In mergers and acquisitions (M&A), the promise of synergies – additional value generated by combining two companies – is often the driving force behind deals. Synergies can manifest as cost savings, revenue enhancements, or strategic advantages, and can seem obvious but realizing them is far from automatic. In part one of this series, we’ll explore the process of how to identify synergies as well as classifying the types of synergies with practical examples.
Identifying Synergies: Where to Start
The first step in unlocking synergies is a thorough assessment of both companies. This involves:
- Evaluating Operational Overlaps: Look for areas where resources, processes, or teams can be consolidated.
- Analyzing Strategic Alignment: Understand how the combined entity’s capabilities can enhance competitive positioning.
- Mapping Dependencies: Identify processes, systems, or regulatory conditions that must align to achieve synergy goals.
For example, in a merger between two manufacturing firms:
- Operational overlap analysis may reveal opportunities to consolidate production facilities, or allow for increases in operational efficiency in one or both facilities;
- Strategic alignment might highlight the potential for leveraging combined R&D capabilities;
- Additionally, the basket of goods could be a valuable product extension; or
- One company has invested in sophisticated technology or expertise that can be leveraged by the other.
The end result of identifying potential synergies leads to a laundry list of opportunities to pursue in the post-close integration and value creation phase. But which are the most important? And how can they be categorized and prioritized accordingly?
Types of Synergies
Synergies in M&A typically fall into two broad categories: cost synergies and revenue synergies.
Cost Synergies
These are efficiency gains and resource optimization, often leading directly to lower operational expenses or indirectly through cost avoidance. Don’t be fooled, these cost synergies carry their own set of risks that if not executed correctly, can actually do more harm than good.
Some common cost synergies are:
- Consolidation of Functions
- Merging administrative departments like HR or finance to reduce overhead costs.
- Economies of Scale/Negotiating Power
- Unit pricing opportunities from better negotiating in contract terms.
- Purchasing materials in bulk to secure supplier discounts.
- Streamlined Supply Chains
- Integrating logistics operations to lower shipping costs.
For instance, after acquiring a competitor, a retail chain might consolidate its distribution centers. The cost synergy would be reducing transportation costs, however, the risk to maintain service levels is opened up during this process.
If executed poorly, customers will leave and the company’s brand reputation will suffer, potentially reducing the overall value of the deal.
Revenue Synergies
These involve growing the top line through expanded market opportunities or enhanced product offerings.
Some common revenue synergies are:
- Cross-Selling: Offering each company’s products or services to the other’s customer base.
- Market Expansion: Leveraging the acquired company’s geographic presence to enter new markets.
- Accelerated Innovation: Combining R&D capabilities to develop new products faster.
- Strategic Pricing: Collaborating on customer segmentation analyses to determine opportunities for pricing changes based on combined customer delivery model
An example of this is when a technology company acquires a startup with complementary products. These complementary offerings may introduce those products to its global customer base, increasing overall sales. Keep in mind, an important step is to ensure these are complementary and not cannibalistic whereby it is a replacement to an existing offering. Further, you’ll want to consider the voice of the customer and the marketplace reputation of both brands to understand any anticipated customer questions related to service standard differences to avoid unnecessary attrition.
Once you’ve identified and classified your synergies, it’s time to understand the potential risks associated with each of them. In part two of this series, Unlocking Value in Mergers and Acquisitions: Synergy Risks to Realization, we discuss common risks associated with synergy realization as well as some important mitigation strategies to employ.
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For more information on this topic, please contact a member of Withum’s Transaction Advisory Team.
