Framework library · M&A and corporate strategy
Synergy assessment
A synergy assessment lists the gains that exist only because two businesses combine, and sizes each one net of what it costs to achieve and discounted for how likely it is. The test is that the synergies, after the cost of achieving them, must be worth more than the premium paid over the target's stand-alone value, or the buyer's shareholders lose.
Use it when
- You are pricing an acquisition or merger and need to know how much of the premium the synergies can justify.
- A board or lender wants the synergy case broken down into items with owners, costs and dates.
- The deal case mixes cost and revenue synergies and you need to see how much of it rests on the less certain revenue side.
- The deal is about to close and you need a baseline against which delivery will be tracked.
Avoid it when
- There is no combination. A stand-alone investment needs a DCF valuation or an investment appraisal, not a synergy case.
- You need the full value of the target. Synergies sit on top of its stand-alone value. Build that first with a DCF valuation.
- The revenue synergies rest on no customer evidence. Test them with customers first, or carry them at a low probability and say so.
- The deal has closed and you are tracking delivery. Use the acquisition integration scorecard, with this register as its baseline.
How to run it
Fix the stand-alone baseline
Write down what each business would earn on its own, from the plans each had before the deal. A synergy is only what changes because of the combination.
List the synergies by type and source
Cost (network, IT, procurement, overheads), revenue (cross-selling, pricing, new markets) and capital (avoided capital spending, working capital). One line per action that one person could own.
Size the yearly value and the cost to achieve
The yearly value once fully delivered, and the one-off cost of getting there: redundancy, decommissioning, systems migration, contract exits. The one-off cost is the figure most often underestimated.
Set the timing and the probability
The year the synergy reaches its full run rate, and the chance it is delivered at all. Give revenue synergies lower probabilities than cost synergies; past mergers missed them far more often.
Read the risk-adjusted totals
Run rate times probability gives the risk-adjusted value. The five-year figure counts each year at full run rate within the first five years, less the one-off cost. Set the totals against the premium.
Give every line an owner
The leader who will be measured on delivering it. A synergy nobody owns is a number in the deal model, not a plan.
Work through it
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Mistakes to avoid
- Counting as synergy an improvement either business planned to make anyway. It belongs in the stand-alone value, which the seller has already priced.
- Carrying revenue synergies at the same probability as cost synergies. Revenue depends on customers, who were not party to the deal.
- Leaving out the one-off costs, or the dis-synergies: customers who leave because of the merger, and contracts with change-of-control clauses.
- Letting the synergy number rise as the bidding rises. Fix the register before the price is negotiated and record every change with its reason.
Where it comes from
No single originator: sizing synergies is common practice in M&A valuation. Mark L. Sirower, The Synergy Trap: How Companies Lose the Acquisition Game (Free Press, 1997), set out the test this register serves, that an acquisition creates value for the buyer only if the synergies exceed the premium. Scott Christofferson, Robert McNish and Diane Sias found revenue synergies were missed far more often than cost synergies, and one-off costs often underestimated ("Where mergers go wrong", McKinsey Quarterly, 2004). Source.
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