- December 13, 2019
- Posted by: Ramkumar
- Category: Mergers And Acquisitions
Cost and Revenue Synergies in Mergers and Acquisitions
Synergy is a phrase that gets used in the connection between mergers and acquisitions (M&A). Synergies in mergers and acquisitions are the notion that the merged value and performance of two businesses will be higher than the sum of the separate, distinct parts. Cost and revenue synergies in mergers and acquisitions are significant for value creation.
Cost Synergies in Mergers and Acquisitions
Cost synergies get feasible when a more economical cost base compared to a standalone basis can sustain the operations of the two businesses getting together. A deflated cost base might, for instance, be the outcome of more agreeable supplier terms via economies of scale. It can also be due to the elimination of duplicate functions, selection of more cost-effective methods, rationalization of procurement spend, or more effective use of fixed assets. The specific root of cost synergies will vary across exclusive deals, the driver of transactions, and industries/verticals. That is to say; there is no one size fits all approach.
Compared to revenue synergies, cost synergies are typically simpler to evaluate and more dependably quantified. Part of the basis for this is that many cost synergies are on solid facts set out in the P&L rather than towering assumptions and best-case scenario supposition. Cost synergies can likewise be more easily managed/controlled than revenue synergies. Overall, cost synergies are more suitable to be achieved in the short term and are, hence, more apt to push the grounds of a deal. Nevertheless, be prepared: Research shows that cost synergy is notably challenging to sustain in the medium and long term. This scenario happens when costs are decreased too drastically or too immediately without executing the required adjustments to processes, organizations, and IT systems. The changes are needed to sustain a further effective operation. Without these, dismissed employees are usually replaced six months following with less qualified new hires, or worse still with even more costly contract personnel.
Cost synergies get assessed very precisely, mainly when the line of business and target company is well recognized. Cost savings can be the simplest type of synergy to accomplish. However, the time needed to achieve them get typically underestimated. The reasons are due to value realization agendas that deviate from the original plan and effect surprises in cash flow planning and synergy reporting.
Several various cost-saving types are viable but arise with a kind of restrictions. Some matters regarding fixed cost reductions to contemplate include:
- Increased costs usually follow economies of the scope by decreasing overlapping functional values in the unified function. For instance, reducing the acquired HR department with ten people may need an addition of two or three in the acquiring organization to drive up the workload.
- Consolidation also produces costs. For instance, local country regulations, implementation of new (more sophisticated) systems and methods, and trade union contracts can raise operating costs and slow execution.
- Change is continuously challenging to execute, and if designed or poorly implemented, management and staff can oppose reductions to the workforce.
When examining variable cost decreases:
- Increased purchasing volume, rising bargaining power, and supply chain productivity are typical routes and often comparatively easy/quick to achieve.
- Banking and insurance costs are opportunities for value capture. They can contribute significant savings as the weighted average cost of capital (WACC) reduces, and negotiating leverage rises.
- Indirect cost savings through improved vendor trust and collaboration (e.g., improved payment and credit terms)
The transfer of best methods and core competencies in each direction among the companies gathering to a transaction can drive to process developments, which in turn drive cost synergies. The consequences of process improvements can be numerous, and their timing can differ considerably. Some deliberations to note include:
- Financial reporting systems can usually be developed comparatively swiftly – however, except this manages to decreased headcount or software modifications, commercial synergies are seldom the result. Process developments can generate both cost savings and revenue augmentation.
- Given the difficulties linked with embedding process variations, synergies manage to coalesce reasonably late.
- Do also have in spirit that in several situations, process enhancements are a necessity to other operating cost decreases (particularly those associated with headcount reductions).
Revenue Synergies in Mergers and Acquisitions
The value ascribed to revenue synergies is typically much lower than for cost synergies. The view is that revenue synergies are elusive and unachievable. Costs get quickly recognized and material, given they are based on robust data. Revenue synergies, conversely, can be challenging to determine and measure/quantify, are profoundly impacted by exogenous variables (such as responses from customers and the broader market). Thus, more limited confidence is placed on them as a lever for value creation by several deal teams. And when it gets to estimating revenue synergies, it can be hard to differentiate between the benefits derived from a dedicated synergy capture program and what correlates to organic business-as-usual growth.
Still, the probabilities linking to revenue synergies can be hugely meaningful and typically contribute much more possible upside than cost synergies (costs can only decrease so much). For example, synergy opportunities connected to new pricing strategies, bundling of products/services, and accessing new markets are deserving of the hunt and can provide long-term value creation. Long-term studies, too, consistently confirm that revenue synergies accomplished through M&A are further typically more expected to sustain if and once performed. In tradition, seasoned acquirers frequently pursue a mix of both cost and revenue synergy targets for every acquisition. Hence, revenue synergies should be provided with attention and not overlooked.
Price management can contribute to high-impact and quicker returns than other revenue synergy spaces while demanding comparatively limited organizational change. Sales operations and customers anticipate change after M&A, so the window of opportunity to execute price changes can be small. It’s hence critical to get prepared so one can utilize this short window for change.
A review needs to take place during integration design and planning on the pricing changes. There are, of course, some barriers/risks connected with employing pricing as a value creation lever:
- Customers will not perceive that they get added value to offset the price increase. Notable variations in pricing among related sets of products and then being public on the aggressive cost reduction intentions will drive an expectation from customers that prices will reduce. Maintaining expectations with the customers to avoid this is hence crucial.
- The price information is delicate – hence, the target company might not give complete pricing information in the planning phase, driving to false hypotheses related to revenue synergies and delays in their implementation.
- Antitrust/competition regulations might block or restrict the giving of price, customer, and product data during the pre-deal planning phase. An answer to this is to utilize a clean team/cleanroom to handle the analysis and drive the integration design and planning.