During mergers and acquisitions (M&A), a primary motivation is to create a more valuable and efficient company. A frequently cited justification for these unions is the pursuit of synergies, with a strong focus on achieving specific cost savings. These savings are a main reason organizations choose to combine their operations and resources.
Defining Cost Synergy
Cost synergy is the financial benefit that occurs when a merged company’s total operating costs are lower than the combined costs of the two separate entities. This happens because integrating two companies creates opportunities to eliminate duplicate expenses and streamline processes. These are the tangible savings a company can realize after a merger or acquisition, making the new whole cheaper to run than the sum of its parts.
Cost synergies are distinct from revenue synergies, which are based on the idea that the combined company can generate more sales. While appealing, revenue synergies are more speculative and harder to predict accurately. Investors and financial analysts place greater emphasis on cost synergies because they are more quantifiable and achievable.
Common Sources of Cost Synergies
Economies of Scale
Economies of scale are a primary source of cost synergy. When two companies merge, their combined size provides greater purchasing power, allowing the new entity to negotiate lower prices from suppliers for raw materials or services. For instance, two smaller manufacturing firms can pool their orders to command a bulk discount that neither could secure alone.
Operational Consolidation
Consolidating overlapping corporate functions and physical locations provides another area for savings. A merged company does not need two headquarters, finance departments, or human resources teams. Integrating these functions into a single department eliminates redundant salaries and overhead, while closing duplicate offices or plants saves on rent, utilities, and maintenance.
Headcount Reduction
Related to operational consolidation, headcount reduction is an immediate source of savings. When functions like accounting or marketing are combined, many job roles become redundant. For example, the merged entity will only require one Chief Financial Officer, not two. Eliminating duplicate positions reduces payroll expenses, a major operating cost.
Technology and Systems Integration
Merging companies can achieve cost synergies by integrating their technology and systems. This can involve moving all employees onto a single software platform, consolidating data centers, or eliminating redundant software licenses. If one company has a more efficient proprietary technology, extending its use across the new organization can also drive down operational costs.
Supply Chain Optimization
Optimizing the combined supply chain is another source of cost reduction. A merger allows the new company to analyze both distribution networks and adopt the most efficient routes and warehouse locations. For example, one company’s strong West Coast network can be combined with the other’s East Coast network to create an efficient national system. This consolidation reduces transportation, warehousing, and inventory costs.
The Process of Realizing Synergies
Realizing cost synergies is a structured process that begins before a deal is finalized. The first phase is due diligence, where the acquirer analyzes the target’s operations to identify and quantify potential savings. This involves reviewing financial statements, workflows, and organizational charts to estimate where costs can be cut.
After identifying synergies and agreeing to the merger, the integration planning phase begins. Teams from both companies create a roadmap for combining the organizations. This plan outlines specific actions, assigns responsibilities, and sets timelines for consolidating everything from IT systems to supply chains, ensuring it is ready to execute when the deal closes.
The final phase is execution, which begins after the merger is complete. During this stage, the integration plan is put into action. This phase requires careful management and continuous tracking to ensure planned savings are realized. Companies monitor expenses against synergy targets to measure success and make adjustments.
Challenges and Risks in Achieving Cost Synergies
Companies face several challenges in realizing expected cost synergies. Management can be overly optimistic and overestimate potential savings during merger negotiations. The pressure to justify a deal’s price can lead to aggressive synergy targets that are difficult to achieve in practice.
Unforeseen integration costs are another hurdle. Merging two organizations can be expensive, with costs from severance packages, terminating leases, and integrating different IT systems. These hidden costs can erode anticipated savings if not accounted for during planning.
A clash of corporate cultures can hinder the cooperation needed for a smooth integration. If employees from the two companies cannot work together effectively, it can slow the implementation of synergy initiatives. This friction can also lead to the departure of key talent due to uncertainty or dissatisfaction with the new organization.
A Real-World Example of Cost Synergies
The 2015 merger of Kraft Foods and H.J. Heinz, creating The Kraft Heinz Company, is a clear example of a deal driven by cost synergies. Orchestrated by 3G Capital and Berkshire Hathaway, the merger was built on aggressive cost-cutting. The new company announced a target of achieving $1.5 billion in annual cost savings by the end of 2017.
The company pursued these savings through operational consolidation and headcount reduction. It closed several factories and corporate offices across North America, eliminating thousands of duplicated jobs. This addressed redundant manufacturing capacity and administrative overhead in functions like finance, HR, and legal.
Kraft Heinz also focused on supply chain and procurement optimization. By combining their purchasing power, they negotiated lower prices on raw materials, packaging, and logistics. The company implemented a zero-based budgeting system, requiring managers to justify every expense annually to reduce costs across the organization. This combination of strategies allowed Kraft Heinz to pursue its synergy target.