. In this example, when the cost synergy happens between G Inc. and P Inc., the combined company is able to save a lot of costs on logistics, storage, marketing expenses, training expenses (since the employees of P Inc. can train the employees of G Inc. and vice-versa), and also in market research.
That’s why cost synergy is quite effective when the right companies merge together or one company acquires another.
Cost Synergy Example
We note above that the merger between National Bank of Abu Dhabi and First Gulf Bank will result in the cost synergies of around Dh 1 billion. The cost synergies are expected to realize over the next three years driven by network and staff reductions, system integration, consolidation of common business functions etc.
#3 – Financial Synergy
The third type of synergy in mergers and acquisitions is the Financial Synergy. If a mid-level company goes to borrow loan from a bank, the bank may charge more interest. But what if two mid-level companies merge and as a result, a large company goes to borrow the loan from the bank, they will get benefits since they would have better capital structure and better cash flow to support their borrowings.
Financial synergy is when two mid-sized companies merge together to create financial advantages.
By going for financial synergy, these two companies not only achieve financial advantages in the case of borrowing loans or paying less interest but they also are able to achieve additional tax benefits. Plus, they are also able to increase their debt capacity and to reduce the combined cost of capital.
As an example, we can say that Company L and Company M have merged to create a financial synergy. Since they are mid-level companies and if they operate individually, they need to pay a premium for taking loans from the banks or would never be able to reduce the cost of capital. That’s why the merger has turned out to be quite beneficial for both of these companies and we can call it financial synergy.
Can these three types of synergies be achieved at the same time?
Now, this is the burning question.
In an ideal world, these three can be achieved at the same time.
But usually, the parties who decide to go for merger or acquisition aims for one or maximum two types of synergies.
No matter what they choose to achieve, the most important thing is whether the merger or the acquisition would turn out to be beneficial or not.
Aiming for synergy and achieving synergy are completely different things.
If both the companies decide to act together and their employees don’t resist the change, it is quite possible to get great benefits from the mergers or the acquisitions. But in few cases, employees of either of the companies aren’t able to accept the sudden change in working structures, styles, environment, center of control, and so on and so forth.
As a result, not all the mergers or the acquisitions turn out to create greater benefits.
The deciding factor
Another important aspect in this regard is how one would understand whether to buy a company or to sell one or to merge with another.
To understand the opportunity both the buyers and the sellers need to have a comprehensive understanding of the businesses they are in (or they want to be in, in near future).
Understanding an opportunity to synergize isn’t easy to locate. It needs years of experience and a sense of market knowledge that only experienced business owners can have.
Since the failure can be much brutal, it’s always prudent to look at every possible factor before going for any sort of merger or acquisition.
This was the guide to Synergies in Mergers and Acquisitions along with the top 3 types of synergies. Here are the other articles that you may like –
- Best Mergers and Acquisitions (M&A) Books
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- Successful Mergers and Acquisitions
- Golden Parachute