Synergies are the fruit that M&A deals hope to capture.
Understanding the types of synergies in mergers and acquisitions, analyzing them on paper, and maximizing them once the deal has gone through, are essential to getting the most from your M&A transactions.
In this article, we will increase your synergy realization by discussing examples of synergy in mergers and acquisitions, as well as provide insights and strategies related to their capture.
First, let’s take a look at the definition of synergy.
Objective behind Synergies
When justifying large M&A business transactions, companies invariably turn to the synergies that the deal will bring, including cost and revenue synergies.
The ultimate motive of any transaction – whether it be entering a new market, adding a new product line, or adding scale through a bolt-on acquisition – is to generate value and synergies offer chief executives a short-cut to achieving that value.
Synergies not only provide that short-cut, but also offer an excellent means through which the benefits of the deal can be communicated to shareholders and investors.
Overall, synergy is the potential financial benefit achieved when two companies merge.
There are many examples of successful company mergers and acquisitions, and the reason behind their success is the identification of synergies early on.
Types of Synergies
Synergies can be divided into three different categories: revenue synergies, cost synergies, and financial synergies.
Whether you are conducting M&A transaction on the buy or sell-side, synergies are immensely important. They are the driving force behind most mergers and acquisitions.
It’s important to note that any transaction can feature elements of all three in different measures.
For example, the merger of two consumer goods producers could bring revenue synergies through a complementary product range and cost synergies through savings in warehousing and distribution.
Below, we listed an example for each type of synergy.
Revenue synergy is based on the premise that the two companies combined can generate higher sales than the sum of their individual sales.
It should be noted, however, the research shows that capturing revenue synergies takes, on average, a few years longer than capturing cost synergies.
More specifically, McKinsey & Company notes challenges, such as developing appropriate targets and executing new workflow and sales strategies across all functions, make revenue synergies more difficult to capture.
There can be multiple examples of revenue synergies in M&A, but traditionally, revenue synergies result from:
- Reduction of competition
- Access to new markets
Revenue Synergy Example
Disney’s acquisition of Pixar in 2006 is often cited as an example of value generating M&A, and with good reason.The deal made sense on a lot of levels, creating a series of revenue synergies that added billions of dollars in value to the Walt Disney Company stock price.
In 2006, the company had revenues of $33.75 billion. By 2011, it had grown over 20% to $40.89 billion.
By contrast, the S&P 500 shrunk 1% over the same period.
Some of the revenue synergies that the deal brought include:
- Disney’s scale enabled Pixar to release its extremely popular motion pictures more regularly and through an expanded distribution network.
- Merchandise featuring Pixar’s characters, which included children’s favourites like Buzz Lightyear, could be sold through hundreds of Disney stores globally.
- Pixar’s characters could be promoted through Disney’s theme parks, giving enhanced exposure and sales opportunities to Pixar’s output.
If revenue synergies can be considered to be value added at the front-end, cost synergies might well be considered value added in the back office.
The two merging companies will be left with excess resources after the transaction – for example, two HR departments – which can be reduced with the aim of generating cost synergies. Achieving these synergies tends to be easier on paper than in practice.
Generally, merger of two companies can create cost-savings due to:
- Marketing strategies and channels
Increased marketing channels and resources may result in reduced costs.
- Shared information and resources
Similarly, increasing the acquirer’s access to new research and development can allow for advancements in production that yield cost savings.
While layoffs are not always part of mergers and acquisitions, they are associated with the combining of two companies as most companies do not need two of each C-suite position and some staff positions. The elimination of some heavy-hitting salaries can result in cost savings.
Streamlined processes can save time and money as they have the potential to make the new company more efficient. Additionally, supply chains can become more efficient and the new, larger company can usually negotiate better prices from suppliers.
Cost Synergy Example
The merger of Exxon and Mobil in 1998 to create the world’s largest oil company by market cap, generated massive cost savings.
As two US oil companies, they possessed several assets that were essentially overlapping each other and could be sold, including refineries and 2,400 service stations. In addition, a total of 16,000 people were laid off, allowing the company to generate cost synergies of over $5 billion.
With this in mind, how does one calculate cost synergies in M&A?
Well, this is more of an artful and thoughtful estimation, than exact calculation.
Identifying overlapping staff and the corresponding saved compensation costs, estimating the impact of sharing supplies and perhaps even office locations, and predicting the role efficiency will play when the two companies and their best practices and best employees merge are some of the main considerations taken when calculating cost synergy.
Financial synergies are the improvements in financial activities and conditions for a company that come about as a result of a transaction. This typically includes a strengthened balance sheet, a lower cost of capital, tax benefits, and easier access for the combined firm to capital.
The last of these, the improved access to capital, is usually not easy to measure, but the logic behind the reasoning is widely held to be solid.
Financial Synergy Example
A good example of financial synergies in a deal was the proposed $160 billion acquisition of Allergan by Pfizer.
Allergan is a pharmaceuticals company based in Ireland, enjoying low corporate tax rates, which Pfizer wanted a piece of. The deal would have saved Pfizer billions in annual tax returns, until the US government stepped in and prohibited the deal on that same basis.
Financial analysts and valuation analysts will typically work together to identify potential financial synergies.
All in all, revenue, cost, and financial are the three most common acquisition synergies examples. The goal of any merged firm is to grow the synergies and hope that they reach their full potential post-close.
Achieving Successful Synergies
Good M&A practice is about achieving synergies.
Unlocking the value inherent in combining two or more companies is what should drive all M&A practice. In that sense, what passes for good M&A practice is often the same as the best way to achieve successful synergies.
Certain points should be emphasised here though, as clearly, not all acquisitions will be synergy-creating:
Valuation is key
Even if there are synergies to be achieved through a deal, the consideration paid for the acquisition has to be low enough to benefit from them. So, if the synergies are estimated at $100M, and the acquisition price is $200M over the market price, the deal will still almost certainly be value destructive in the long run.
You can learn more about valuation in the M&AScience Academy.
Under-promise and over-deliver
When it comes to synergies, it’s always better to understate them before the deal. If you think there are $100M of synergies that can be unlocked from a deal between cost, revenue, and financial synergies, it’s good to aim for them. However, history shows that it’s a much better idea to base acquisitions on realistic rather than ambitious synergies.
Focus on quick wins first
The integration phase of anM&A transaction is essentially about getting to the synergies of the deal as quickly as possible. There is now universal agreement that, where integration is concerned, speed is everything. Concentrate on the quick wins in the deal first (for example, sales channel integration) and slowly work towards more challenging ones (layoffs and redundancy packages for surplus employees).
Example of Successful Synergy
Almost all value generating M&A transitions have synergy at their core (hence the reason why it’s the favoured motive of chief executives to justify their deals). The Disney acquisition of Pixar (and later, Marvel) may be the textbook example for finding good synergies, but for the sake of variation, the Facebook acquisition of Instagram in 2012 also takes some beating. Here is a monthly user growth of Instagram, according to Statista.
The acquisition enabled Facebook to:
- Acquire a company that was growing faster and had millions of the same users as its own platform.
- Create a unique and hitherto unassailable proposition for advertisers looking to reach certain demographics.
- Gave access to the best photo generating technology on the web – Facebook had previously tried to create a photo platform to little success.
- Enabled Facebook to gain access to some of the best developers on the planet, pooling the human capital of the two technology firms.
Example of Negative Synergy
Just as successful synergies are at the heart of all good M&A, the opposite can be said of value destructive M&A.
And if two companies that generate great synergies are just able to ‘fit together perfectly’, the companies that don’t fit together – and seem like they never can – are the ones that destroy value. Here again, there’s a long list. We’ve opted for the Quaker Oats and Snapple deal, because on the surface, it may have seemed to make sense in several ways (analysts were in unison on it being a good deal, pre-close).
Look underneath the cover, and that wasn’t so:
- Both companies, although fast moving consumer goods, sold in distinctly different sales channels: QuakerOats in supermarkets and large retailers; Snapple in gas stations and small, independent stores.
- The branding for each was distinctly different. Whereas Quaker Oats sought to appeal to mothers and family buyers, Snapple was aimed at teenagers and young adults. It used ‘shock jock’ Howard Stern in its adverts – not someone you’d expect mothers to listen to when making consumption choices.
- Quaker Oats was ultimately looking to take a slice of the soft drinks market, pitting itself against Coca-Cola. That’s a tall ask for any deal. One which was ultimately too tall for them to deliver on.
How to Create Synergy Realization
As we often say, no one wants a deal that only looks good on paper; therefore, synergy realization is essential.
In fact, while deals can fail for a variety of reasons, one considerable reason is the inability to capture predicted synergies.
With this in mind, here is how to maximize your deal’s synergy realization:
1. Don’t lose sight of your overarching goal/objective
To achieve synergy, be sure all stakeholders and team members stay focused on the predetermined objective throughout the M&A process.
Adopting a more Agile M&A practice can help with this as with Agile the focus is always on the main objective rather than plowing through a long list of tasks that may or may not be necessary (and can cause deal fatigue).
2. Focus on “easy” value drivers
Because the first year of integration is critical for capturing synergies, it is wise early on to prioritize synergies that are “easy” to capture and will produce the highest return.
More specifically, these “easy” value drivers should match your overarching goal, have the ability to be tracked, and have a high probability of success.
3. Properly plan for integration
Poor integration practices and failure to properly plan for integration when diligence begins often result in lost synergies.
4. Keep acquired companies key employees (and don’t underestimate the importance of culture)
Employees are what make companies successful, and when a merger or acquisition takes place, key employees are often targets for recruiters to poach.
In order to retain key personnel and create a comfortable environment for employees of both companies, leadership must focus on culture and change management.
5. Track synergy process
Finally, when trying to capture different types of synergies, company leaders must find a way to track the progress of the different synergies involved in their deal.
A centralized location for this tracking, such as an M&A project management platform, is recommended. Moreover, M&A synergy benchmarks for the deal should be created and revisited.
6. Analyze your customer base
In order to capture revenue synergies (remember these often take longer to capture) it is critical to complete a deep analysis of each customer relationship.
When analyzing each customer, specifically consider: how long you’ve had a relationship with the customer, how strong the relationship is, what you currently sell to the customer, and what other services and products does the customer use that you could provide.
The sales team should be part of this customer study as it will need to understand the strategy and synergy goals.
How to Create an M&A Synergy Model
Synergies are often calculated by adding the net present value (NPV – the value of the new company) with the premium (P).
Additionally, when developing a M&A synergy model consider the following categories as the cornerstones of your model: how to sell, what to sell, and where to sell. Examine where the opportunities to capture synergies and create value exist in these three categories.
Additionally, using a M&A project management platform, or another tool such as Excel, can be helpful in creating synergy valuation.
For example, a tool such as DealRoom’s M&A deal platform, is designed to be used before a deal even begins. Teams can use features like pipeline management to access company information that is vital in determining synergies.
Another option is to using a valuation spreadsheet, compare the inputs and outputs of the acquirer, the target, to the combined inputs and outputs if the two companies were to merge.
Types of Synergies Outside of Mergers and Acquisitions
It is sometimes overlooked that generating synergies is not limited to the sphere of mergers and acquisitions.
In fact, looking for synergies in a company’s existing operations and partnerships is an excellent way to generate value. For example, pooling some resources with a trusted and non-competing partner is one such way of doing so.
Different types of synergies that typically occur outside of M&A include:
As mentioned above, pooling resources can be an effective way for two non-competing companies to generate value (after all, what is M&A if not the combination of resources). This is sometimes referred to as modular synergies. These usually involve companies bundling packages of products or services to generate greater value from the combinations. Examples of modular synergies include:
- Southwest Airlines partnering with hotel firms and car rental companies to provide complete packages to its customers.
- Coca-Cola teamed up with Jack Daniels to create a ‘Jack and Coke’ offering to their customers.
Sequential synergies refer to the value that can be generated along a company’s value chain. Although in many cases, this value is generated by virtue of acquiring a firm upstream or downstream in a company’s value chain (see article on vertical acquisitions here),it can also be achieved by choosing partners that are naturally synergistic with your own. Examples of sequential synergies include:
- The example of Chanel outsourcing their branded watches to Swiss watch manufacturers (who they subsequently acquired).
- Amazon Direct Fulfilment has ultimately become the logistics provider for thousands of small businesses, generating far more value for them in their warehousing and distribution than would have been possible individually.
No matter what the merger and acquisition synergy is for a particular deal, it must be considered throughout every stage of the deal.
Synergies can often be easy to identify but hard to realize; therefore, it is critical to understand when the deal closes, there is still a great amount of work to be done to yield the identified benefits.
Post-close synergy work needs to be planned early and carried on months, sometimes even years, after a close.
Additionally, while practitioners must be ambitious in identifying and outlining expected deal synergies, it is vital that they are realistic and do not not overestimate the deal’s potential synergies and value drivers.