Academic journal article Management Accounting Quarterly

Effectively Realizing Synergies: Lessons Learned from 10 Years of M&A Activities

Academic journal article Management Accounting Quarterly

Effectively Realizing Synergies: Lessons Learned from 10 Years of M&A Activities

Article excerpt

Targets in mergers and acquisitions (M&A) deals are chosen for strategic fit reasons with the goal being to improve the performance of the combined companies and thus create value for shareholders exceeding the costs of the acquisition. Typically, the target company is chosen so that the combined business is capable of generating more revenue than the sum of the stand-alone revenues in the long run, i.e., 1+1 [greater than or equal to] 2. Additionally, the combined cost baseline can be reduced by streamlining redundant processes as well as by economies of scale, i.e., 1+1 [less than or equal to] 2. The result of these two synergetic effects leads to an overall increased profit margin, which in turn increases the net post-merger value of the two companies compared to their stand-alone values. These synergetic effects are, effectively, the only tangible justification for an acquisition.

Although the realization of synergies is straightforward in theory, according to Jens Kengelbach, approximately two-thirds of all M&A transactions actually destroy value for shareholders. (1) Frequently, this is because parts of the synergies are given to the target stakeholders in the form of a premium. Value is then destroyed if sufficient synergies cannot be identified or realized. James McLetchie and Andy West further describe that most mergers are doomed from the beginning (with an average failure rate of 70%) and find reasons for failure in the limited ability to set accurate synergy expectations during due diligence and shortcomings during execution. (2)

To better understand these difficulties, we analyze lessons learned from our experience with more than 10 M&A projects performed in the last 10 years within one of Europe's largest engineering companies. We focus on four key topics:

* Synergy generation,

* Synergy target setting,

* Synergy measure quantification, and

* Synergy tracking.

In the first part of this article, we present background from literature and practice on the specific challenges associated with synergies, i.e., target setting, measure quantification, realization, and tracking. Next, we provide information on the data analysis and underlying case studies as well as offer insights on the four topic areas. Finally, we summarize lessons learned and discuss future implications.

BACKGROUND

Cost and Revenue Synergies

Synergies generally can be clustered into two groups: cost synergies and revenue synergies. Cost synergies reduce the combined cost baseline of a new business, e.g., by bundling purchasing power, consolidating footprints, or rightsizing redundant functions. Cost synergies also may include an optimized tax setup or reduced costs in lending and financing due to a better cost structure, a higher rating, or greater creditworthiness.

Cost synergies are easy to quantify, and their realization depends largely on management's ability to drive targets to tangible synergy measures that are, in turn, backed by an implementation plan. To ensure this realization, management needs a consistent methodology to measure and track quantification.

According to Stewart Early, only 61% of all mergers achieve 90% or more of the expected cost synergies. (3) In most cases, the typical sources of estimation errors were the underestimation of one-time costs for implementation, inability to ground estimates in bottom-up analyses, and failure to verify management estimates against previous transactions.

Revenue synergies, on the other hand, add additional revenue volume to the combined business by, for example, leveraging cross-selling opportunities and increasing market penetration due to a complementary product portfolio.

In contrast to cost synergies, revenue synergies depend largely on the economic environment and are more difficult to predict and implement. This fact is supported by examining Early, who shows that in only 30% of all analyzed M&A transactions was the new business able to deliver 90% or more of the expected synergies. …

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