Synergy Meaning Concept and Types
Synergy is the idea that the value and performance of two companies together will be greater than the value and performance of each company alone. Most of the time, the word “synergy” is used to talk about mergers and acquisitions (M&A). Synergy, or the financial benefit that might come from putting two companies together, is often what makes a merger happen.
The idea of synergy is that the whole is worth more than the sum of its parts. Most mergers and acquisitions (M&A) are based on this line of thinking. Investment bankers and corporate executives often use synergy as a reason for the deal. In other words, when two companies join together in a merger, the value of the new company will be higher than the value of each of the two companies that were merged.
The Idea of Synergy
The goal of mergers and acquisitions (M&A) is to improve the financial performance of the company for the shareholders. Two businesses can join together to make one company that can make more money than either of them could have on their own, or to create one company that can get rid of or streamline redundant processes and save a lot of money. Because of this principle, during the M&A process, synergy is looked at. A synergy merge is sometimes used to describe what happens when two companies join forces to make their business more efficient or to make it bigger.
The synergistic effect of a merger will help shareholders if the share price of a company goes up after the merger. The expected synergy from the merger can be caused by many things, like more money coming in, combining talent and technology, or cutting costs.
For example, when Proctor & Gamble Company bought Gillette in 2005, a P&G news release said that “the increases to the company’s growth objectives are driven by the identified synergy opportunities from the P&G/Gillette combination.” The company still expects cost synergies of about $1 to $1.2 billion and an increase of about $750 million in annual sales by 2008. In the same press release, A.G. Lafley, who was the chairman, president, and CEO of P&G at the time, said, “We are both leaders in our own fields, and together we will be even stronger and better.” The idea behind synergy is that when two companies work together, they can make more money than either could have done alone.
A company may also try to create synergy by combining products or markets instead of merging with another company. For example, a store that sells clothes might decide to cross-sell other products, like jewellery or belts, in order to make more money.
A company can also create synergy by putting together cross-disciplinary workgroups, where each person brings a unique set of skills or experiences to the group. For instance, a team working on a new product might include marketers, analysts, and R&D experts. This way of putting together a team could lead to more work and more capacity, and in the end, a better product than all the team members could make if they worked alone.
Synergy can be bad as well. Negative synergy happens when the combined value of the two things is less than the value of each thing on its own. This could happen if the merged companies have trouble because their leaders and company cultures are very different.
The goodwill account on a company’s balance sheet shows how synergy is used. Goodwill is an intangible asset that stands for the part of a business’s value that can’t be explained by its other assets. Synergies might not always have a monetary value, but they could lower the cost of sales, increase the profit margin, or help the company grow in the future. For synergy to affect the value, it must lead to higher cash flows from existing assets, higher expected growth rates, longer growth periods, or a lower cost of capital.
Types of Synergy
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Operating Synergy
“Operating synergy” is when the value of two businesses together is greater than the value of the two businesses separately, and when the combined business helps the two businesses increase their operating income and grow faster. Operating synergies come about because:
Economies of scale, more pricing power, and higher margins due to a larger market share and less competition, a combination of different functional strengths, like good marketing skills and a good product line, or higher levels of growth from new and expanded markets.
Operating synergies are created when companies that are good at different things like production, research and development, marketing, and finance merge, buy, or take over other companies that are good at those things. This can also help achieve operating efficiencies. Tata Steel is one of the largest steel companies in India. In 2007, it bought Corus, the second largest steel company in Europe.
Tata Steel bought the big European steel company Corus for $12.02 billion. This made the Indian company the fifth largest steel producer in the world. The goal of the purchase was to give Tata steel access to the European markets and find synergies in manufacturing, purchasing, research and development, logistics, and back office operations.
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Financial Synergy
Financial synergies are most often appraised in the context of mergers and acquisitions, but latest strategic alliances include strategic partnerships. These types of synergies relate to improvement in the financial metric of a combined business such as revenue, debt capacity, cost of capital, profitability, etc. Examples of positive financial synergies include: Increased revenues through a larger customer base, lower costs through streamlined operations, talent and technology harmonies.
In addition to above, financial synergies can result in the following benefits post acquisition: Increased debt capacity, greater cash flows, lower cost of capital, tax benefits etc. The Renault-Nissan (Franco – Japanese) strategic partnership or car making alliance expects to generate 5.5 billion euros ($6 billion) of synergies in 2018 by integrating more divisions and sharing resources better within the partnership. Increased union between the French carmaker and its 43.4 percent-owned Japanese partner generated more than 4 billion euros in synergies in 2015.
The two companies go together to benefit from cost cutting. As of December 2016, the Alliance is the world’s leading plug-in-electric vehicle manufacturer, with global sales since 2010 of almost 425,000 pure electric vehicles, including those manufactured by Mitsubishi Motors which is also now part of the Alliance.
The strategic alliance partnership between Renault and Nissan is not a merger or an acquisition. The two companies are joined together through a cross-sharing agreement. The structure was unique in the auto industry during the 1990s consolidation trend and later served as a model for General Motors and PSA Peugeot Citroen.
Marketing synergy means that the different parts of the marketing mix work well together. For example, if you seize an opportunity that lets you make better use of the marketing and distribution facilities you already have, you might be able to increase sales without causing costs to go up at the same rate. Hero Cycles of India and Honda Motor of Japan worked together to make Hero Honda Ltd.
Hero Cycle’s long experience with Indian roads and customers in both rural and urban areas, along with Honda Motor’s advanced technology, created the synergy effect that was needed to make a highly fuel-efficient and sturdy motorcycle that met the needs of Indian customers and could handle the rough roads as early as 1985. The two people worked together for 26 years.