What are synergies in M&A? Types of synergies and examples

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Synergy is often the main driver behind merger and acquisition transactions. However, according to Deloitte’s survey, only 24% of firms typically achieve at least 80% of their synergy targets. This highlights the challenge of achieving synergies in M&A that many dealmakers face.

In this article, we delve into what M&A synergy is, its types, best practices, and examples to equip you with the required knowledge to easily navigate the complexities of synergies in the M&A process.

What are M&A synergies?

M&A synergy appears when the combined value, resources, market presence, and performance of two companies are greater than the sum of their separate parts. In other words, synergies in M&A are the benefits that are achieved by combining two companies into one (or when one company acquires another).

To better illustrate the synergy concept, consider an example: Company A is valued at $250 million, while Company B is valued at $150 million. After the merger, the value of the companies combined is $500 million (rather than $400 million). It means that a merger created a synergy of $100 million. 

Still, there are several different types of synergies in M&A, and we define them further.

Types of M&A synergies

Typically, there are three main types of synergies: cost synergies, revenue synergies, and financial synergies. Let’s explore what each of these types implies.

Cost synergies

Cost synergies in M&A correspond to cost reductions or cost savings as the result of a merger. Generally, cost synergies are considered to be more likely realized and, thus, often viewed as more credible. 

A real-life example of a deal where cost synergy was achieved is the merger between Exxon and Mobil in 1999, forming ExxonMobil Corporation, one of the largest publicly traded companies in the world.

  • How it works: Company A is a manufacturing firm, while Company B is a logistics company. By combining their businesses, merged firms can achieve cost synergies by eliminating redundant expenses such as separate warehouses and distribution centers. This optimizes the supply chain, reduces overhead costs, and enhances efficiency through economies of scale and streamlined operations, resulting in increased profitability for the combined entity. 

There are several ways through which a company can extract cost synergies:

  • Supply chain optimization. When two companies merge, they can improve coordination and efficiency throughout the supply chain by leveraging shared resources, minimizing transportation costs, and reducing inventory levels.
  • Marketing and sales improvement. A merger enables two entities to combine sales and marketing departments (and cut redundancies) and, thus, helps to reduce costs expensed on these sectors.
    IT systems integrations. Consolidation of two companies implies shared technology platforms and systems, which enhances productivity, reduces IT costs, and streamlines processes across the merged entity.
  • Workforce optimization. A merger of two companies allows for a combination workforce, and thus, certain redundant positions might occur. For instance, two HR departments or legal teams. Redundant positions will need to be eliminated then, which will result in cost savings for the company.
  • Intellectual property (IP) and patents consolidation. In case an acquirer pays a target company for access to the patent or certain IP, a merger then eliminates this expense. This charge essentially transforms into an intercompany transaction.

Revenue synergies

Revenue synergies refer to the potential revenue increase as a result of the M&A deal. This is typically possible when a combined company can sell more products or services than two separate entities, and thus, generate more cash flows and produce a higher revenue. 

Generally, revenue synergies are considered to be a bit harder to realize since it takes longer to generate synergies compared to cost synergies.

A real example of a merger where revenue synergy was achieved is the acquisition of Pixar Animation Studios by The Walt Disney Company in 2006.

  • How it works: Company A, a software company, acquires Company B, a complementary service provider. As a result, they can cross-sell their products to each other’s customer bases, which leads to increased sales. Additionally, the merged entity might be able to offer bundled packages or create new products that capitalize on the strengths of both companies, further driving revenue growth. 

Revenue synergies are commonly achieved through the following aspects:

  • Patents. Through a merger, companies get access to each other’s patents and IP, which brings an opportunity to develop new products or services, and thus, increase the revenue of the combined company.
  • Market expansion. A deal enables companies to leverage each other’s distribution networks, sales teams, or geographical coverage. As a result, the merged entity can access new markets or enter existing ones more deeply, increasing sales opportunities.
  • Cross-selling. Combining the customer bases of the merging entities allows for cross-selling additional products or services to existing customers and upselling higher-value offerings.

Financial synergies

Financial synergies in M&A refer to the potential increase in value that results from the combination of two companies, achieved primarily through improved financial performance or efficiency. In other words, it improves a combined company’s capital structure and, thus, results in benefits in terms of debt capacity or tax savings. 

A real-life example of an M&A deal where financial synergies were achieved is Facebook’s acquisition of Instagram in 2012 which resulted in exponential growth of Instagram.

  • How it works: Company A and Company B are two mid-sized companies. Company A wants to get a loan from the bank, but the terms are not favorable since a bank can charge higher interest rates. To solve this, Company A merges with Company B forming one big company with a stronger financial profile. Thus, loan conditions for the bigger combined company improve. With enhanced cash flow and a more robust capital structure, the merged entity is better positioned to meet its financial obligations, resulting in reduced borrowing costs and increased confidence from lenders in timely loan repayment. 

Financial synergies are commonly achieved through the following aspects:

  • Tax benefits. Mergers can create opportunities for tax optimization through strategies like utilizing net operating losses, tax credits, or restructuring entities to minimize tax liabilities. Additionally, international mergers may allow for tax efficiencies through the reorganization of global operations.
  • Enhanced cash flows. A merger of two companies improves cash flows and thus, improves investment capabilities, liquidity, and financial flexibility. This also leads to the increased debt capacity of the combined entity.
  • Improved capital structure. Financial synergy is also realized by improved capital structure. This is possible due to the enhanced credit ratings, reduced borrowing costs, and optimized debt and equity ratio as a result of a merger.
  • Risk diversification. A merger allows for diversifying across products, markets, or regions. This can reduce overall business risk by spreading exposure to economic downturns, regulatory changes, or industry-specific challenges.
Note: Cost, revenue, and financial synergies can also be categorized into hard and soft. Hard synergies typically refer to cost savings, while soft synergies refer to revenue increases and financial synergies.

How to estimate an M&A synergy?

Estimating the synergies in a merger or acquisition is crucial for determining the potential value creation from the deal. 

Synergy estimation can be done through various models and methods. Let’s describe the most common ones:

  • Discounted cash flow (DCF). This method estimates the present value of future cash flows generated by the combined entity. Synergies are incorporated by adjusting the cash flow projections to reflect the expected benefits from the merger or acquisition.
  • Multiples method. The multiples approach refers to the utilization of market-driven multiples (like EBITDA, revenue, or earnings) with anticipated synergies, combining them into the valuation of the target company.
  • Company comparable analysis (CCA). This method involves comparing the target company with similar companies that have undergone similar mergers or acquisitions. Synergies are estimated based on the valuation multiples (such as Price-to-earnings or Price-to-sales) of comparable transactions.
  • Precedent transactions analysis (PTA). PTA involves analyzing past M&A transactions in the same industry. Synergies are estimated based on the premiums paid in previous deals and the resulting value creation.
  • Sum-of-the-parts (SOTP) analysis. This method involves valuing each business unit or division of the combined entity separately and then summing them up. Synergies are estimated by identifying overlaps or efficiencies that can be achieved by combining the different parts.
Additional read: If you want to learn more about common business valuation methods, explore our dedicated article.

Risks and negative synergies

Negative synergy occurs when the value of the combined company is less than the value of separate entities before the transaction. One of the best illustrations of the negative synergy is the deal between Quaker Oats and Snapple that took place in 1994.

Negative synergy typically happens due to poor transaction execution or integration. And considering the striking deal failure rate, which ranges between 70% and 90%, according to HBR, taking certain M&A risks into account is essential. 

So what are the common risks that prevent businesses from achieving potential financial benefit through synergies?

  • Overestimation. There’s a risk that synergies are overestimated during the planning phase, leading to unrealistic expectations and disappointment when anticipated benefits fail to materialize. This can occur due to underestimating integration costs, overestimating revenue synergies, or facing unforeseen challenges.
  • Regulatory hurdles. Mergers and acquisitions often face regulatory scrutiny, especially in highly competitive industries or where consolidation may raise antitrust concerns. Regulatory delays or requirements can impact the deal timeline and, thus, the success of synergy realization.
  • Cultural differences. A merger of two different companies is always about a combination of different corporate cultures, values, and ways of doing things. These differences can lead to conflicts, resistance to change, and difficulty in integration. In fact, poor cultural fit is a reason for 41% of failed deals.
  • Integration challenges. Combining different systems, processes, and technologies can be complex and time-consuming. That’s why integration issues often arise, causing disruptions in operations and potentially impacting customer service and satisfaction.
  • Loss of key talent. During mergers or acquisitions, there is a risk of losing key employees who may feel uncertain about their future roles or dissatisfied with changes in the organization. This, in turn, can hinder the realization of synergies and negatively impact overall performance.

Best practices for successful M&A synergy

Let’s define the key aspects to consider in the process of achieving anticipated synergies:

  • Thorough due diligence. Conduct comprehensive due diligence to assess the compatibility, strengths, weaknesses, and potential synergies between the two entities. Understand each other’s cultures, operations, financials, and market positions. Identify potential risks and opportunities at the early stages of the M&A process to ensure effective decision-making.
  • Clear integration strategy. To succeed, you need to have a clear integration strategy that takes all potential risks into account. Define integration priorities, timelines, and KPIs. Assign dedicated integration teams with clear roles and responsibilities to ensure effective execution.
  • Transparent communication and change management. Communicate openly with employees, customers, suppliers, and other stakeholders throughout the integration process. You should also be ready to proactively address concerns, manage expectations, and emphasize the shared vision and benefits of the merger or acquisition. Additionally, implement robust change management processes to facilitate smooth transitions and minimize disruption.
  • Cultural alignment. To prevent cultural clashes, you need to recognize and address cultural differences between the merging entities at the early stages. For this, invest in cultural integration initiatives, such as leadership workshops, team-building exercises, and cross-functional projects, to build trust, respect, and a sense of belonging.
  • Continuous monitoring and optimization. Continuously monitor integration progress and synergy realization against predefined metrics and milestones. Regularly assess the effectiveness of integration efforts and make necessary adjustments to optimize synergies and mitigate risks.
Additional read: Explore more about the ways of organizing post-merger integrations successfully in our dedicated article.

Examples of successful M&A synergies

Now, let’s briefly review the top three examples of mergers and acquisitions where certain types of synergies were achieved.

1. Amazon and Whole Foods

Amazon’s acquisition of Whole Foods took place in 2017. The deal was estimated at $13.7 billion and allowed Amazon to enter the grocery market. 

With this deal companies achieved the following:

  • The customer experience at Whole Foods was enhanced thanks to leveraging the e-commerce capabilities of Amazon, including online food ordering and delivery.
  • The online presence of Whole Foods has also improved thanks to using Amazon technologies and digital platforms.
  • Amazon got a chance to be physically present in the Whole Foods stores, which also helped to access its loyal customer base.

2. Procter & Gamble and Gillette

Procter & Gamble acquired Gillette for $57 billion in 2005. Warren Buffett, once one of the largest Gillette investors called this transaction a “dream deal”. 

Through this merger, companies achieved the following:

  • Procter & Gamble and Gillette combined their customer bases and distribution channels, which enabled cross-selling of their products.
  • Companies exchanged their talent and expertise, which allowed them to improve their performance.
  • A merger enabled companies to expand their international presence.

3. Fairfax and Nine Entertainment

Nine Entertainment Co. acquired Fairfax Media in 2018 for $4 billion. This deal resulted in significant synergy between the two media entities, creating a powerful and diversified media conglomerate in the Australian market. 

Through this transaction, companies achieved the following:

  • Nine’s strengths in television broadcasting with Fairfax’s expertise in print and digital media allowed the combined entity to offer a broader range of content across multiple platforms.
  • Fairfax’s strong digital presence, including websites and online publications, complemented Nine’s digital strategy, which enabled leverage of Fairfax’s digital expertise to enhance its online offerings.
  • Nine got an opportunity to promote its television programs through Fairfax’s newspapers and digital platforms, while Fairfax could leverage Nine’s popular shows to attract subscribers and viewers to its content offerings.

Key takeaways

  • Synergies in M&A refer to the concept when the combined value, resources, market presence, and performance of two companies are greater than the sum of their separate parts.
  • There are three main types of synergies in M&A: cost synergies, revenue synergies, and financial synergies.
  • Cost synergies occur when a merger results in certain cost reductions or cost savings.
  • Revenue synergies result in increased revenue for the combined entity as a result of the merger.
  • Financial synergies refer to the potential increase in value that results from the combination of two companies, achieved primarily through improved financial performance or efficiency.

Author

Ronald Hernandez

Founder, CEO at dataroom-providers.org

Data room selection & optimization expert with 10+ years of helping companies collaborate more securely on sensitive documents.

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