The main methodology is the author's interview of the CEOs of many successful acquiring firms as well as case studies of unsuccessful firms some based on secondary sources. This methodology is complemented by academic research on these topics dating back to the early s that had raised caution signals but were largely ignored.
The key finding is that it is very difficult to evaluate the nature of synergies, especially revenue synergies, during merger negotiations. This leads to overpayment and unanticipated integration problems. The practical implication is to discount any revenue synergies more heavily than you may be inclined to do. Alert managers to the problem of justifying an acquisition or a merger based on the synergy rationale.
Invest in getting to know the target — possibly years in advance. The value is to alert managers considering related mergers to some potential landmines and what to do about them. Chatterjee, S. Emerald Group Publishing Limited. Your Money. Personal Finance. Your Practice. Popular Courses. Fundamental Analysis Tools for Fundamental Analysis. What Is Synergy? Key Takeaways Synergy is the concept that the value and performance of two companies combined will be greater than the sum of the separate individual parts.
The expected synergy achieved through a merger can be attributed to various factors, such as increased revenues, combined talent and technology, and cost reduction. In addition to merging with another company, a company can also create synergy by combining products or markets, such as when one company cross-sells another company's products to increase revenues. Companies can also achieve synergy between different departments by setting up cross-disciplinary workgroups in which teams work cooperatively to increase productivity and innovation.
Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation.
This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Terms Understanding Horizontal Mergers A horizontal merger is a merger or business consolidation that occurs between firms that operate in the same industry, usually as larger companies attempt to create more efficient economies of scale.
What Is a Congeneric Merger A congeneric merger is where the acquiring company and the target company do not offer the same products but are in a related industry or market.
What Is Cost Synergy? Cost synergy is savings, which can take many forms, in operating costs expected after the merger of two companies.
They argued that the program would incur considerable opportunity costs, forcing them to divert marketing funds and management time from other local brands. The key to resolving the dispute lay in determining the strategic importance of the planned rollout.
If the rollout was strategically important, either to the units involved or to the overall corporation, then the benefits would likely outweigh the opportunity costs. But if some other more strategically important initiative was likely to be delayed in order to implement the rollout, then the opportunity costs would be greater. After some soul-searching by the units and by corporate marketing, it was agreed that the rollout had low strategic importance, except in three units. Headquarters scaled back the initiative.
It would give advice and support to those units that wanted to go ahead with the product launch, but it would not impose a rollout on the other units. Sizing the prize provides a counterweight to the synergy bias, forcing corporate managers to substantiate their assumptions that the synergy initiatives they propose will create big net benefits. And, by leading to the disaggregation of broad initiatives into discrete, well-defined programs, sizing the prize can set the stage for a focused, successful implementation.
Even when a synergy prize is found to be sizable, corporate executives should not necessarily rush in. We would in general urge a cautious approach unless the need for corporate intervention is clear and compelling.
Corporate executives should start with the assumption that when it makes good commercial sense, the business-unit managers will usually cooperate without the need for corporate involvement. When is intervention by the corporate parent justified? Only when corporate executives can, first, point to a specific problem that is preventing the unit managers from working together; second, show why their involvement would solve the problem; and third, confirm that they have the skills required to get the job done.
In those circumstances, there is what we call a parenting opportunity. We have found that genuine parenting opportunities tend to take four forms:. Perception opportunities arise when businesses are unaware of the potential benefits of synergy. The oversight may be caused by a lack of interest, a lack of information, or a lack of personal contacts. The parent can help fill the perception gap by, for example, disseminating important information or by introducing aggressive performance targets that encourage units to look to other units for better ways to operate.
In general, the greater the number of business units in a company, the more likely it is that perception opportunities will arise. ABB, for example, has 5, profit centers organized into a number of business areas. In its power transformer area alone, there are more than 30 units.
It is clearly impractical for every unit head to know what is going on in each of the other 29 units. The cost of scanning is too high. The area head, therefore, plays an important role in facilitating the information flow, passing on best-practice ideas and introducing managers to one another.
In addition, the area head regularly publishes financial and operating information about each business, enabling cross-unit comparisons and helping each business identify units from which it can learn useful lessons.
Evaluation opportunities arise when the businesses fail to assess correctly the costs and benefits of a potential synergy. The German subsidiary of one multinational company, for example, was fiercely protective of a new product it had developed. It was not only reluctant to help other units develop similar products, it even refused visits from unit and corporate-center technicians. The reason?
The German managers did not trust their French and Italian colleagues to price the new product appropriately. They feared those units would not position it as a premium product and, as a result, would undermine price levels throughout Europe, reducing the exceptional profits being generated in the German market.
The standoff was resolved only when corporate executives walked the German managers through the cost-benefit calculations step by step and guaranteed that prices would be kept above a certain minimum in all countries. Motivation opportunities, which derive from a simple lack of enthusiasm by one or more units, can stop collaboration dead in its tracks. Disincentives come in a number of forms. Unit managers may, for example, believe that the personal costs of cooperating are too high—that their personal empires or bonuses may be put at risk.
Or transfer-pricing mechanisms may, in effect, penalize one unit for cooperating with another. Or two unit managers may simply dislike each other, preventing them from working together constructively. Identifying and removing motivational roadblocks, whether they reside in measurement and reward systems or in interpersonal relations, can be one of the toughest, but most valuable, roles for the corporate executive.
In one company, the CEO tried for five years to get the managers responsible for North American and European operations to cooperate. The North American business was run by a headstrong young woman with a strong belief in an open management style.
Europe was run by a reserved, traditional Englishman who preferred to operate through formal, hierarchical structures. Both managers privately aspired to run the entire global business, but publicly they argued that there were few overlaps between their businesses that would merit collaboration.
After a series of failed attempts to get the businesses to work together, each of which ended in bitter rows and recriminations, the CEO finally lost patience and fired both managers. In their places, he appointed more compatible managers who were able to work together with a great deal of success. The business heads of a European chemical company, for example, agreed that it would be valuable to pool their resources when setting up an Asia-Pacific office in Singapore.
Their aim was to improve the effectiveness of their sales efforts in markets that were unfamiliar to all of them. The initiative failed because none of the businesses had a suitable candidate to head the office; the individual appointed was not well connected in the region and lacked the skills needed to open new accounts. If the parent had intervened, by providing a suitable manager from its central staff or training and by coaching the man appointed, the chances of success would have increased greatly.
Thinking through the nature of the parenting opportunity, and hence the role that the parent needs to play, helps corporate executives pinpoint which type of intervention, if any, makes sense. But any decision to intervene should also take account of the skills of the managers involved.
Appointing a purchasing specialist to advise the businesses on gaining leverage by pooling their purchases may be an excellent idea, but if the parent does not have the right person to do the job, the new appointment will end up irritating and alienating the businesses. A lack of the right skills can thwart even the best of intentions. Any decision for parental intervention should also take account of the skills of the managers involved.
The discipline of pinpointing the parenting opportunity is probably the most valuable contribution that we have to offer to corporate executives in search of synergy. Thinking clearly about why parental intervention is needed can help managers avoid mirages and select suitable interventions.
Unless a parenting opportunity can be pinpointed, our advice is not to intervene at all. The synergy is attractive; the parenting opportunity is clear; the skills are in place. Is it time to act? Not necessarily. A final discipline is in order: looking carefully for any collateral damage that may occur from the synergy program.
If corporate executives overlook the negative knock-on effects, they risk great harm. Some synergy efforts send the wrong signals to line managers and employees, clouding their understanding of corporate priorities and damaging the credibility of headquarters.
When one company set up a coordination committee to seek marketing synergies among its businesses, the unit managers thought the CEO was abandoning his much-communicated goal of promoting stronger accountability at the individual unit level. They saw the corporate committee as a sign of a return to more centralized control.
In fact, the shift of accountability to the units remained a core strategic thrust—the synergy initiative was simply a tactical effort intended to save money. They began looking inward rather than outward. Top-down synergy efforts can also undermine employee motivation and innovation. One consumer-goods company, for example, launched an effort to coordinate research and development across its European units.
Although the effort appeared to be highly attractive, offering substantial productivity gains, it backfired. A key source of innovation in the company had been the internal competition between the U. By establishing a combined research unit, headquarters ended the competition—and the creativity. The effort succeeded in eliminating duplicated effort and achieving economies of scale, but these gains were overshadowed by the unanticipated downsides. In other cases, cooperation can distort the way unit managers think about their business, leading to wrongheaded decisions.
Consider the experience of a diversified retailing company that tried to encourage greater cooperation between its two appliance-retailing businesses. One of the businesses, which focused on selling top-quality appliances at premium prices, was highly profitable. The other, which pursued a pile-it-high, sell-it-cheap strategy, was barely breaking even.
The group CEO recognized the differences between the businesses, but he felt certain that synergy could be achieved, particularly in purchasing.
To encourage greater cooperation, he put the head of the profitable business in charge of both operations. The new leader of the two business units initially looked for areas where purchases could be pooled to gain greater leverage over suppliers. But although some small cost reductions were quickly realized, the program soon ran into difficulty: the two businesses were buying different kinds of products, with different price points and different proportions of store-branded items.
It was clear that big savings could only be achieved if the two businesses bought identical products. The managers of the struggling unit initially resisted this course, but as they learned more about the product and pricing strategies of their more successful partner, their thinking began to change.
Entranced by the wide margins available from selling premium goods, they began shifting their strategy. They bought better-quality products, boosted service levels, and raised prices. The result was calamitous. In emulating its sister company, the unit had undermined its business.
It had tried to take its product mix upscale without taking account of its competitive positioning. The new strategy was soon reversed, but it took more than a year to remove the inappropriate products from the supply chain.
The unit suffered big losses and major write-offs. It is never possible to predict all the unintended consequences that can flow from a synergy initiative or, for that matter, from any management action. But by simply being aware that business-unit collaboration can have big downsides, managers will be able to take a more objective, rigorous view of potential synergy efforts. In some cases, they will be able to structure the effort to avoid many of the potential downsides. In other cases, they will be able to kill proposals that would have created more problems than they solved.
Managers have sometimes accused us of being too skeptical about synergy. They argue that the disciplined approach we recommend—clarifying the real benefits to be gained, examining the potential for parental involvement, taking into account the possible downsides—will mean that fewer initiatives will be launched. And they are right. We believe that corporate managers should be more selective in their synergy interventions. In all too many companies, synergy programs are considered no-brainers.
Cooperation and sharing are viewed as ideals that are beyond debate. Real synergy opportunities exist in most large companies, but they are rarely as plentiful as executives assume.
The challenge is to distinguish the valid opportunities from the mirages. By taking a more disciplined approach to achieving synergy, an executive can gain its rewards while avoiding its frustrations.
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