VALUE CREATION THROUGH M&As AND SYNERGIES OF
A synergy is an outcome enhancing the value of a merged firm above the combined value of
the two separate firms. There are several reasons that lead to synergies during the activity of
merger and acquisition transactions. When two entities merge, they bring some added
benefits with them. There can be cost savings due to operational efficiencies or revenue
upside due to more productive use of combined assets, human resources, finance and
marketing that can easily be shared across internal borders of the merging entities. The
rationale behind M &A transactions is to improve the organization’s performance. However,
there are several instances that have proved this is not as simple as it seems.
In the past few years, mergers and acquisitions have become a very well known subject with
a lot of attention for it. For instance, this subject has not only been highlighted in journals,
papers, television, internet and other media, but also theoretical and empirical research on
mergers and acquisitions has increased significantly.
Well known mergers and acquisitions that have received a lot of attention in the media are the
merger between Shell and Royal Dutch into Royal Dutch Shell in the year 2005, the
acquisition of KLM by Air France in 2003 and the merger between Arcelor and Mittal Steel
in 2006. The broad opinion about the mergers and acquisitions in the media is that the value
of the combined firm increased compared to the sum of the individual firms. Primary reasons
the perceived increase in value out of such transactions were the estimated benefits from
synergy and increasing market power.
Besides merging with another firm, a company can try to develop synergy by blending
products or markets. For instance, a retail business that sells outfits may decide to cross-sell
clothes by proffering accessories like belts, wallets, footwear jewellery, to upsurge its
revenue. A firm may also attain synergy by establishing cross-disciplinary work groups, in
which each member of the firm may apply his or her own unique talent and expertise. For
instance, a product development team generally comprises of analysts, researchers,
marketers, and other experts. This alliance of all the experts invariably leads to enhanced
capacity and work flow and eventually, will create a stiff competition in the market.
Mergers and acquisitions have a great range of sub elements. To name a few, what are the
motives, the value creation but also the social consequences of mergers and acquisitions? Let
us discuss one such element, namely, the value creation out of mergers and acquisitions.
In order to understand the value creation by mergers and acquisitions for shareholders, the
valuation of mergers and acquisitions has to be ascertained. The influence of the payment
method on mergers and acquisitions, value from synergies by M&A and the value for the
shareholder of acquiring firm and the target firm, all have to be comprehended.
The working of synergy can be easily understood with the help of an illustration. For example
there are two companies. Company A and B decide to undergo synergy since they believe
that a merger would reduce their overall operating cost and they can increase their market
share. Primary reason behind their decision for a merger is that Company B produces raw
materials and Company A procures them to prepare finished products and sells in the market.
So after merging, Company A would not need to search out for vendors for getting raw
materials. At the same time, Company B has a committed buyer and can reduce its sales and
marketing budget. Also by merging, the companies can spend the savings, inter alia, in
developing better technology for production and engage and train better human resources.
These are among the primary reasons for undergoing merger or acquisition in order to attain
8.1.1 How to value mergers and acquisitions?
Measuring the performance leads to specific outcomes. There can be three possible outcomes
of an M&A transaction - value creation, value conservation and value destroying. The
investment return is identical to the required return in value conservation. This implies that
the net present value is zero. With value creation the investment return exceeds the required
return and will have a positive net present value. The investor should be very satisfied with
this result, because it exceeds the expectations and it is difficult to realise into the market.
With value destroying the investment returns are not enough to equal the required returns. In
this case the investor is disappointed, because the investor could have better invested in other
There is always inkling whether synergy creates value or not. But synergy is that added value
that is formed by coalition of two firms that generate opportunities that would not have been
possible for these firms operating separately. Thus when the value of the corporations
together is more than the sum of a single corporation, synergy prevails. Synergy can be
classified into operating synergies and financial synergies– the former influences the working
of the combined operations and encompasses the advantages of the economies of scale,
pricing power and elevated prospective growth. And in most of the cases, it represents higher
expected future cash flows. The latter, plays a role if the combined value of the assets of the
individual firms has a bigger value than the value of the stock market assigned to the assets.
(Goergen and Renneboog, 2003).
There is another type of synergy that is known as collusive synergy emanates from price
related resources and is has higher value than the other synergies. The type of synergy is
always determined on the basis of resources that develop it.
18.104.22.168 Operating synergies
They always provide the company for prospects to upgrade the operating income from the
already subsisting assets which will contribute towards the growth of the firm. Operating
synergies can be divided into four types.
The first type is economies of scale. When there emerges a proportionate saving in costs that
is gained by increased level of production, it leads to cost cutting.
The second type of operating synergies is enlarged market power of the company. When the
two firms blend, they capture higher market share which consequently reduces the
competition. And the new merged firm is always in an advantageous position as compared to
its rival firms.
The next type of synergy is the integration of functional strengths in the new company. A
paramount advantage of a merger is the human resource. The key areas where both the firms
are lacking (individually) can be filled up / complemented by the human resources which
again becomes an added advantage for the firm.
The last type of synergy is the increasing growth in the markets. The new corporation will
have a probability of covering a wide share of market and can easily increase the sales that
will result in more revenue for the corporation.
8.2 Identification of synergies
On the basis of their impact on cash flows, synergies can be classified into cost, revenue,
financial and market synergies.
8.2.1 Cost synergy
It refers to a reduction/elimination of administrative and overhead costs as a result of the
consolidation of operations of the combined companies. Cost synergies are often achieved
through a reduction in the number of employees, elimination of excess resources due to
integration processes, economies of scale, etc.
Following are the types of cost-saving synergies that can be achieved when two firms merge:
22.214.171.124 Shared Information Technology: When a company merges with the other it
can have access to a better information and technology and it would lead to a greater
126.96.36.199 Supply Chain Efficiencies: If a firm already has covered a large portion of
market for its sales, the other firm by merging with it can take the benefit of
increasing its supply chain removing / reducing the other competitors. It would also
reduce the cost for both the firms.
188.8.131.52 Surged Sales and Marketing: -When there is refinement in the distribution
channels of the company, it can have enlarged scope for sales and marketing. And this
refinement can be easily brought by the process of M&A. It will reduce the cost and
will lead to cost efficiency.
184.108.40.206 Research and Development: A major reason for carrying out a merger and
acquisition (M&A) is to gain access to technological knowledge and to increase new
product development (NPD) capabilities. To achieve the desired effect of improving a
firm's capacity for innovation, this knowledge must be combined with the acquiring
firm's existing resources. Either firm may have had access to research and
development efforts that, when applied to their counterpart firm, allow for better
development or room to cut costs in production without sacrificing quality.
220.127.116.11 Lower outgo on Salaries and Wages: when the companies merge, invariably
there is a rationalisation / reduction in the HR department so as to avoid overlapping
of the functions performed. Thus this will lower the company’s outgo on salaries and
wages. For example, a merged company may not require two CEOs or two CFOs.
18.104.22.168 Lower outgo on technology expenses: The acquiring firm can avoid the
expense of technology transfer fees that it paid to the target firm earlier by merging
with the latter and transferring the technology
right to the acquirer.
8.2.2 Revenue synergy
It indicates the enhanced ability of the combined company to sell more or generate more
revenue through cross-selling, gaining access to new markets, selling and distribution of
similar or complementary products, reduction of competition, integrated distribution
Here are the types of revenue enhancing synergies that can be realized when two companies
22.214.171.124 Complementary geographies and customers: The two individual firms that
have their own geographical areas of operation, when blend, may have access to a
larger area and can elevate their customers base and sales. These increased sales will
add to the revenue of the firm.
126.96.36.199 Complementary products: The products that are produced by the
independent firms can become an advantage when the firm merges with the other and
complement each other’s products which will upsurge the firm’s revenue by increase
188.8.131.52 Patents: Corresponding to the cost-saving effect of patent, a firm can also
increase its revenue by having access to the patent of the other firm and it can create
a stiff rivalry in the market.
8.2.3 Financial synergy
They are represented by better profitability emerging as a result of lower costs of capital,
improved cash flows, higher revenue of combined companies, improved capacity to handle
debts/liabilities, a better risktaking ability and probable tax benefits.
8.2.4 Market synergy
Through M&A are achieved by way of enhanced negotiation/bargaining abilities, increased
recognition and market standing of the combined entity at the industry level, etc. 1
As the basic formula of mathematics states that one plus one equals two, it exhibits a
rationale that nothing can be formed from a non existing thing, similar is the reason behind
the idea of synergies that add value during a merger or acquisition. There have been a lot of
unsuccessful mergers and acquisitions in the past which have invited criticisms and this has
led to the researchers questioning the existence of synergies, insisting that some M&A
transactions simply annihilate the value instead of creating it. And nowadays, an increasing
number of companies have made this process of M&A an intrinsic part of their growth
strategy. Unless it was not profitable, these acquisitions had presumably not taken place to
such a large extent.
Negative synergies also persist in the business world. The whole is less than the sum of its
parts in the presence of negative synergy. It simply means that the firms can individually
operate better than performing operations after merging with another firm. In mathematical
terms, two plus two equals three when there persists a negative synergy. A direct instance of
1 Types of Synergies, CFI, https://corporatefinanceinstitute.com/resources/knowledge/valuation/types-of-
this is an overly social work team that does not spend its skills and knowledge on working
and emphasise more on ‘team building’. Also negative synergies start persisting when there
arises difference in the leadership styles and company cultures.
The main purpose of majority of the mergers and acquisition process is to attain synergy and
create a value for the new organisation. Though the prospective synergies are acknowledged
in the beginning of mergers and acquisitions, the agreement does not assure that the synergy
will be realised in the end. Complexities occur when synergies are put from thought to action.
A primary logic for such problem is the excessive attention given to tangible aspects, the
financials and very less attention on the soft sides of the integration.
There are many mistakes committed during M&A and the opportunities are overlooked often
within a reasonable time. Also sometimes there is misapprehension of culture prevailing
around. Sometimes, the purported or naturally assumed synergies differ practically and
theoretically i.e. they appear realistic and achievable though when brought into action
become hard to be realized.
8.3 Layers of value creation
The framework defines following layers of value creation:
• Protect the base business: efforts to preserve pre-merger value and maintain the core
• Capture combinational synergies: traditional value creation efforts to achieve
economies of scale and enhanced efficiency
• Seek select transformational synergies: often ignored, often capability-based
opportunities to create value by radically transforming targeted functions, processes,
or business units.
8.3.1 Levers of value creation
Within each layer of value creation, companies can pull three levers to realize value:
• Cost: capture cost savings by eliminating redundancies and improving efficiencies
• Capital: improve the balance sheet by reducing such things as working capital, fixed
assets, and borrowing or funding costs
• Revenue: enhance revenue growth by acquiring or building new capabilities (e.g.,
cross-fertilizing product portfolios, geographies, customer segments, and channels).2
8.4 Valuation of synergies
Subsequent to the identification of the synergies, another most crucial milestone in the
process of value creation is to guesstimate the expected synergies. This
procedureencompasses the evaluation of various multiples to compare the estimations made
with the industry benchmarks. In order to obtain a proper computation or valuation of
synergy, traditional discounted cash flow method is generally used by examining the details
of all transactions. Therefore, the purpose of value creation is achieved only when the
realised level of synergy is adequate to justify the invested amount and risk affiliated to
merger and acquisition.Though focus and organized planning a prerequisite in order to realise
the synergy and to meet the agreement goals.
8.5 Structured process
An organized process is prerequisite for confirmingthat the operational issues are highlighted
and addressed. Companies sometimes allow operational teams administer the synergy
realization process where they actually try to accentuate on the ‘business-as-usual’ activities
rather than focussing on synergy initiatives. So an assembled program should always
incorporate leadership of employees and must concentrate on driving these initiatives and
give them ample primacy among the plethora of other business-as-usual activities.
When large corporations merge and come together, they have their own apparent cultures
which makes it mandatory to develop a systematic synergy realization process that is in
concurrence with the cultures of both the organizations. A systematic and well-developed
2Oliver Engert & Rob Rosiello, Perspectives on merger integration, Mcksinsey.com,
assimilation process facilitates the realization of M&A benefits and also helps in improving
the quantum of benefits realised.
8.6 Challenges in meeting Synergy Targets
Mergers often set goals that cannot be achieved but even just the pretence is comforting. In
the corporate world, there is a general presumption that at least half of the mergers fail to
accomplish the goals that brought them to consider merger in the first place. Post-merger
integration is an interactive process, where people of two different institutions learn to co-
operate to transfer their strategic capabilities.
While overall strategic alignment often defines the benefits realisation pace and success,
organizations sometimes are not able to forecast the synergy realization due to many
challenges some of which include poor planning and communication, unarranged execution
and inadequate monitoring.
Following figure showcases the key reasons behind the challenges in meeting synergy targets
as per a post-merger integration survey.
In the present business world full of stiff competition, it has become so imperative for
business organizations to comply with the standards that have been set up by the competitive
forces in market in order to sustain for a long term. Therefore, the organizations try to create
3 India’s Post-Integration Merger Survey, PwC, https://www.pwc.in/assets/pdfs/publications/2018/value-
value in some or the other form so as to compete with the rivals and Merger and Acquisition
in one such way where they can develop synergy.
Comprehension of an opportunity to synergy in M&A is not an easy process. It requires
experience and acquaintance with the knowledge of the market. Its failure can be very brutal
thus it’s prudent to consider every probable factor before opting for any kind of merger or
Creating and realizing synergies is a long process on average 5-10 years. An M&A process
encompasses three essential aspects; the strategic intent phase, the due diligence phase, and
finally the integration phase. Prime elements of achieving success in conducting M&A are
that you develop a notable management group which will accentuate on the creation and
realisation of synergies and will also focus on encouraging and guiding managers through
proffering new thrilling challenges.
Another important factor in this regard is to apprehend whether to buy a company or to sell
one or to merge with other. And to understand the opportunity, both the parties must have a
cognitive understanding of the businesses they are into.
“Think of value creation, not valuation”
-Pranav Marwah, ThinQbate