Synergy (sin-er-jee)
–n, pl -gies
1. The interaction of elements that when combined produce a total effect that is greater than the sum of the individual elements, contributions, etc.
2. The potential ability of individual organizations or groups to be more successful or productive as a result of a merger.
Have you ever wondered why some acquisitions are successful and some are miserable failures?
In a typical strategic acquisition situation, the case for a business acquisition is built on an assessment of potential synergies that can be realized by completing an acquisition. Let’s take a closer look at the synergies that an acquisition can produce.
Synergies are usually categorized as either revenue synergies or cost synergies.
Revenue synergies are opportunities to increase revenues as a result of an acquisition. Revenue synergies arise in two ways. The first opportunity for revenue synergies is the ability to sell more to existing customers of the two combining entities. This can be the case when the service mix of the two companies are not the same. For example, a landscape maintenance company might buy an irrigation company, expanding its product line, in the expectation that it will be able to sell irrigation services to its existing landscape maintenance customers. If the expected portion of the combining companies’ existing revenues are retained and new revenues are generated by selling irrigation services to maintenance customers or maintenance services to irrigation customers, a revenue synergy is realized. The expectation of such revenue synergies is often a key driver of acquisition activity. However, the possibility of this kind of revenue synergy is often discounted in acquisition valuation analysis because it is somewhat speculative in nature – it depends on successful cross-selling after a transaction is completed.
The other type of revenue synergy arises when a company acquires a service line that it has historically out-sourced. For example, a maintenance company may have historically outsourced fertilization and weed control services. If it acquires a fertilization company, it can bring the services previously outsourced in house and immediately realize a revenue synergy. Because this synergy can be realized by management action, it is less speculative and more appropriate for consideration in valuation analysis.
Cost synergies may arise in a variety of ways. Duplicate activities can be eliminated. Facilities can be combined or eliminated. Duplicate personnel can be eliminated. The combined company may be able to exercise greater purchasing power. Overhead can be spread over a larger base. Cost synergies can be relatively objective and appropriate for consideration in analyzing a potential transaction.
Why then do many acquisitions fail to live up to their expectations when it come to synergies? There are really two reasons. First, it is very easy to over-estimate the value of synergies and the time and process required to realize them. Second, in many acquisitions, there is too much focus on “getting the deal done” and too little focus on what comes next – the blocking and tackling required to integrate an acquisition and realize its full potential to the combined entity.
Those acquisitions that are successful, sometimes wildly successful, are founded on a realistic assessment of the value of the acquisition to the combined business, including meaningful synergies, and have a well-planned integration plan to make sure the acquisition goes as smoothly as possible and the synergies that were identified in the planning and evaluation process are actually realized by the combined business.