What is Synergy
Synergy is the concept that the value and performance of two companies combined will be greater than the sum of the separate individual parts. Synergy is a term that is most commonly used in the context of mergers and acquisitions (M&A). Synergy, or the potential financial benefit achieved through the combining of companies, is often a driving force behind a merger.
BREAKING DOWN Synergy
Mergers and acquisitions (M&A) are made with the goal of improving the company's financial performance for the shareholders. Two businesses can merge to form one company that is capable of producing more revenue than either could have been able to independently, or to create one company that is able to eliminate or streamline redundant processes, resulting in significant cost reduction. Because of this principle, the potential synergy is examined during the merger and acquisition process. If two companies can merge to create greater efficiency or scale, the result is what is sometimes referred to as a synergy merge.
Shareholders will benefit if a company's post-merger share price increases due to the synergistic effect of the deal. The expected synergy achieved through the merger can be attributed to various factors, such as increased revenues, combined talent and technology, or cost reduction.
For example, when Proctor & Gamble Company acquired Gillette in 2005, a P&G news release cited that "The increases to the company's growth objectives are driven by the identified synergy opportunities from the P&G/Gillette combination. The company continues to expect cost synergies of approximately $1 to $1.2 billion…and an increase in the annual sales run-rate of about $750 million by 2008." In the same press release, then P&G chairman, president and chief executive A.G. Lafley stated, "…We are both industry leaders on our own, and we will be even stronger and even better together." This is the idea behind synergy - that by combining two companies the financial results are greater than what either could have achieved alone.
In addition to merging with another company, a company may also attempt to create synergy by combining products or markets. For example, a retail business that sells clothes may decide to cross-sell products by offering accessories, such as jewelry or belts, to increase revenue. A company can also achieve synergy by setting up cross-disciplinary work groups, in which each member of the team brings with him or her a unique skill set or experience. For example, a product development team may consist of marketers, analysts, and R&D experts. This team formation could result in increased capacity and work flow and, ultimately, a better product than all the team members could produce if they work separately.
Synergy can also be negative. Negative synergy is derived when the value of the combined entities is less than the value of each entity if it operated alone. This could result if the merged firms experience problems caused by vastly different leadership styles and company cultures.
Synergy is reflected on a company's balance sheet through its goodwill account. Goodwill is an intangible asset that represents the portion of the business value that cannot be attributed to other business assets. Synergies may not necessarily have a monetary value, but could reduce the costs of sales and increase profit margin or future growth. In order for a synergy to have an effect on value, it must produce higher cash flows from existing assets, higher expected growth rates, longer growth period, or lower cost of capital.