Synergy is a concept that says, “the whole is greater than the sum of its parts”. It is combining the effort and performance of two companies to accomplish more than the sum of the separate individual parts. The term is often used in the context of mergers and acquisitions where two companies combine their value and performance to achieve greater financial benefit.
A Little More on What is Synergy
The companies opt for merger and acquisition to work together for earning a greater financial benefit. Two companies may merge to put together their resources and eliminate redundant processes resulting in cost reduction. They may also merge to form a single company that produces more financial revenue than the sum of the individual parts. A synergy merge is where the two merging companies can create more efficiency and revenue by their combined effort.
Synergy merge often benefits the shareholders as the share price of the company increases in this process. Companies spent a lot of time to identify and quantify synergies.
There are mainly three types of synergies in the context of merger and acquisitions: cost savings, revenue scaling and financial.
Cost Savings Synergy
When two companies form a single company by a merger to effectively reduce the cost, it is called cost savings synergy. Two different companies may have access to two different sets of information and technology. By a merger, both firms can take advantage of the combined information technology leading to enhanced operational efficiency. Similarly, a merger can help the companies to reduce the cost associated with supply and distribution. The cost of warehouses, delivery truck, delivery fuel, and insurance can be reduced by a merger. The cost of research and development may also reduce significantly by a merger. Suppose, one of the companies produces a cheaper and more durable alloy that can be used in the products of the other company. A merger will help the later company to reduce its production cost without going through a costly R&D process. The combined salaries and wage may also get reduced as the merged companies won’t need two CEOs, CFOs and so on.
Revenue scaling synergy
Companies often merge together to scale their revenue. Two companies may produce complementary products and when merged together those products can be bundled to produce higher scales to their consumers. When the two merging companies operate in two different geographical spaces, a merger gives them access to a wider market leading to greater revenue. Combining the skill and expertise of the employees of the two companies may also result in increased revenue for the companies.
Two companies can merge together to lower their combined cost of capital. A merger can also have some unique tax benefits and may increase debt capacity. However, studies have shown in most of the cases this type of synergy is illusive and counterproductive but in certain situations, this can be beneficial too.
Synergy can also have a negative effect on individual companies. In certain situations, the value of combined entities becomes less than the sum of each participating entities. The performance of the merged firms can be poorer than the performance of the individual companies due to several reasons including different leadership styles and company cultures.
References for Synergy
Academic Research on Synergy
Desperately seeking synergy, Goold, M., & Campbell, A. (1998). Harvard Business Review, 76(5), 131-143. This paper argues that corporate executives often make mistakes while initiating a merger process as they have strong biases in favor of synergy. These biases influence them to overestimate the benefits and underestimate the costs involved in synergy. The paper identifies four types of synergy biases including parenting bias, skills bias and upside bias. This paper says the executives should follow a disciplined approach while considering a possible synergy in order to avoid failure.They need to clearly analyze the potential benefit and possible downsides to achieve the desired gain.
Crossing the great divide: coproduction, synergy, and development, Ostrom, E. (1996). World development, 24(6), 1073-1087. This paper presents two different cases related to coproduction. In both cases, public officials play a major role. The first case is from Brazil where the public officials encourage citizen contribution to the production of urban infrastructure. On the other hand, in Nigeria, the citizens are discouraged by the public officials from contributing towards the primary education.The theory of co-production and its relevance in understanding the cases of Brazil and Nigeria is briefly discussed in the third section. The implication of coproduction in polycentric systems for synergy and development is discussed in the last section of the paper.
Government action, social capital and development: reviewing the evidence on synergy, Evans, P. (1996). World development, 24(6), 1119-1132. This article discusses the state-society synergy and explores its forms and sources. The paper argues that synergy can be more successfully adopted in the societies that are built on egalitarian principles and have a presence of robust and coherent state bureaucracies. It further says, however, that synergy can be constructed in more adverse circumstances that exist in the third world nations.
The rationale behind interfirm tender offers: Information or synergy?, Bradley, M., Desai, A., & Kim, E. H. (1983). Journal of financial economics, 11(1-4), 183-206. The paper attempts to find out the motivation behind the interfirm tender offers. It examines the returns earned by the stockholders of both types of firms, the firms that have made unsuccessful offers and the firms that were targets of such offers. The paper concludes, the rationale behind such interfirm tender offers are potential synergies and not simply superior information regarding the true value of the target firm.
Motivational synergy: Toward new conceptualizations of intrinsic and extrinsic motivation in the workplace, Amabile, T. M. (1993). Human resource management review, 3(3), 185-201. This paper presents a model of motivational synergy. This model highlights the ways of interaction between intrinsic motivation and extrinsic motivation. The model is built upon the previous conceptualizations and extends further. The prevailing psychological view asserts that extrinsic motivation undermines intrinsic motivation. This model proposes under certain conditions extrinsic motivation can combine synergistically with intrinsic motivation. This is possible particularly in the cases when the initial levels of intrinsic motivation are high. The paper suggests that such synergistic motivational combinations should result in a high level of employee satisfaction and performance. The paper proposes two mechanisms for these combinations: extrinsics in service of intrinsics, and the motivation-work cycle match.
State-society synergy: government and social capital in development, Evans, P. (1997). This is a compilation of papers presented at a meeting of Social Capital and Public Affairs Project’s Economic Development Working Group, which was held on 5–6 May 1995. It was a project of the American Academy of Arts and Sciences. The articles in this volume examine the effect of state-society synergy. This volume presents five studies based on the experience of a range of countries including Russia, China, Mexico, Brazil, Taiwan, and India. The studies show that active government and mobilized civil society can enhance each other’s developmental efforts and generate “state-society synergy.”
Partnership synergy: a practical framework for studying and strengthening the collaborative advantage, Lasker, R. D., Weiss, E. S., & Miller, R. (2001). The Milbank Quarterly, 79(2), 179-205. This paper provides a practical framework for studying and strengthening the collaborative advantage. In the US health system, a major part of the investment in health partnership is made on the assumption that collaboration is a more efficient way to achieve health and health system goals than the single agent efforts. The paper provides a clear conceptualization of the mechanism of collaborative advantage that can test this assumption and strengthen the capacity of partnerships for achieving the goals more efficiently. It suggests synergy is the mechanism that gives collaboration with its unique advantage. The framework provided by the paper can be used for assessing partnership synergy and identifying its likely determinants. It is a useful tool for addressing critical policy, evaluation, and management issues related to collaboration.
Types of synergy and economic value: The impact of acquisitions on merging and rival firms, Chatterjee, S. (1986). Strategic management journal, 7(2), 119-139. Companies go for an acquisition to create economic value. This paper compares three types of resources that create this value. The resources are classified as cost of capital related (resulting in financial synergy), cost of production related (resulting in operational synergy), and price related (resulting in collusive synergy). The study concludes that resources behind the collusive synergy, are on average, create the highest value. It further shows that the cost of capital related resources tends to create more value than the cost of production related resources.
Understanding the impact of synergy in multimedia communications, Naik, P. A., & Raman, K. (2003). Journal of Marketing Research, 40(4), 375-388. This paper examines the role of synergy in multimedia communications by extending a commonly used dynamic advertising model to multimedia environments. It demonstrates how the Kalman filtering methodology can be applied to estimate the effectiveness of synergy among multimedia communication.
Exploring the synergy between entrepreneurship and innovation, Zhao, F. (2005). International Journal of Entrepreneurial Behavior & Research, 11(1), 25-41. This paper presents an empirical study of various organizations to analyze the complementary nature if entrepreneurship and innovation. It develops an integrative framework of the interaction between entrepreneurship and innovation.