In the previous article we explained what synergies are and how they add value to corporations. Executives take extra measures to identify synergies within their business or between their business and target companies in an acquisition or partnership.
In this blog post we will delve into different types of synergies. Understanding these will help you rationalize what makes the companies choose one target over another when they decide to grow inorganically.
Inorganic strategies create synergies that classify in one of three categories based on the effect they create. These are revenue, cost and financial synergies. We will look at each category and provide examples of each.
Revenue synergies are potential revenue streams available to the combined entities that would not exist when they operate in isolation. Here are some examples of revenue synergies:
- Cross selling to existing customers
- Geographic expansion
- Offering bundles and solutions
- Revenue management
- Channel expansion
- Optimize coverage and channels
- Salesforce effectiveness
Revenue synergies normally take longer to realize than cost synergies but they often turn out to be the most lucrative growth path if owned and executed properly. In other words, they are more speculative as they largely depend on how the future sales will go after the deal closes.
Cost synergies are those that mergers bring about by combining, eliminating or streamlining redundant processes. They are easier to predict as they are calculated based on the current spending of both organizations in specific areas such as IT, sales and marketing, etc. Unlike the general perception that cost synergies are only associated with RIF (reduction in force), there are many other forms of cost synergies such as IT consolidation, reduced S&M spending and renegotiated agreements that may not necessarily result in such measures. Some examples of cost synergies are:
- Reducing staff headcount by identifying functional duplication
- Reducing rent by consolidating offices and other locations
- Consolidating suppliers &/or renegotiating supplier terms
- Increasing utilization of capital assets such as factories, transportation etc.
- Reducing professional services fees
In some scenarios a transaction can yield lower cost of capital. These are commonly known as financial synergies. However one could also categorize these as cost synergies. Financial synergies reduce the cost a company needs to meet to secure various funding resources to finance its business. Take for example a small business cost of debt significantly reducing when it merges with a larger company which has a larger balance sheet and cash flow supporting the loan.
Some synergies may not directly map to one of the three categories above but ultimately result in securing revenues or preventing future costs. For instance these could help keep leadership in specific markets or protect the company from future lawsuits.
Applications of synergy in the real world
Some interesting acquisitions strategies are listed below:
- Robinhood’s acquisition of recruiting firm Binc to double the size of its recruiting firm and accelerate access to talent.
- Google’s acquisition of Motorola was to get access to patents that protect Android handset makers from being sued by rivals Microsoft and Apple.
- Special purpose acquisition companies, as a shell corporation, on a stock exchange acquiring a private company without going through the traditional lengthy IPO process.
- KnowBe4 acquired MediaPro, a security and privacy training solutions company, to expand in the security awareness training market
The synergy types discussed in this article are internal, That is they focus on the internal capabilities of the two businesses. In a future post we will talk about Network synergy which has been researched at Wharton School of Business. The idea of network synergy is that the external partnership of the combined company proves to be more valuable than the separate partnership the two firms would have signed on their own.
Determining and evaluating different types of deal synergies ahead of closing gives the buyer negotiation leverage. It avoids overpaying for or lowball offering the deal which in turn increases the chance of success in the acquisition.