Reaping The Rewards: How Cost Synergies Boost M&A Outcomes

One of the primary objectives of any M&A deal is cost synergies and the maximum value gained from the transaction.

The synergies that result when two independent companies pool resources should be higher than the synergies in each participant.

Dealmakers aim for different types of synergies, including hard synergies like costs and revenue gains or soft synergies.

Soft synergies contribute significantly to successful integration and boost value from the transaction. For example, company culture, employee coordination, and lower attrition.

The most crucial is cost synergy, or lowering the operating costs post-merger, which companies can achieve with increased efficiency.

Understanding Cost Synergies and How to Achieve Them

Cost synergies are essentially cases where the new company post-merger has lower expenses than the combined expenses of the participants.

The amount should be lower than the combined costs when totaling the buyer’s and seller’s operating expenses.

These cost efficiencies can result from benefits from the merger, like economical vendor contracts and consolidating premises and manufacturing facilities.

Eliminating duplicated tasks, distribution channels, worker roles, and other expenses frees up substantial capital and resources for other uses.

Better resource management leads to wealth creation for the new company, which is something shareholders and stakeholders appreciate. That’s how cost synergies boost M&A outcomes. Here’s an example:

Company A generates revenues worth $1M per quarter, and Company B generates $1.5M during a similar interval.

Post-merger, the combined revenues of both companies is $3.25M. This excess value generation can result in higher sales since customers can purchase package deals.

Alternatively, their products now carry enhanced features because of IP and technology sharing. Users benefit from higher-quality products and are willing to pay more.

Then again, both companies take advantage of efficient distribution channels, and the market presence each has in broader locations.

Combining logistics helps achieve cost synergies, which translate into economical pricing and higher sales and revenues.

How Cost Synergies Boost M&A Outcomes

When two companies enter into a strategic partnership and merge, their primary objective is adding value to their operations.

They can do this by getting rid of duplicated and redundant equipment and machinery and investing in better technology.

Expanding to other locations, countrywide or global, to capture new markets and client demographics is a huge advantage.

Both companies can pool resources for economies of scale, buying inventory in bulk and getting better deals from vendors and suppliers.

Cost synergies are distinct from revenue synergies, which are the result of higher sales generated by the merged company.

Offering complementary products and deals, cross-marketing, cross-selling, and better customer service entice buyers to spend more.

Different Types of Cost Synergies

Combining R&D Capabilities

Considering that innovation drives business success, ideating new technology for products is crucial.

Since R&D requires significant investment, pooling resources makes sense for companies. They can outsource research and partner with companies that have developed new ideas.

Alternatively, executing a merger and investing in R&D facilities that benefit the legacy company is a strategy.

For instance, a company developing a new super chip for faster processing may partner with a company building computers. Combining their capabilities could take over the market entirely.

Shutting Down Duplicated Manufacturing and Administrative Units

Once the two companies merge, they can work out of the same administrative premises and shut down redundant manufacturing facilities.

By producing products within a single unit, they can benefit from economies of scale and save on rent and utilities. Saving on insurance costs, leases, costs of renting, and depreciation are other advantages.

Selling off unnecessary real estate brings in liquidity that the legacy company can use to expand the business.

The savings on rent can be diverted toward sourcing inventory, hiring talent and skillsets, or investing in further R&D.

Eliminating the Cost of Intellectual Property and Patents

If a company must pay a subscription to a smaller agency owning IP patents and assets, acquiring or merging with it is a strategic partnership.

The proprietary assets become in-house property and don’t need to incur the fee. The acquiring company can also take advantage of running the R&D division.

Technicians and engineers can continue to develop more IP and IA thanks to access to advanced resources.

Not only does the legacy company continue to use the IP to manufacture its products, it can also generate revenues. Leasing out the patents to third-party lessees creates an additional income source.

Then again, sharing information about the best practices for running the business efficiently and economically also results in savings.

Cutting Back on Salaries and Wages

Post-merger integration typically involves lay-offs. The surviving company has shared administrative and manufacturing units.

As a result, it can cut back on the workforce needed to run them. Fewer employees translate into lower wages and salaries and eliminate the need to provide benefits and retirement packages.

A single board of directors and executives can efficiently run the integrated company, making it less top-heavy and more economical. However,

if the merger is executed for the purpose of expansion to cross-country or cross-border locations, the reverse may be true.

The new company may need to maintain separate offices and hire bigger teams to keep up with expanded operations.

However, the expansion cost will pay for itself by increasing sales and higher revenues.

Aside from in-house teams, mergers result in saving on professional services costs, such as legal and accounting.

Companies also need to hire firms that provide financial advice, IT management, architects, and more. Instead of two companies paying for services, they can save on costs by merging.

Efficient and Economical Supply Chain

An integrated larger organization is likely to ramp up its need for inventory, including raw materials, tools, and equipment.

Thus, it can bargain for discounted prices for bulk orders. Better supply chain connections and long-term contracts are another strategy for economies of scale.

Multiple vendors vying for orders can also gain the advantage of competitive pricing. This, is turn, results in significant savings for the surviving company.

Improved Sales, Marketing, and Advertising

A merger between two distinct, well-known brands enhances the brand value of the new company.

Announcing the collaboration attracts customer attention, and combining advertising efforts needs fewer resources. The company can get enhanced marketing success with less spending.

Advertising complementary products as part of package deals customers can take advantage of is a great strategy.

Economizing on Manufacturing Costs

Companies often enter into mergers to take advantage of cost-effective manufacturing resources.

Collaborating with off-shore companies lets them benefit from cheaper labor costs and lower overhead prices. These may include power, water, and raw materials.

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Why Accurately Estimating Cost Synergies Pre-Merger is Crucial

M&A advisors from both parties estimate the merger’s benefits and the resultant synergies.

They may rely on top-down indicators to calculate the cost synergies and include them in the M&A valuation. These indicators may include financial metrics and commercial due diligence.

Testing customer satisfaction levels with companies’ products and services and their market presence is also part of the due diligence.

However, companies often think that cost synergies are easy to achieve. As a result, they may miscalculate the cost synergies or overestimate them.

Dealmakers may realize that the operational advantages they anticipated don’t pan out as expected or take longer to achieve.

This impacts the management’s credibility in its ability to manage the transaction properly.

This scenario can be easily avoided by deploying the right strategies to estimate the potential cost savings, such as comparing transactions.

Both companies should list their internal costs and do a comparative analysis to see how removing duplicated assets and operations work. And if they influence costs.

Identifying the particular cost savings accurately and how to achieve them is thus crucial.

Advisors and dealmakers should include them as a part of the due diligence process. That’s how they can ensure that M&A valuations are precisely calculated.

Dealmakers can thus design a new operating model that leverages the maximum advantage from cost savings.

How to Estimate Potential Cost Synergies

Most dealmakers and advisors invariably focus on revenue synergies as the real indicator of the merger’s success.

However, these metrics can be speculative since it is impossible to predict how customers will respond to the merger. Or if market conditions will remain unchanged.

Customers may continue to purchase products as before and welcome the opportunity to buy combo deals. Alternatively, the combined brand value may not generate adequate interest and sales may actually drop.

An unexpected downturn because of unforeseen macroeconomic conditions could also result in falling revenues.

However, adding up current costs accurately requires pulling numbers from both companies’ balance sheets. For instance, if one company is merging with another for its IP, the subscription costs are instantly eliminated.

The surviving company will also cut back on the costs of maintaining two distinct administrative offices and manufacturing units.

The costs associated with rent, utilities, employees, and other add-ons also go away. These are actual expenses that translate into real savings.

When estimating cost synergies, companies can do a comparative analysis of similar M&A deals within their vertical.

Their M&A advisors may review comparable acquisitions and use them as a starting point.

For instance, let’s assume that the cost synergies in a comparable transaction totaled 5% of the enterprise value (EV). It would be safe to assume that the savings in this transaction can also be 5%.

However, the actual synergies may also depend on the internal operational efficiencies of each brand.

Alternatively, both participants in the M&A deal can draw numbers from their financials and compare them.

Executing this step as part of the due diligence ensures that the surviving company derives maximum value from the transaction.

Criteria for Accurately Estimating Cost Synergies

When working out how cost synergies boost M&A outcomes, dealmakers should be aware of certain criteria.

For starters, they’ll verify the sources of the numbers and how they are generated. If the metrics come from actual costs on P&L statements, they are reliable.

For instance, adding up salaries and wages, rental fees and utilities paid month-over-month and insurance premiums. If the estimates are in the form of percentages and estimated savings, they may not be reliable.

Dealmakers should also factor in the time needed to execute the integration and realize the synergies. Transitioning to new premises, closing leases, and selling off furniture takes time.

The surviving company will also need time to manage human resources and assess the skill sets they absolutely need. Next, they’ll execute layoffs and ensure a new company culture is instituted and accepted.

Mergers and integrations are never smooth, and challenges arise, such as disgruntled employees, attrition, and high customer churn rates. These hurdles can involve added expenses that dealmakers can’t anticipate accurately.

For instance, dealmakers may factor in cost synergies like savings on leases and rental costs. However, they may also have to pay lease-break fees.

Then again, lowering employee headcount is a cost synergy. But, before the synergy can be achieved, the company will incur severance costs.

In the initial stages of the M&A implementation and integration process, the surviving company may incur significant costs.

These costs are one-time but may offset the savings the company hopes to make from cost synergies. Factoring in this possibility is crucial to avoid unpleasant surprises later.

The Takeaway!

Companies have their objectives for entering into M&A transactions, and cost synergies are one of the most critical.

Cutting back on costs by pooling resources helps raise the surviving company’s bottom line. Higher profits contribute to long-term success, scalability, and sustainability.

However, before the cost synergies and savings add up, the merger may incur expenses. Integration costs and getting the surviving company back on track and operating as usual may require some capital investment.

However, after the company completes the integration, the cost synergies ensure long-term growth.

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