Before you get any more interested to know about the brighter side of your married life, we shall clarify that this article talks about the ‘marriage of companies’, which is done through the process called ‘merger and acquisition’ (M&A). M&As are all about attaining synergies. The success of any M&A depends on an accurate estimation of the synergy which is expected to be realised from the deal. In this article, we will try to understand synergies and its types.
Investopedia defines synergy as “An idea that the value and performance of two companies combined will be greater than the sum of the individual parts”. It is the interaction among two companies that creates an enhanced combined effect.
Types of synergy
Generally the synergies can be classified into five types- cost savings, revenue enhancements, process improvements, financial engineering and tax benefits.
Cost savings: It is the most common type of synergy. This synergy usually comes from job cuts, elimination of facilities and related expenses that are no longer needed when functions are consolidated of two companies, economies of scale in purchasing etc.
Revenue enhancements: Many companies enter into M&A in order to reach new markets and grow revenues and earnings. A merger expands two companies' marketing and distribution and thus gives them new sales opportunities.
Process improvements: This synergy is achieved through the transfer of best practices and core competencies from one company to other that result into both cost savings and revenue enhancements.
Financial engineering: Some companies find synergy through financial engineering, where an acquisition can increase the size of the company to a level where it has economic benefits in terms of combined working capital requirements, cost of capital etc.
Tax benefits: This synergy can be achieved by ways of transfer of brands and intellectual properties to a low tax subsidiary, locating central purchasing and shared services in locations with tax advantages, reducing debt in high tax subsidiary etc.
Of all the above mentioned types of synergies, cost savings, revenue enhancements and process improvement are the most likely ones for which the companies enter into M&A. The other two, financial engineering and tax benefits are generally not considered the primary reasons by companies for M&A but are supplementary benefits which can be derived from the deal.