Synergies are a form of value addition created in merger and acquisition (M&A) activities. The value addition is a representation of the finances in the form of revenues and costs that these merged businesses can achieve. The value addition is not possible when businesses operate as separate entities. Formation of synergies can help businesses attain higher output, better placement of staff and good facilities (Ogada, Njuguna and Achoki, 2016). However, the past decade has witnessed a transformation in the formation of synergies. Traditionally, organizations merged to reduce costs or to expand their geographical presence. However, in the modern value creation process, businesses merge to expand their business capabilities into new domains (Loukianova, Nikulin and Vedernikov, 2017).
The performance of mergers and acquisitions (M&A) is closely related to synergies. Synergies offer advantages to the merged businesses in the form of higher profits and lower costs. In this context, the present article explores the different types of synergies in mergers and acquisitions (M&A). Additionally, the article examines the role of synergies in the traditional and modern value creation process among the mergers and acquisitions.
These synergies relate to production costs. They are formed in merger or acquisition deals to cut the production expenses (Chatterjee, 1986). Cost synergies or the operational synergies enable businesses to save expenses on major activities like training and logistics. The formation of M&A enables consolidation of production activities, leading to economies of scale. This economies of scale, in turn, results in lowered input costs and lower prices for customers. This, in turn, can help them fain a higher share of the market (Loukianova, Nikulin and Vedernikov, 2017). Moreover, operational synergies also encompass the exchange of advanced technology, vendor network, logistics process, monitoring and control systems and feedback mechanisms.
Financial synergies relate to the cost of capital and are formed to help firms get better financial assistance from financial institutions such as banks. These benefit the firms in terms of taxes and can reduce the cost of capital required on combining the operations together. The businesses are also able to improve their debt capacity in the short run Financial synergies among M&A that occur through the increase in the capacity to undertake a risk. Additionally, it increases the capacity to establish gains. Furthermore, it offers tax advantages and develops the ability of the firm to achieve financial economies of scale. This assists the businesses in reducing their transaction costs (Jallow, Masazing and Basit, 2017).
This type of synergy relates to the product price or revenue generated by the business. Their main objective is to generate greater revenues from the operation of two or more businesses in collusion. In this process, the firms share their resources, skills and capabilities to expand their business operations in the form of more products or services. This also enables the business to operate with more cash flow at disposal in the short run. By creating a pool of suppliers and customers, the merged businesses generate a greater capacity for the production of goods. Furthermore, the formation of horizontal mergers (a merger between companies of different industries) or vertical mergers (a merger between firms of the same industry) allows the businesses to explore new market opportunities and expand their operations. (Jallow, Masazing and Basit, 2017).
Value creation in mergers and acquisitions (M&A)
Financial, operational and collusive synergies can improve the performance of businesses after the formation of the M&A. These synergies further create value for the shareholders in the form of efficiency gains. This process is termed as ‘value creation’ (Kurokawa, 2010). The value creation process can be of two types.
The traditional value creation process
Companies before the year 2000 merged to expand their production capacity as well as to reduce costs. Therefore, the traditional value creation process focused on achieving economies of scale and efficiency enhancement. However, the 19th-century merged businesses failed to capture the combination synergies focusing on cost and capital. The reason was that the businesses were not ready to face the uncertainty and risk related to such synergies. The businesses have therefore not considered the revenue synergies in the value creation process. The ignorance has costed the businesses in terms of the loss in value (Vargo, Maglio and Akaka, 2008).
The notion of integration of two businesses to create value from the M&A in the traditional process had some loopholes. The cultural conflict was realized as one of the reasons for the failure of integrated firms to create value (Remanda, 2016). Secondly, they could not adapt to the new justifications of merging or acquiring. Furthermore, they resorted to value destructing ways, like changing policies to reward employees or cancelling the rewards for the acquired firms. Lastly, there was a lack of articulation from the leaders regarding the new purpose of the combined firms. The need for better leadership, organizational structure and the similarity behind the motive of the merger are realized under the traditional value creation process (Swaminathan, Murshed and Hulland, 2008).
The modern value creation process
In the modern era, the merger and acquisition activities take place to expand and diversify into new areas of business. The notion of relatedness among the firms combined has been discouraged. Value creation in the modern process does not depend on the size of the acquired and acquiring firm (Grönroos and Voima, 2013). It takes into account the earnings on the wealth of the shareholders. If the earnings are found to grow in a stable pattern, the value creation by businesses is a success. The value creation in the modern process also depends on international or cross border linkages (Singh and Pattanayak, 2014). International ties help domestic businesses outshine. Furthermore, local market innovators prove to be important in value creation. Innovations in the companies are motivated due to fast-changing technology along with a healthy debt and equity market. The integration is now focused on creating value through increased capabilities and bringing change in the business models. For value creation, it has become important to understand consumer demand, changing models and logic for transactions between firms (Martínez et al., 2016).
Differences between traditional and modern value creation process and its impact on shareholders’ wealth
Synergies in Mergers and acquisitions between businesses play a very important role in determining the survival and profit generation of the business in the market. M&A can generate synergies through effective business operations, higher revenue and availability of adequate funds. The process of traditional value creation focused on enhancing the production capacity of the merged firms. This created value for businesses by generating economies of scale.in the process of production. However, this process was limited to the delivery of higher output in the manufacturing sector. The modern value creation allows businesses to expand their landscape of opportunities. This process focused upon value co-creation based on the needs of the consumer. The adoption of this process can assist the businesses in achieving financial and operational efficiency.
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