How it Works: Synergy

The word comes from ancient Greek: synergia means working together. Andrew Campbell and Michael Goold, two British academics, define it as “links between business units that result in additional value creation”. It is, they go on to say, “a Holy Grail for large multi-unit companies”. It is something akin to the philosopher’s stone: seeming to create extra value without consuming resources.

Synergy has been used as part of the justification for almost every takeover since Alexander moved into Egypt. In the 20th century the idea was refreshed by Ruth Benedict, an anthropologist. She used the word when writing during the second world war about communities where cooperation was rewarded and proved advantageous to all. The idea was picked up and transferred to the business world by Abraham Maslow. It fitted well with Maslow’s non-authoritarian model of organisational structure.

The business gains from synergy are often not distinguished sufficiently well from those that come from combining two businesses in such a way as to create value. Synergy is passive; it happens when two things come together regardless of what else they do. If a company buys one of its major suppliers, the synergy comes from the fact that it is now a preferred customer, not from the subsequent reorganisation of the supplier’s warehouses so that they are more conveniently located for their new owner.

Promises of synergy are rarely fulfilled. Campbell and Goold say: “Synergy initiatives often fall short of management’s expectations.” They quote the example of a firm of consultants where, to gain synergy, the IT specialists were merged with the strategy specialists, until the day when the it people found that the strategy people were on a completely different scale of pay and perks. All the synergy gains were lost in an instant. The authors end their article by quoting the physicians’ creed: “First ensure you do no harm.”

The synergy from mergers and acquisitions (M&A) is particularly elusive. Leon Cooperman, a senior executive at Goldman Sachs, a big investment banking adviser on M&A, when asked to name one big merger that had lived up to expectations, said: “I’m sure that there are success stories out there. But at this moment I draw a blank.”

Michael Porter, who looked closely at the activities of 33 large American companies between 1950 and 1986, found that 55% of their acquisitions were later divested. Of their forays into unrelated industries (the fashion at the time was for conglomerates), 74% were later divested.

Synergy fails to materialise in M&A for two main reasons:

• Managers give too much attention to financial and strategic aspects during the negotiation of the deal. All eyes are focused on striking the right price (whatever it is), not on extracting the full value.

• Managers underestimate the cultural differences between organisations. These can be particularly significant in deals that cross borders. An Anglo-French merger between packaging companies Metal Box and Carnaud, for instance, was notorious for the refusal of managers from different cultures to work with each other. It has been said that cross-border deals work well in the airline industry because people have gone into that particular business to meet and understand people from other cultures. The same cannot be said of people who go into packaging.

The unbundling of organisations, which often occurs after a prolonged period of mergers and acquisitions, involves a sort of reverse synergy. In this, three minus two equals more than one. This greater value is realised either through a capital gain from the sale of previously bundled assets (a process often referred to as asset stripping), or through an improvement in the margins on the unbundled businesses.