“The whole is greater than the sum of its parts.”
– Aristotle, 3rd Century B.C. Greek Philosopher
Synergy is one of the most overused and misunderstood terms in business. Frankly, synergy is one of the most important forms of value when it comes to strategic decision-making. Why do companies merge? Answer: synergies. Why do multiple products get launched as a family? Answer: synergies. Why do partnerships exist? Answer: synergies. Why are departments consolidated in an organization? Answer: Hopefully synergies, but often not. Ok, you get the point. As a strategic leader, you have to be looking for potential synergies in your decision-making constantly. If you do, you’ll find a lot of cash under a lot of rocks.
What are Synergies?
I’m going to save you the time and money of sitting through a ten-week MBA course on mergers & acquisitions (sorry Professor Thorburn). Mergers & acquisitions, partnerships, and consolidations are primarily about by the value created from the synergies between two or more entities. Synergy is when 1 + 1 is greater than 2.
There are four main types of synergies, including revenue, cost, capital, and other financial synergies. Whenever considering any investment, partnership, or consolidation, the evaluation should focus on the potential revenue, cost, capital, and other financial synergies.
When two different entities bring together disparate, but complementary assets, they often create synergies. There are many examples of small technology companies being acquired or partnering with large companies that plug the technology into the larger company’s broad solution set, distribution network, and marketing engine, realizing a substantial growth in revenues of the technology itself, and revenues of other solutions influenced by having the technology as part of the solution.
Or, the flip side happens when a large company acquires a small company with established distribution and presence in an emerging market. The large company can leverage the small company’s established distribution and presence in the emerging market. Two market leaders that merge can also create revenue synergy by restricting supply and increasing prices.
Revenue synergies are also important to think through when investing in new products and services. Typically, companies invest in products and services that are complementary to existing products and services, which will create revenue synergies by creating a broader solution for customers.
Cost synergies are generally created by combining two or more entities and eliminating redundancies, improving scale efficiency, and increasing negotiating leverage over suppliers and partners. The elimination of cost redundancies can relate to processes, personnel, maintenance and operation of capital, distribution, and marketing. Combining the best practices of the different entities and driving more volume through processes create scale efficiencies. Combining the purchasing power of two or more entities, and the transparency of actual costs and prices paid by the different entities drives negotiating leverage over suppliers and partners.
Capital synergies are created primarily by combining two or more entities and selling off excess capital such as property, plant, and equipment, with the intent of increasing the utilization of the remaining capital. Realizing capital synergies also creates cost synergies, through the elimination of maintaining and operating the eliminated capital. Increasing leverage over customers, suppliers, and partners can also create capital synergies through improved terms for accounts payable and accounts receivable.
Other Financial Synergies
Other financial synergies can be created primarily through pooling together assets to create a larger borrowing capacity, tax advantages of increasing debt and deducting the interest payments from earnings, and by combining the value of deferred tax assets to offset the potential taxes generated by the future profit of combined entities.
Below is a nice visual logic tree that outlines the various sources of synergy, which you can use to better evaluate potential options.
How do you conduct Synergy Analysis?
As you evaluate potential investments, partnerships, and consolidations of teams or groups, you need to think through and analyze the potential revenue, cost, capital, and other financial synergies of combining entities. Here are some of the best practices for evaluating synergies and realizing their value.
Use the Sources of Synergy to Brainstorm
The logic tree, on the previous page, can serve as a great starting point to brainstorm some potential synergies between two or more entities. As you brainstorm, also evaluate, at a high level or level of magnitude, the potential value, and difficulty in realizing the synergy.
Look for Clean and Easy Synergies
Complexity is one of the largest hurdles in harvesting synergies from mergers & acquisitions, partnerships, and consolidations. It is one thing to say there are cost synergies due to redundant processes and systems, yet realizing those cost synergies can be an absolute nightmare. To map potentially thousands of different processes, integrate all of the related databases and systems, and implement consolidated processes and systems and train all of the stakeholders, while a financial bonanza for consultants, can negate a large portion of any potential cost synergies. Complexity can take down any potential synergy. You want to look for true plug-and-play and scalable situations, without the need for customization, investment into new capabilities, or large increases in operating costs.
Understand the Customer Perspective with Revenue Synergies
There is a reason why a lot of partnerships, mergers & acquisitions fail. Beyond the complexity that often gets in the way of realizing synergies, there are often difficulties in realizing revenue synergies. As you assess revenue synergies, it is critical to look at the synergies from the view of a customer. Are the products or services complementary? How are the combined products and services going to be branded? Will it be simple for the customer to understand, purchase, and service? As you think about revenue synergies, you have to think through if it makes sense from a customer perspective. And, to understand the potential fit and value, you can always conduct focus groups and surveys to understand the customer perspective on potential synergies.
Be Conservative in Calculations
It is important to be conservative once you start calculating and estimating potential value generated from synergies. While the magnitude of the synergies is what often provides the sizzle for combining two entities, the magnitude often fizzles in trying to harvest the synergies. Don’t use the best case (e.g., eliminating all the fixed costs of an acquisition) as the base case in calculating values. It is typically best practice to shave off 20-40% of the potential synergies to arrive at a probably base case.
With Partnerships understand Motivation
I’ve executed a lot of partnerships, and the first thing both parties need to understand, articulate, and be transparent about clearly are the motivations of each party in developing a partnership. If the motivations aren’t aligned, the partnership is destined to fail. I’ve seen a lot of potential partnerships formed under pretenses and unethical motivations, and just like a relationship, if there isn’t a foundation of trust and respect, it will never work out in the long term.
Realize the Cost and Capital Synergies
Mergers & acquisitions and consolidations of teams, groups, and business units are often formed under the pretense of potential value creation from cost and capital synergies, only never to realize those synergies. Cost synergies, related to redundant personnel, are especially difficult to realize since they necessitate laying off or repurposing personnel for different roles. Furthermore, as stated before, the complexity of combining and integrating processes and systems can be overwhelming. One of the best practices in realizing cost synergies is to eliminate one of the entities’ processes and systems, and port over the least amount of critical data to the new systems.
DOWNLOAD THE SYNERGY POWERPOINT WORKSHEET
To get you going on understanding the full breadth of synergies for a new project, product, service M&A, or consolidation, download the free Synergy PowerPoint Worksheet.