Mastering Synergies with VDR

In this digital age “synergy” has become quite a corporate buzzword. And in mergers and acquisitions, it’s importance can’t be overstated as assessment of the potential synergy is perhaps the most important task in any merger and acquisition deal. Some of the main synergies that are unlocked due to a merger of companies include cost reduction, greater market power, shared knowledge, and transformational synergy. Moreover each of these come with their own unique opportunities and execution risks.

Leaner Operations

When companies merge the new company becomes larger than it was, and they will have some redundancies that will need to be trimmed down. While before the merger there were two accounting departments, two executive teams, and two organizational systems, now there will need to be only one. Thus by reducing duplicate systems, cost synergies can be unlocked.  This type of synergy works best when the merging companies are very similar, since they most often have parallel systems and roles. The newly merged company will need more administrative resources than it did before, but there will also be plenty of redundancies. This results in a reduction in operating costs as a percentage of revenue. Reducing redundancies after two companies have merged is hard. After firms have merged companies often try to preserve morale by going easy on layoffs and intense restructuring. However, this can be detrimental to one of the main benefits of the merger: more efficient operations.

Bigger is Better: Market Share and Balance Sheet

One of the most obvious benefits of merging two similar companies is that the market becomes less competitive. With a larger market share, companies can throw their weight around against the remaining large competitors. Moreover their financial clout also increases and they can obtain more attractive financing by borrowing against their combined revenue. But large mergers between competitors also attracts greater legal scrutiny. Moreover mergers can also hurt a company’s brand, and customers may leave if they feel that the spirit of the company has changed due to the buyout. Workers also jump the ship for the same reason.

Merger Combines Knowledge, Betters Problem Solving

After a merger, companies can combine their know-how to better solve problems. That is why one often sees large firms gobbling up smaller firms from their industry, but most often it is not for their revenues, but because they have found some unique way to solve problems within the industry or their products.

Transformational Synergies

Each of the above synergies have been combinational in nature. In each case, when the two firms combine they contribute something to each other in order to create a larger, more efficient body of knowledge, an operational redundancy that led to lower costs, or a larger, more powerful firm.

But Transformational synergy, on the other hand, gives the acquiring company the ability to completely change its business model, target market, or revenue make-up. This entails larger risks and potential payoffs, because the company is charting out on unfamiliar territory. This synergy is unlocked when an acquisition target does something completely different from the parent company. Thus the Execution Risk is High when Targeting Transformational Synergy.

Merging brands can thus impact every aspect of a company’s performance, from
operating margin to market power to the innovative edge. The executive team must take a deliberate, informed, and bold approach to valuing these synergies, and pick the best fit for the business and its environment. For investors, it is a valuable skill to recognize the signs of a future flop or a match made in heaven.