Only 24% of companies accomplish 80% of their synergies targets, according to Deloitte. This brings the importance of correct synergies identification and estimation for the overall deal success.

In this article, we focus on the concept of M&A synergies, outline the main risks associated with synergies realization, and suggest the best practices for achieving synergies. Read on!

What are M&A synergies?

M&A synergies refer to the concept that the two companies’ combined value, market presence, performance, and resources after a merger or acquisition are greater than the sum of their individual parts.

For instance, Company X is valued at $350 million, and Company Y is valued at $100 million. As a result of a merger, the combined value of the company is $520 million (rather than $450 million). Therefore, a merger between Company X and Company Y has created a synergy of $70 million. 

There are different types of synergies in M&A: cost synergies, revenue synergies, and financial synergies. We explore each type in more detail further.

M&A synergy valuation methods

How do you assess whether the two companies combined realize synergies? There are four common valuation methods: 

  • Discounted cash flow analysis (DCF). Future cash flows of the merged entity are forecasted and discounted back to their present value using a discount rate that reflects the riskiness of the investment. Synergies are incorporated into the cash flow projections by adjusting revenue, cost, or capital expenditure forecasts to reflect the expected benefits of the merger.
  • Multiples method. This method implies comparing financial metrics like earnings, revenue, or EBITDA of similar companies in the industry. By applying these metrics to merged firms, analysts can estimate potential synergies if the combined value exceeds the sum of individual values.
  • Sum-of-the-parts analysis (SOTP). This method breaks down a company into its individual parts, like divisions or business units. Each part is valued separately, considering its unique characteristics, allowing analysts to assess the synergy more accurately.
  • Precedent transactions analysis (PTA). This method involves comparing the deal with similar M&A transactions in the same industry to assess the premiums paid for synergies. By comparing the premiums paid in past transactions to the financial metrics of the target company, analysts can estimate the potential value of synergies in the current M&A deal.

Types of M&A synergies

Let’s now take a closer look at three main types of synergy in mergers and acquisitions. 

Cost synergies

Cost synergies in M&A refer to cost savings or cost reductions as a result of a merger.

Cost synergies may be achieved in the following ways:

  • Workforce optimization. The consolidation of two companies implies combining workforces as well, which can result in some redundancies in positions or departments. For instance, there won’t be a need for two legal or HR departments, as well as two CEOs. This allows a merged entity to generate synergies by eliminating redundant positions and, thus, saving costs.
  • IT systems integration. The consolidation of two IT platforms and systems into one allows a merged company to achieve synergy by enhancing overall productivity, streamlining IT processes across the organization, and, thus, reducing IT costs.
  • Supply chain consolidation. Rationalizing the combined supply chain can lead to cost savings. This might involve renegotiating contracts with suppliers, consolidating vendors, or optimizing logistics to reduce transportation costs.
  • Real estate consolidation. Consolidating office space and facilities results in significant cost savings through reduced rent, utilities, and maintenance expenses. This helps to lower costs for real estate and extract cost synergies.
  • Intellectual property and patents consolidation. When an acquirer pays a target company for access to its patents or intellectual property prior transaction, the merger then eliminates this expense.

Example: Let’s consider two retail companies, Company X and Company Y, that merge. 

They both have separate distribution centers located close to each other. By consolidating these distribution centers into one central location after the merger, they can reduce transportation costs, warehouse rental expenses, and staffing needs. This consolidation results in cost savings in terms of inventory management, shipping logistics, and facility maintenance, thereby achieving cost synergies in an M&A process.

Revenue synergies

Revenue synergies in M&A correspond to the potential revenue increase as the result of an M&A activity. Realizing revenue synergies is usually possible because a combined entity gets an opportunity to sell more services and products and, thus, produce higher revenue.

Revenue synergies can be achieved in the following aspects:

  • Cross-selling. By combining product or service offerings, the merged entity can cross-sell to each other’s customer bases. For example, if Company A sells software and Company B sells hardware, the merged entity can offer bundled solutions to customers, increasing sales for both products.
  • Market expansion. Merging companies often operate in complementary geographic locations or have complementary target markets. By leveraging each other’s distribution networks, sales channels, or customer relationships, the combined entity can enter new markets or reach a broader customer base.
  • Innovations and development. Pooling together R&D resources, technology, and intellectual property can result in the development of new products or services that neither company could have achieved individually. This innovation can attract new customers and increase revenue streams.
  • Enhanced customer experience. Combining the strengths of both companies’ customer service, support, and engagement capabilities can improve the overall customer experience. Satisfied existing customers are more likely to become repeat buyers and brand advocates, which can help to increase revenue.

Example: Let’s say a software company (Company X) buys a marketing agency (Company Y). 

After the deal, Company X can use Company Y’s expertise to sell its software better, which leads to increased sales. Meanwhile, Company Y can now offer packages that include the software, making its services more attractive. Together, they make more revenue than they did separately because they’re working together and reaching more customers.

Financial synergies

Financial synergies in merger and acquisition transactions relate to the company’s cost of capital. This synergy type is about potential financial benefits (such as increased value creation, economies of scale, or access to capital assets) that arise from combining two companies. 

Financial synergies are usually achieved through the following:

  • Tax benefits. M&A strategy can create opportunities to optimize tax structures and realize tax benefits. This might include utilizing tax-loss carryforwards, restructuring operations to take advantage of tax incentives or exemptions, or implementing tax-efficient financing strategies.
  • Improved purchasing power. A larger combined entity often has greater bargaining power with suppliers, allowing it to negotiate more favorable terms, discounts, or volume pricing. This can result in cost savings on raw materials, components, or other inputs required for production.
  • Working capital improvements. Merging companies can optimize working capital management practices to improve cash flow and liquidity. This might involve streamlining inventory levels, reducing receivables collection times, or negotiating extended payment terms with suppliers, freeing up cash for other uses.
  • Risk diversification. By diversifying their revenue streams, customer base, geographic presence, or service offerings, merging companies can reduce their overall risk profile and enhance financial stability. This can make the combined entity more resilient to economic hurdles or industry-specific challenges.

Example: Let’s consider Company X and Company Y, two mid-sized firms. 

Company X needs a bank loan but faces unfavorable terms due to higher interest rates. To tackle this, Company X merges with Company Y, creating a larger, financially stronger entity. As a result, the loan conditions for the combined company improve significantly. With improved cash flow and capital structure, the merged company gains better leverage to fulfill its financial commitments, leading to reduced borrowing expenses and instilling greater trust among lenders regarding timely repayment.

Extra: Cost, revenue, and financial synergies are also categorized into hard and soft synergies. Such a categorization refers to the nature of realization. 
Cost synergies are typically easier to achieve, that’s why they’re considered hard synergies, while revenue and financial synergies are more difficult to achieve and considered soft synergies.

Risks and negative synergies explained

Negative synergy occurs when, after the merger, the value of merged companies is less than the value of each company separately before the deal. One of the best examples of negative synergies is the historical deal failure of AOL and Time Warner in 2000. 

Below is the list of main risks to take into account in M&A practice to achieve deal synergies:

  • Cultural differences. When two entities with different organizational cultures come together, it can lead to clashes and challenge the integration process. In fact, global M&A practitioners state that culture clashes are the reason for 30% of failed transactions.
  • Regulatory challenges. Mergers and acquisitions may face regulatory scrutiny or certain legal obstacles, delaying integration and increasing costs. This, in turn, can negatively impact the realization of expected synergies.
  • Overestimation. There’s a risk of overestimating the potential synergies, leading to unrealistic expectations and disappointment if targets aren’t met. This often occurs when facing unexpected challenges or underestimating the costs needed for integration.
  • Loss of key personnel. During the integration process, talented employees may leave due to uncertainty or dissatisfaction arising from the merger. This can result in loss of valuable expertise and significantly impact overall company operations.
  • Customer disruptions. Changes in products, services, or customer-facing processes that typically accompany a merger can lead to dissatisfaction among existing customers. This, in turn, might hinder a merged entity to capture synergies.

M&A synergy best practices

To get the best out of anticipated synergies, ensure the following:

  • Careful due diligence. Conduct comprehensive due diligence to identify potential synergies early in the process. This includes analyzing financials, operational processes, market positioning, and cultural fit between the merging entities.
  • Clear integration plan. Develop a detailed integration plan that outlines specific actions and timelines for realizing synergies across different functional areas. The plan should address cultural integration, operational alignment, technology integration, and other key aspects of the merger or acquisition.
  • Leadership alignment. Ensure alignment among senior leadership from both organizations regarding the strategic vision, priorities, and approach to integration. This is essential for driving synergy realization and managing change effectively.
  • Cultural alignment. Pay attention to cultural integration and take proactive steps to align organizational cultures. Foster a culture of collaboration, respect, and inclusion to facilitate synergy realization and promote employee engagement.
  • Continuous monitoring and improvement. Ensure continuous improvement and learning throughout the integration process. Ask for stakeholders for feedback, evaluate the effectiveness of synergy initiatives, and make necessary adjustments to optimize outcomes over time.
Extra reading: In our dedicated article, learn how to plan and conduct post-merger integrations efficiently.

Examples of successful M&A synergies

Now, let’s take a look at real-life examples of M&A deals where synergies were achieved.

1. Exxon and Mobil (1999)

The merger between Exxon and Mobil is an example of cost synergy. 

This deal allowed the two entities to become the largest oil company in the world. By integrating manufacturing processes, the combined organization sold lots of refineries and 2,400 service stations. Additionally, they laid off about 16,000 employees. This resulted in a positive synergy of $5 billion.

2. Pixar and Disney (2006)

Disney’s acquisition of Pixar is an example of revenue synergy.

By the time of the deal, Disney’s revenue was $33.7 billion. After the merger, it has grown to $40.89 billion. Such an increase was possible because Disney was actively proposing Pixar’s characters in their theme parks. What’s more, Disney was selling Pixar’s merchandise in stores around the world, and Pixar was releasing new movies more regularly.

3. Facebook and Instagram (2012)

Facebook’s acquisition of Instagram is an example of financial synergy.

With this deal, Facebook received access to the best developers and other IT specialists, got an opportunity to integrate the best photo-generating technology, and benefited from the fast-growing platform with millions of potential clients. Instagram has experienced an incredible growth since the merger.

Summing up

Let’s briefly sum up the main insights from the article: 

  • Synergy in M&A refers to the concept that the value of two combined companies is greater than the value of their separate assets.
  • The main types of synergies include financial, cost, and revenue synergies.
  • Revenue synergies result in increased revenue, cost synergies lead to cost savings, and financial synergies bring certain financial benefits.
  • Common methods for synergy evaluation include DCF, sum-of-the-parts analysis, multiples method, and precedent transaction analysis.
  • Some of the successful M&A deals where synergies were achieved include transactions between Facebook and Instagram, Pixar and Disney, and Exxon and Mobil.