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Cost synergies: how to achieve economies of scale in M&A
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Cost synergies: how to achieve economies of scale in M&A

na Economy
cost synergies
cost synergies

Synergy in M&A is a beneficial result of the deal that both the seller and buyer anticipate. Synergy in M&A means that the value of a newly created combined entity is greater than the value of two separate companies.

There are three main types of synergies in M&A: revenue synergy, cost synergy, and financial synergy. This article focuses on cost synergy. 

Continue reading to learn more about cost synergies definition and examples, the main types of cost synergy, how to calculate cost synergies, and the main pitfalls to watch out for in the process of achieving cost synergy.

What are cost synergies?

Cost synergies are the savings in operating costs of a combined company after two companies merge. Such cost savings happen due to increased efficiencies that allow cutting costs in certain areas of business operations. 

Thus, cost synergies occur when a combined merged firm can gain greater cost reductions than two companies would gain individually.

Cost synergies examples

Below are the 2 main real-world examples of cost synergies in deal-making: 

  • Exxon and Mobil (1998)

The $75 billion merger of Exxon and Mobil allowed two separate companies to become the largest oil company in the world. By this deal, Exxon and Mobil united their manufacturing processes and sold many redundant refineries and 2,400 service stations. Additionally, 16,000 employees were laid off. This, in turn, allowed a newly formed company to achieve a $5-billion synergy.

  • Nine Entertainment and Fairfax (2018)

The $4 billion merger of Nine Entertainment and Fairfax aimed to create the largest media company in Australia. By this deal, Nine Entertainment and Fairfax united their operations which allowed them to reduce headcount: reportedly, about 144 roles were made redundant which affected 92 people. Additionally, they reached a cost reduction in technology, media sales, and products. As a result, the merged firm achieved a cost synergy of about $65 million.

Note: To discover more real-life examples of different types of M&A deals (both successful and not) and learn from their experience, explore our blog. For instance, you can find the conglomerate merger example in our dedicated article.

Types of cost synergies in M&A

Types of cost synergies largely depend on the forms the cost synergy can take in mergers and acquisitions.

Below is the list of cost synergy types that come from different sources:

  1. Patents and licensing. In case the acquiring firm was paying the target company for access to its patents, a merger reduces such a need, and thus, helps to reduce overall costs and unlock potential savings.
  2. Shared information technology. After the completion of all M&A process steps and a merger of two companies, the combined entity gets access to each company’s proprietary information. This helps to increase operational efficiency and improve products without paying extra.
  3. Supply chain efficiency. If any of the merged companies have better supply chain relationships, the other company can take advantage of it by the merger. As a result, the combined entity might have a streamlined supply chain, which allows for cost savings. This is especially applicable to companies that produce complementary products, such as electronics and accessories, for example.
  4. Reduced headcount and salary optimization. As a result of a merger of two companies, a combined entity can’t have two CEOs, two Marketing Directors, two CFOs, etc. Thus, a merger of two companies often results in large layoffs of redundant employees. This, in turn, results in large cost savings, since layoffs lead to salary optimization.
  5. Improved sales and marketing. With a merger, two companies can access better distribution and marketing channels, which enables cost savings in developing and establishing efficient marketing channels by each company individually.
  6. Shared research and development. A merger of two entities lets either of these companies have access to another’s achievements in the R&D department. This reduces the need for this company to spend on R&D operations on its own and, as a result, brings an opportunity to develop great products and services and save costs.
  7. Reduced rent. When two companies operate separately, they might have a lot of buildings or equipment to rent. When those companies merge, the need to rent certain buildings or equipment might disappear, which opens room for great cost savings.

How does cost synergy work?

M&A cost synergies occur when two businesses can improve and streamline processes by combining their operations and thus, save costs. This generally works through:

  • Eliminating redundancies

When two companies merge, their departments, positions, and equipment might duplicate and become redundant. As a result, the combined company abandons all the redundancies, which creates room for cost savings.

  • Economies of scale

When one company merges with another, it creates opportunities for a new company to improve production and overall efficiency. As a result, it helps a combined company to scale faster and easier.

  • Staff optimization

A merger of two companies entails the optimization of working capital since there’s no need to have two similar positions or departments. Thus, it creates a cost synergy that allows to cut costs on salaries by massive lay-offs.

  • Technology integration

A merger allows two separate companies to migrate into a single IT platform, which can significantly cut costs on licensing. Explore how a technical due diligence checklist can assist you in the process of tech review and integration in our dedicated article.

How to measure the success of cost synergy?

This is what to pay attention to when evaluating whether expected synergies were achieved: 

  • Cost savings vs. projections

Compare the projected cost savings made during the merger with the actual savings achieved. This involves analyzing expenses, including operational costs, reduced overheads, and eliminated redundancies.

  • Financial performance

Check the financial statements and performance metrics of the combined company after the merger. Pay attention to such metrics as profit margins, return on investment (ROI), and earnings before interest, taxes, depreciation, and amortization (EBITDA).

  • Operational efficiency

Assess whether the integration processes resulted in streamlined and improved operations. For this, evaluate productivity metrics and improvement timelines.

  • Customer and employee satisfaction

Check whether the business integration process has impacted the customer base and whether the employees stay satisfied, productive, and motivated. A successful merger should ideally enhance customer experiences and maintain or improve employee satisfaction.

  • Management and stakeholder perception

Pay attention to the way company leaders and stakeholders perceive the results of the merger. The positive perception might indicate the successful integration and synergy, or at least speak about its future potential.

Challenges and pitfalls in achieving cost synergies

While capturing cost synergies, companies combined can experience various pitfalls that might impact the expected results. To achieve the cost synergy you planned for, watch out for the following: 

  • Synergy overestimation

This is the most common mistake when assessing the potential cost synergies that lead to unrealistic expectations. Ensure you take all the aspects into account when projecting cost synergies’ potential on the deal structuring stage.

  • Culture clashes

The merger of two companies is also a merger of two cultures. Often, companies experience difficulties with combining two different cultures into one, like it was with AOL and Time Warner. Such an oversight can significantly impact the post-integration process and the synergy’s success in general. Read more about the post-merger integration checklist in our dedicated article.

  • Integration challenges

Combining different systems and processes from the merging entities can be challenging. Aligning operations smoothly requires meticulous planning and execution to avoid disruptions and inefficiencies. 

  • Regulatory hurdles

Mergers often face scrutiny from regulatory bodies. If the integration plan encounters regulatory obstacles, it can delay the expected average cost synergies in mergers.

  • Hidden costs

Often, estimated integration costs turn out to be much higher in reality, which, in turn, significantly impacts the expected cost synergy. Additionally, there can be unforeseen extra cost drivers such as legal fees and costs for retraining employees or updating technologies, which can impact expected synergies.

  • Management and stakeholder communication

The quality of communication between merging companies’ leaders and stakeholders is vital for achieving cost synergies. If it’s impossible to establish effective collaboration between the sell- and buy-side, it can result in failed synergy or at least significantly impact its success.

Final words

If the combined value of a newly formed entity is greater than the value of two separate companies before a merger, synergy is created. There are cost synergies, revenue synergies, and financial synergies.
Cost saving synergies are attributed to situations when a combined company can cut costs and thus, generate large cost savings. Among the sources that cost synergies come from are reduced headcount, shared information technology, supply chain efficiencies, shared research and development, reduced rent, and improved sales and marketing.

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