M&A: Identifying and Realizing Synergies
Mergers and acquisitions – more popularly known as M&A – take place for a variety of reasons. The increasing competitiveness in the global business stage calls for firms, companies and organizations to redefine their goals and broaden their horizons while sharpening their business focus. Diversification through the acquisition of, or merger with, other companies and businesses is one method employed by today’s large companies.
Mergers and acquisitions are also entered into by businesses for the simple reason that they are seeking growth: growth of their market share, and growth of their company, as a whole. It is also one way of nurturing the growth of their power over costs, pricing, and similar aspects of business.
But, aside from these, there is another reason why M&As take place: Synergy, or deriving benefits from two companies or businesses joining its forces together.
In this article, you will start learning about 1) synergy defined, 2) synergistic benefits derived from M&A, 3) types of synergies, and 4) realizing synergies.
You might have come across the word “synergy” in your readings about M&A, and why not? After all, it is said to be one of the most commonly used terms in relation with the subject.
Synergy refers to the concept of two companies with complementary strengths and weaknesses combining their respective value and performance, resulting in total value and performance that is greater than the sum of the two companies. It has also been defined as the increase in competitiveness and cash flows beyond what the two companies are expected to accomplish if they maintain standalone operations. If we are going to talk about something more quantifiable, we can say that synergy is that extra value that can be created from a takeover or business combination.
It is likened to the concept of two heads being better than one, and of two companies combined together becoming more valuable, more solid, and much stronger than when they are separate.
Normally, people have this notion that a merger or an acquisition means that one party wins while the other one loses. The acquiring company is the one that wins, and the acquired company is the one on the losing end. Synergy is not about that.
In Synergy, both companies are winners. The shareholders of the acquired company win by receiving a premium from the acquisition. The shareholders of the acquiring company realize increased value thanks to the synergies obtained in the acquisition. It is, for all intents and purposes, a win-win situation. This is the main reason why synergies are said to be the main incentives or driving forces in M&As.
But there is one question that has to be answered: when is value, by virtue of synergies, created?
Let us say, for example, that Company A, which has a market value of $20 million, is targeted for acquisition by Company B, a larger company. After a long and tedious negotiation and applying due diligence, Company B paid $25 million for Company A. Company B paid $5 million more than the value of the company, which means that it has paid a bid premium of 25%.
For the shareholders of Company A, they have obtained an increased value in the form of the premium. But what about the shareholders of Company B? At this point, they have not yet seen if paying the 25% bid premium was worth it.
The only time that value is created is if the bid premium has been justified, and that is when the acquisition manages to achieve synergies that is equal to, or more than, $5 million.
SYNERGISTIC BENEFITS DERIVED FROM M&A
The main idea behind Synergy is that, by combining two companies, they can expect financial results that are far greater that what each could have achieved if they did not join forces. Shareholder value is ultimately created, much higher than its value prior to a merger or acquisition.
When we speak of synergy, it usually comes in two forms:
- Revenue synergies, which pertain to enhanced performance, as evidenced by increased revenue.
- Cost synergies, or greater cost efficiency; more specifically, reduced costs. It points to the savings, particularly in operating costs, after the two companies have joined their strengths.
To better understand them, let us try to break down the benefits that companies entering into M&A transactions hope to achieve in a synergy merge.
Economies of Scale
In the competitive business field, it is almost always the bigger companies that have the greater power. Size does matter, and so businesses will always find a way to be bigger than the competition. It is a fact that bigger companies have better chances of improving their purchasing power and even finding suppliers that can provide raw materials at low costs. The opportunities for saving more on costs are definitely more than what are available to smaller companies. Bigger companies also have stronger clout when it comes to negotiations and similar business transactions. Therefore, we cannot really blame companies for wanting to merge, for the simple reason that they want to be bigger.
One other advantage of mergers is having consolidated gains, facilitated by the combined companies’ increased focus on its core capabilities and even paying more attention to niche areas.
Savings from reduction of people
Mergers result in human resources that are tighter and more compact. Lay-offs and separations come with the territory when it comes to M&A. A ship only has one captain, and the combination of two companies means that there will only be one leader of the combined company. A resulting organizational audit will reveal some positions or jobs to be redundant – a sure sign of inefficiencies – and streamlining the tasks and responsibilities would mean job cuts. This reduction of staff members will result in reduced manpower costs, even after paying the severance packages to those who were let go of.
Aside from reduction of people, savings can also be obtained by virtue of the fact that retaining the best people for the tasks at hand would mean there is no longer a need for the resulting company to spend money and other resources in training and educating its employees.
Improved market reach
Think of one company operating in one market combining with another company that operates in another market. This means that the resulting company will have access to both markets, and the larger economies of scale is also likely to mean that it will have greater potential to reach new markets. The resulting company will also be able to take advantage of new sales and purchase opportunities, due to the expansion of its supply, marketing and distribution chains.
The speed with which a company can also enter new markets is faster. Say, for example, that a company wants to enter a new market. The whole process requires acquisition of new resources, educating and training people to facilitate entry into that market, and developing business models and plans applicable to that market. By acquiring another company or a firm, especially one that already has a foothold in that market you are targeting, or one that has the resources needed, the entry will be sped up.
Enhanced industry visibility
A bigger company has a wider market reach, can have better performance and enhanced efficiencies, and eventually have an improved ranking in the industry. This is not the final benefit, though, because the enhancement of the business in the industry also places it in a better position to raise capital or funding, when and if needed.
Acquisition of new talent and technology
The streamlining of the personnel or human resources of the combined company will result in the improvement of your people’s productivity due, in large part, to the discovery of new talent. Combining companies will also mean pooling each other’s technologies together and even sharing knowledge and technical know-how. This would go a long way in helping the company develop and maintain its competitive edge, since it is a fact that being updated with the recent developments and advancements in technology is a vital aspect of business.
TYPES OF SYNERGIES
There have been a lot of categorizations for synergies but, in an effort to simplify matters, they have been broken into two forms, as mentioned earlier, which are the Revenue Synergies and Cost Synergies. However, to provide more details, we can further break them down into 4 types: Cost, Revenue, Financial, and Market.
When we speak of synergies that involve the reduction or decrease in costs, we are referring to cost synergies. More often than not, these costs include administrative and overhead costs, which can be reduced, or even completely eliminated in some cases, by combining activities, technologies or resources after the business combination. Resources that are not used to their full capacities may also be used up to 100%, and even have extended usage, instead of having to purchase new resources or technology altogether.
A good example of cost that can be reduced through M&A is research and development. It takes money for a company to conduct R&D when developing a new product, or a process, or any other business-related matter. However, by combining resources with another company, the money (and time) usually spent in obtaining the required and desired knowledge will be considerably reduced or, in some cases, even fully done away with.
Some of the identified cost synergies, which are mainly achieved thanks to the consolidation of the operations of the combined companies, are:
- Reduction of employees or job and position redundancies;
- Reduction of administrative and factory overheads, arising from consolidation of marketing, accounting, information technology, and production line functions;
- Elimination of excess facilities and integration of complementary technologies, which could also be signified by shortening of production processes and disposal of surplus facilities; and
- Increase in purchasing power, as manifested in the improved bargaining power of the company with supplies, distributors and other business collaborators.
These refer to synergies that increase the revenues of the company. This means that the business combination has enabled the company has greater ability to sell more of its products or services, or even increase its selling prices to generate more revenue. It may include activities such as cross-selling and bundling. It may also involve having an expanded product line and being able to reach more customers or buyers.
The most common revenue synergies are:
- Cross-selling, or being able to sell products to new markets, niches, or customer bases;
- Marketing, selling and distribution of similar or complementary products, which is applicable when the businesses that have combined belong to the same industry (as is often the case);
- Gaining access to new markets, made possible by the existing foothold of one of the companies to a market that was not previously accessible to the other company;
- Sharing of distribution channels, where the combination results to having more channels for the distribution of products and services; and
- Reduction or elimination of competition, spurred by the larger and more dominant presence of the two business joining forces.
Companies that undergo business combination are likely to find themselves enjoying lower costs of capital and improved cash flows. Profitability is also a potential synergy that can be enjoyed by the resulting company, due to these lowered risks, improved performance, and reduced costs.
The most common examples of financial synergies are:
- Higher revenues and cash inflow from sale of products and services of the combined companies;
- Reduced costs, thanks to the streamlining of operations of the resulting business;
- Higher profits, by virtue of the improved revenue generation and cost efficiency measures implemented after the combination;
- Improved capacity of the combined business to handle its debts or liabilities;
- Lower cost of capital and business risk, made possible by the combination of two business, making for a more solid entity; and
- Possible tax benefits arising from the combination of the businesses and their operations.
These synergies are often seen in the enhanced negotiation capabilities of the company, particularly when dealing with suppliers and partners, as well as its customers.
Some of these synergies are:
- Greater bargaining and negotiating power, where the company is likely to elicit more trust from suppliers, customers and other business partners, when it is trying to enter into transactions with them;
- Increased recognition of the combined business in the industry, where two businesses with separate standings are now seen as one entity, with their combination increasing their power in the industry they are in; and
- Stronger standing, where the resulting business is bigger, and is less vulnerable to hostile takeovers by other businesses.
One of the harsh realities about synergies that many companies attempting M&A often learn the hard way is that synergies do not really count for anything unless they are realized. Being able to identify the synergies is one thing; incorporating or integrating them into M&A is another. A failed M&A basically means synergies that have defaulted; in short, they are of no use at all.
During the integration process, in order to realize synergies, keep the following in mind:
- Synergies must be looked at from a long-term perspective. After all, they are expected to benefit the business in the long-run, so viewing them form a short-term standpoint will not do the company any good. Keep in mind that businesses do not grow overnight, and profits are realized over a period or length of time. When changes are implemented within an organization, it takes time for it to adapt, and there is no denying that M&A is a major change.
- Timing plays an important role. Many businesses undergoing M&A have lost estimated synergies for the simple reason that they were not able to handle some integration issues quickly enough. Thus, it is important to always be kept up to date on issues such as the daily operations as well as maintenance of the business which include, but are not limited to, sales, marketing and other financial transactions.
- Management and leadership play an important role in the realization of synergies. In short, it is the managers that play the largest role in the realization of the synergies that have been identified. Therefore, it is important for managers – from top to middle management – to be made aware of their responsibilities and, at the same time, keep them motivated to see that M&A through.
- Involvement of the employees is also vital. It is the employees or the personnel who will carry out the operations of the business. Thus, they play an important role in M&A as well. Business combination means the people of two companies having to work together, and it is highly likely that either group come from different backgrounds and culture. These differences can play a major role in the realization of synergies and of the integration as a whole.
- Know your goals and stick to it. Keep your focus during the M&A. Otherwise, you will lose sight of what the true goal is, and the synergies will be lost to you. By keeping your eye on the ball, you will be able to easily make moves to adapt to certain situations.
- Monitoring and feedback. There is a need to always conduct surveillance while realizing synergies. This is so that you can track your progress, and see if you are on track towards the goals you have set earlier.
Take note that not all synergies are positive. There are also negative synergies that managers and business people involved in M&As have to watch out for. Some of the more prevalent examples include culture clashes among the people in the combining companies, underutilization of available resources, and reduced operational efficiency.
Identifying and realizing synergies is often easier said than done, but when done properly, and with a lot of caution, the results can be greatly satisfying – and highly profitable – for everyone involved.
In San Francisco, we meet founder and CEO of Datameer, Stefan Groschupf. He shares his story of …
Welcome to the 10th episode of our podcast! You can download the podcast to your computer or …