When speaking about mergers and acquisitions you often hear the word “synergy” used to explain the rationale of a deal.
Here are just a few examples from recent headlines:
- “The Renault-Nissan carmaking alliance expects to generate 5.5 billion euros ($6 billion) of synergies in 2018.”
- “[Sysco] said it believed it could achieve $600 million in synergies within four years even after the divestitures.”
- “BlackBerry and Good combined will raise the bar in the enterprise mobility market. We are expecting significant operating expense synergies.”
But what exactly do these companies mean when they say a deal will generate synergies? Synergy can be defined as “the increased effectiveness that results when two or more people or businesses work together.”
With acquisitions, there are really two kinds of synergy: cost cutting and increasing revenues.
Cost Cutting Synergies
The synergy we most commonly encounter involves decreasing costs. It’s the low-hanging fruit, an easy concept to quantify and justify. However, it’s also short-sighted. It limits future growth and offers diminishing returns—you can’t cut the CFO or other positions twice, after all. There are only so many ways you can decrease costs, and once you’ve done it you won’t get any further growth.
The other type of synergy involves increasing revenues. That’s where your focus should be because it offers long-term benefits, growth opportunities, and optionality. You can get more value out of an acquisition when you look beyond cutting people, facilities, or other costs.
Is There a Lack of Synergy?
On the flipside, you should also consider the potential for a costly lack of synergy. Will the acquisition decrease revenues and increase costs? Will it provide a long-term position for growth, or is it just a distraction for our company?
It’s important to strike a balance, and that means taking a hard look at all the potential pros and cons of the transaction. Then you’ll have a clearer picture of the true value of the company, rather than being blinded by cost savings.