Financial Synergy

Financial Synergy

A compass with the word synergy written on it, illustrating financial synergy as a goal.

Key Takeaways About Financial Synergy:

This guide explains what financial synergy is and why it’s important. Understanding financial synergies is important for understanding mergers & acquisitions (M&A). Financial synergy is what strategic buyers are looking to create in an M&A transaction. To learn more about mergers & acquisitions, read our guide: The M&A Process Explained.

  • There are two major categories that financial synergies fall into—revenue enhancements and cost savings.
  • Cost-Savings are financial synergies that occur when two companies merge, and the effect is lowering the costs of doing business through increased operating efficiencies.
  • Revenue enhancements are financial synergies that result in the business’ ability to generate more cash flows through more effective use of assets.
  • In M&A, cost savings are referred to as "hard synergies," and revenue enhancements are referred to as "soft synergies."

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How Financial Synergy Fits Into M&A:

The basic premise of financial synergy in M&A is that when one company acquires another or merges with another, the two entities will be worth more combined than they were separately.

In mergers & acquisitions, buyers (acquirers of other businesses) are usually placed into two categories—financial buyers and strategic buyers. Generally speaking, strategic buyers are more interested in achieving synergies than financial buyers. You can learn more about the difference here: Financial vs Strategic Buyers.

In summary, strategic buyers are usually large corporations in the same industry that are looking to buy other businesses to achieve financial synergies, and for Vertical Integration and Horizontal Integration. An understanding of financial synergies shows you why strategic buyers would want to consider buying a business at any given price.

The basic idea is that after the merger or acquisition the resulting business will be better than it was before. Here’s an example to illustrate this: if Company A is valued at $200m and buys Company B for $50m, and the resulting company is valued at $350m—we look at the merger or the acquisition as what created that additional $100m value (above the combined value of each of the businesses individually).

The above example illustrates how M&A transactions can create value. In business, this is called inorganic growth. Inorganic growth is growth that comes as a result of M&A—versus growing the core operations of the business. Organic growth is what most people are talking about when they talk about “scaling” a business. Organic growth is driven by sales and marketing, improving the product, and by hiring a great team—as opposed to M&A transactions that result in inorganic growth. You can learn more about the difference between organic vs inorganic growth here.

Financial Synergy - Cost Savings:

Now that we understand what financial synergy is, and how creating financial synergies is the objective of strategic buyers in M&A transactions, let’s look at some examples of cost saving strategies. Here are three good examples of cost savings:

  • Layoffs—Are when companies reduce their labor force. Layoffs often come about as a result of M&A transactions between strategic buyers because there will be a portion of the labor force that is now redundant. By eliminating and consolidating these redundant jobs, companies can create cost savings.
  • Supply Chain Efficiencies—As a result of the merger or the acquisition, the business likely has increased negotiating power with suppliers—from their increased purchasing power. Often, they will be able to negotiate better prices on supplies, better accounts payable terms, or both. If both companies already have manufacturing facilities, supply chain efficiencies can come from closing the redundant facilities.
  • Reduced Distribution Costs—Normally both companies would be doing marketing and selling independently. Now there are opportunities to create cost saving synergies by consolidating and focusing these efforts. Often, now the costs can be consolidated or even cut in half. If both companies hire marketing firms, then post-acquisition, only one may be necessary. Maybe both products can be sold through the same salesforce or the same distribution channels as well. Additionally, if both companies have retail locations, now maybe fewer—or even half of them—may be necessary.

Financial Synergy - Revenue Enhancements:

Above we saw how financial synergy can benefit companies in the form of cost savings. Now we’ll look at three good examples of how companies can benefit from synergy in the form of revenue enhancements:

  • Price Points & Upselling—When Company A buys Company B it’s easy to see how they can benefit from increased profit from reducing costs. Additionally, they can potentially benefit from a revenue/cash flow standpoint from raising prices. If Company A is operating in a competitive environment, perhaps through a merger they can create a unique offer that would allow them to break the “apples to apples” comparison that was driving prices down in their industry. Now as a result of the merger Company A may be able to increase it’s prices through bundling products, offering Company B’s products at the same time. This process could also be unbundled and both companies could take advantage of upselling the other company’s products at time of purchase. In the last section we saw how M&A transactions could lower cost structures, here we’ve seen how they could increase cash flow without proportionally increasing costs.
  • Access to New Markets—A big reason why strategic buyers look to do M&A transactions is to gain access to new markets. This works from multiple angles, including gaining access to new demographic and new geographic markets. Coca-Cola has used this strategy to gain access to new geographic markets for decades. This can also be done to gain access to new demographics through cross selling. In many cases it’s easier to buy an existing brand in a new market, than it is to try and break a new brand into an established market.
  • Patents and R&D—Access to cutting edge R&D or to new patents can present an opportunity to create new revenue streams. Additionally, there may be brand new products with sales that are growing slower than they potentially could with a larger company’s distribution network. Buying a company with patents, R&D or new product lines that offer potential revenue streams is another big reason for doing M&A deals. This is type of motivation for M&A is commonplace in the software & technology industries.

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