What is it?
Synergy is a benefit that can only be achieved by working together. It is a concept that together we are greater than individually. For example, after synergy, there will be the need for only one marketing, finance, and human resource department. Synergy is often goal while merger and acquisition, for obtaining the successful benefit, we should be looking for a situation where the market value of combination (AB) is greater than the market value of A and B separately.
How the value of synergy arises?
There are different sources from which synergic gains can be achieved, most important of them are discussed hereunder:
- Synergy from operating economies: Economy in operation can be attained by having horizontal combination, vertical combination and eliminating inefficiencies. An entity with fixed cost can decrease per unit cost and increases profit by improving its capacity by the economy of scale or economy of vertical integration.
- Synergy from financial strategy: It can be achieved by reduced risk after diversification.
- Synergy from other effects: After a merger of two companies, by increased market share and power, the entity can drive prices to increase revenue.
How it works (Example)
In country P, there are four companies in the telecom sector with company A, 40 percent share, company B, 25 percent share, company C, 20 percent share and company D, 15 percent market share. Due to unstable economic conditions and high taxes in country P, profit margin has been decreased drastically. In this scenario, Company B and D may attain synergy benefit like, to attain economies of scale for increasing profit margin and gain market share to lead etc.
Why it matters
It is generally accepted that primary objective of a commercial entity is to maximize shareholder wealth in long term. For this, synergy may result in more efficiency in operations with higher profits.