What Is Cost Synergy? Definition, How It Works, and Types

What Is Cost Synergy?

Cost synergy is the savings in operating costs expected after the merger of two companies. Cost synergies are cost reductions due to the increased efficiencies in the combined company. Cost synergy is one of three major synergy types, with the other two being revenue and financial synergies. 

Key Takeaways

  • Cost synergy is the reduction of costs due to increased efficiencies following a merger of two companies. 
  • The cost savings due to cost synergy can take many forms, including layoffs, technological improvements, supply chain advancements, and research and development. 
  • A merger can also create revenue synergies, which allow the newly formed company to generate more sales via efficiencies, such as access to patents or having complementary products. 
  • Synergies can be measured by looking at comparable or like transactions, or by assessing each company individually to determine potential savings, usually via a bottom-up analysis. 

How Cost Synergy Works

Merger and acquisition (M&A) cost synergies may arise from lowered expenses as a result of increased efficiencies of the two merged companies. These expenses can include such things as redundant insurance, equipment, and physical locations. It may also come from economies of scale and volume buying derived from the larger combined size of the two companies.

Cost synergies can be measured by comparing comparable transactions or by looking internally at each company. In the case of assessing each company, a bottom-up analysis can be completed to see how additional assets or operations will affect cost savings. 

Types of Cost Synergies

The savings in operating costs can take many forms. Often mergers result in the layoffs of some employees who are no longer needed. If two companies have large sales departments and operate in the same regions, it may not be necessary to keep employees from both companies. On the other hand, if the two companies complement each other geographically, layoffs may not be necessary.

Cost synergy may also result from when one of the companies involved in the merger has proprietary technology that would benefit the other company. If one company owns information technology that makes it more efficient than competitors, this will provide the same benefit to the other company in the merger, resulting in cost savings.

Savings may also be gained in the supply chain. One company may have better supply chain relationships, possibly including lower input costs, which would benefit the merger partner. On the other hand, since the new combined company will be larger it may enjoy a better bargaining position with suppliers, resulting in lower input costs.

Cost synergy may also arise from research and development. If one of the merger partners has produced a component that enhances the products of the other and it would otherwise be unavailable, then cost savings result from the second partner not having to develop that component on its own.

Cost Synergy vs. Revenue Synergy 

Revenue synergies, like cost synergies, are the result of a merger. With revenue synergies, the newly merged company can generate more sales than the two companies can separately. Key revenue synergies may include access to patents or other intellectual property and having complementary products, customers, or geographical locations that create opportunities for cross-marketing, cross-selling, bundling, and providing a more rounded customer experience.