Types Of Synergy

A wide range of researchers discuss the various types of synergy (e.g. Mulherin & Boone, 2000; Howell, 1970; Goold & Campbell, 1998; and Bradley, Desai, and Kim, 1988). Three groups of types of synergies based on four authors’ definitions are documented below:

Patrick A. Gaughan Michael A. Hitt Alfred Rappaport / Erik Devos et al

• operational

• financial • operational

• financial

• managerial • market power

• operational

• financial

• tax shields

First, Gaughan (2007) discusses operational and financial synergies. According to him, operational synergy comes in the form of revenue enrichments and cost cutbacks. Financial synergy is achieved when the cost of capital may be curtailed through the combination of two companies. Operating synergies

Operational synergy is created when the cash flow from operations is improved whereas financial synergy is generated by interest tax shields, the change in capital structure, and financing. When key decision makers are capable of combining the two entities to generate more value, it is considered as achieving the managerial synergy.

The above types of synergy can be equated to other definitions of synergy discussed by Rappaport (1998) and Devos, Kadapakkam, and Krishnamurthy’s (2008) as market power, operational, financial, and tax shields. The bigger size of the new entity as a result of the merger is the market power synergy. While economies of scale generate operational synergy, and financial synergy is created as the result of reduced risk and lowered cost of capital. Finally, tax shields are created from increased interests of the combined

Efficiency synergies are the most popular synergies to chase as cost reductions are relatively easy to realize through layoffs, a combined headquarters, and other cost cutting opportunities due to the merger(Habeck et al., 2000). However, Habeck et al. (2000) assert that potential upside is, in fact, in revenue/growth synergies as cost reductions are not a driving force that will strengthen the company in the future. It is possible to measure cost synergies and, hence, can be adjusted in price as they can be controlled, i.e. they cannot be changed immediately due to change in choice of the customer.

Negative Synergies

When the combination of two companies incurs higher costs or lower revenue, the combination is said to create a negative synergy that means diminishing of the value. The value is not only destroyed; competitors get the opportunity for strengthening their position in the acquiring business (Sirower, 1997). When the resulting entity observes operational inefficiencies due to their large size and thus resulting into the formation of negative synergies, divestiture can be the solution.(Fulghieri and Hodrick, 2006).

Value creation through