Defining and capturing synergy
Introduction
Synergy can be defined as the value of the cost saving and revenue enhancements of an
acquisition. It represents the premium paid and consequently becomes the target for the
Director responsible for the subsequent integration.
Deal advisers push for speed and encourage confidence in the achievement of synergies
as their fees depend on this. The result is that a price is set which includes a generous bid
premium – supported by heroic assumptions on the synergies that can be achieved.
The process of identifying these synergy gains is usually top down rather than bottom-up.
Bid premiums backed by heroic pre-deal assumptions often lead to impossible challenges
for the post acquisition integration teams
Figure 1:
Elusive synergies?
Company
Deal
size
Premium
Expected
growth
i
before deal
Required
growth
after
ii
deal
Deutsche
Bank/
Bankers
Trust
$8.9
billion
42%
2.6%
7.1%
Exxon/Mobil
$77.2
billion
34%
9.9%
12.9%
Comment
Cultures and organisational
structure differ widely.
Growth must almost treble to justify
the price
Implies need to increase return on
capital to 17.3%
Mobil's highest ROCE since 1993
has been 12.2%
Source: Fortune, Jan 1999 based on Stern Stewart's analysis
1
Target company's expected ten-year annualized growth in net operating profits after tax (NOPAT) implied by the market
price
1
NOPAT growth implied by proposed price for target company
Any bid premium reflects, either wholly or in part, the anticipated synergies. It is important
to be realistic when assessing the value of the acquisition. This entails digging deeper into
the operational details prior to closing the deal. To do this, senior managers must guard
against being overtaken by the enthusiasm of the advisors, investors, press and
stakeholder institutions for the deal.
As can be seen from the frequent high level failures to deliver synergies, this lesson often is
ignored.
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The sources of synergy
There are seven sources of synergyiii. These can be divided into revenue enhancements or
cost reductions.
Figure 2:
Sources of synergy
Revenue enhancements
Cost reductions
Co-ordinated strategies
The benefits of reduced competition between
competitors can lead to optimised pricing and greater
co-ordination of reactions to competitive threats.
Shared know-how
This involves the sharing of best practice in business
processes, leveraging expertise in functional areas or pooling
knowledge about how to succeed in specific markets.
Horizontal integration
This involves the expansion of product lines to the
same market or the extension of similar product lines
into different geographic (or other, not just
geographic) markets.
Shared tangible resources
This entails achieving the benefits of economies of scale and
eliminating duplicated effort when physical assets and
resources are shared. These include: manufacturing
facilities, R&D facilities, warehousing and logistics.
Shared head-office functions
Acquisitions almost always lead to economies of scale for
certain head office functions such as HR, Finance, Legal and
PR.
Pooled negotiating power
Purchasing power results from increased scale. At the very
minimum, purchasing power can be extended to overhead
items such as stationery, travel, telephones and to assets
such as vehicles.
Vertical integration
This entails bringing together the flow of products and
services between businesses.
Why are synergies so difficult to realise
Revenue enhancing synergies usually make up the larger proportion of the total synergy
gains expected. However, once the deal has been signed, they are often relegated in
importance because they are insufficiently tangible and they take longer to achieve. The
emphasis is usually placed on the "hard" numbers – the cost reduction exercises such as
head office and procurement duplication.
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Figure 4:
Source of synergy
Shared know-how
Shared tangible
resources
Shared head-office
functions
Pooled negotiating
power
Co-ordinated
strategies
Vertical integration
Horizontal
integration
How elusive are different types of synergy?
The know-how is usually not formalised, but tacit. This achievement
of such synergies means that managers have to formalise what they
do. This is not only extremely difficult, but is perceived as weakening
their position within the company.
Easy to say, but difficult to implement because one side invariably
loses out in the integration process which leads to political warfare.
Differing IT systems, platforms and infrastructures can also hinder the
process.
Take one of two forms - a) bold and efficient whereby the acquirer
makes the decisions and moves fast. This leads to a loss of morale
which affects subsequent levels of collaboration or b) co-operative
whereby the acquirer keeps both management team alongside. This
takes longer, and has the risk that acquirer is perceived as too
consensus driven and lacks the will to turn the business around.
Reasonably straightforward if the head office uses its powers of
influence over the business units. Requirements, procedures and key
suppliers will differ. Mandates are usually required to implement the
savings. Usually seen as a quick win - of benefit because profits
increase without the need to reduce headcount.
The acquisition of a competitor can often be perceived as a war
against the culture, management and products of the acquired
company. The achievement of any co-ordinated strategies depends
on the success of the rationalisation of product lines into the same
market (or the extension of products into new markets). This is
usually slow and entails winners and losers in senior sales positions
causing political fall-out.
Usually sold internally as making the supply chain more efficient.
However, the integration of an internal supplier with an internal
customer only makes sense if costs are reduced below market rates.
However, the customer feels trapped by the single supplier
relationship and the supplier becomes a monopoly with a desire to
push prices up not down. If the supplier becomes a cost centre, then
the loss of P&L status can be demotivating.
Sales-force morale suffers because of the rationalisation and the need
to spread themselves across a wider product range. Geographic
extensions only work if the products are correctly targeted at the new
markets. If not this results in further sales-force resentment.
Scale: 1=Straightforward
1
Scale of
ease
How elusive is it?
4=Difficult
These are derived from our own work and from Synergy, a 1998 book by Goold and Campbell, published by Capstone
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4
3
2
1
3
4
3
The table argues that most of the seven sources of synergy are difficult to achieve. These
specific difficulties are made worse by the context in which an acquisition is made. For
example:
External deal-makers drive the process
Making a large acquisition entails using the services of one of the Merchant Banks.
These institutions capture a percentage of the value once the deal has closed. They
therefore take considerable risks in offering their services up front, but benefit
enormously once a deal has closed. It is therefore in their interests to drive the deal
forward as quickly as possible. The due diligence processes are risks to them in that
they may uncover issues that could put a stop to the deal. Within this context, it is no
surprise that the discussions over potential synergies are dealt with confidently.
Availability of data
Data rooms made available during the deal process provide some information about
the operations but usually not enough to judge how large the synergies could be.
The result is that a set of poorly worked assumptions are made which soon form part
of the financial models and therefore become set in stone. The underlying data
behind these assumptions can be "back of the envelope" which are difficult to find
after the deal has gone through.
In addition, where the data rooms do hold information, it is weighted in favour of
costs rather than revenue synergies. The data room will provide detailed
management accounts, but will not elucidate key account plans or information on
customer needs going forward. This further encourages the short-term focus on cost
reduction as part of the integration process.
The nature of strategy
The traditional process for making acquisitions is as follows:

Develop corporate strategy

Shortlist companies

Pitch
This approach has been undermined by the demise of corporate planning. These
days, companies pronounce vision and mission statements, but have no clear plan to
achieving them.
More typically, companies find themselves sitting on excess funds and face pressure
from investors to earn positive EVA results. A CEO facing this scenario calls in the
merchant bankers who find suitable acquisitions. Each could be described as
suitable against the broad backdrop of the corporate vision. Strategy becomes a
reactive event to an opportunity.
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How should synergies be valued before the deal?
The analysis undertaken by acquirers on likely synergy gains is often rudimentary.
Assumptions are made about head office cost reduction, sales increments, and production
scale economies. A final figure is carved out of three or four components, a date by which
this is to be achieved and no more background information. It is this number that pays for
the bid premium. It is therefore important to dig more deeply.
Step 1: Disaggregate the potential benefits
The first step is to disaggregate the potential benefits into their component parts.
This will allow managers to determine the specific questions that they need to answer
before the deal.
Figure 5 provides an example.
Disaggregating the benefits
No need for duplicate
Treasuers , HR directors
and FDs
Reduction
in Head Office costs
What are the salaries and on-costs?
Length of service contracts?
Are earn-outs being offered?
Can the space be used?
Removal of non-execs
What are the costs?
How much is left to pay?
Removal of bank
charges and fees
How much is left to pay in this financial year?
How much next year?
Centralising payroll
How different are the terms and conditions?
Can our systems deal with this added complexity?
How will payroll changes be organised?
Reduce staff
communications
costs per head
What are the costs of the staff communications pa?
How much for the rest of this financial year?
Are their printing costs high or lower than
ours?
Step 2: Dig for the answers
The second step is for the acquirer to use its operational managers to uncover the
answers. Ideally, this will be done through face-to-face discussions with operational
managers in equivalent positions on the other side. If this proves to be difficult, then
place more resource into finding the answers a) within the data room and b) through
covert discussions with suppliers and customers. This exercise must be orchestrated
effectively and will require the full-time support of a project manager assigned to the
task.
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Step 3: Gauge the result
The third step is to document what has been found in such a way that it is useful
during the integration process. Prepare an expected value against each of the
disaggregated synergy areas and provide a minimum and maximum. We advocate
simulating the final results using specialist PC packages.
Step 4: Ensure you have the capability to achieve the benefits
Some companies simply allocate the task of achieving the benefits to line managers.
This is a risky process because it assumes a) that they want to be involved and b)
are capable of making it happen. In practice, it is wise to allocate the more important
project to a central team (see next section) and to ensure that you have the right
level of external consultancy support if the company is relatively inexperienced in
making acquisitions.
Synergy realisation – focus your effort
Once the deal has been signed, a process needs to be implemented to achieve the
integration. This entails dealing with both a large number of administrative issues and the
achievement of the strategically important synergy gains. It is very easy during the first 100
days to become lost in the detail and disregard the more important matters.
The importance of focussing effort on the few integration projects likely to lead to the most
benefit cannot be underestimated. Figure 6 shows a template to prioritise the potential
projects.
Figure 6:
Prioritisation
Projects
in Rank
Order
PBT
Scaled 1-10
Where 10 = R500k
Weighted 50%
Ease of
Implementation
Scaled 1-10
Weight = 20%
Timescales to
Implementation
Scaled 1-10
Weight = 30%

The Integration Director will have a "to do" list of several hundred items. It is
important to understand how these should be allocated. If all the activities are
allocated to a team, then the integration will become rooted in bureaucracy. If
they are all allocated to the line, then the board will not be able to monitor and
push for progress. To overcome these potential problems, the following
principles should be adopted:

Non-complex issues should never be allocated to a team as this will slow down
progress. Allocate them to the relevant individual and tick them off as soon as
they have been completed;
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
Do not allocate radical cost reductions to teams comprising members with a
vested interest. It's better to make these decisions at the top with a small team of
analysts;

Projects with high levels of potential synergies, but with complexities should be
allocated to joint integration team and directed by an integration project board,
who act as representatives of the Integration Director. These teams should be
disbanded once they have made their recommendations.
Synergy monitoring – output control
It is vital to understand how well the integration is progressing. This entails firming up on
the estimated synergy gains and simulating the final result. We advocate using project
templates with weekly progress reports for the five or six priority projects. Other synergy
activities can be monitored on a monthly basis.
Integration requires a temporary organisational structure to be created for a period of
around six months. This is illustrated below in Figure 7.
Figure 7: Illustrative Integration Project Management Organisation
Integration
Integration
Project
ProjectBoard
Board
Meeting
monthly
Integration
Management
Integration
Management
Team
Team
Programme
Programme
Office
Office
Mentors to priority projects
Mentors brief
to priority
projects
Watching
over others
Watching brief over others
Meeting
weekly
Business unit, HQ and functional sponsorship team
Projects
managed
by by
Projects
managed
project
managers
allocated
to business
units, units,
project managers allocated
to business
functions
and
HQ
who
own
the
project
functions and BPO HQ who own thesponsors
project sponsors
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Conclusions
Once the deal is signed, ensure that a correct balance is found between cost reductions
and revenue enhancements. There will always be pressure to focus on cost reduction,
because it is more tangible.
Prioritise the projects that could be undertaken and implement a rigorous project
management approach with senior involvement on a weekly basis.
Monitor success and track the achievement of synergies. Only disband the integration
teams once there is certainty of success. It is at this point that implementation actions can
be allocated to line management and incorporated in the on-going performance
management system.
-o0oAbout Auxilium Africa
Auxilium Africa was formed to provide incubation and start up services; consulting on
business expansion into Southern Africa; and specialist advice on all aspects of mergers
and acquisitions.
The company brings to bear in-depth experience from a team of specialist consultants
across a diverse range of disciplines, including finance, strategy development, operations
and logistics, information technology, marketing and communications, and organisational
development.
To contact Auxilium Africa call: +27 (11) 283 7710
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