Dis-Synergies in M&A

The concept of a synergy in the context of M&A is commonly understood to mean a situation where the whole is greater than the sum of the parts as two businesses combine. Dis-synergies (or “dissynergies”), on the other hand, refers to a situation where the whole is less than the sum of the parts. A dis-synergy is essentially the opposite of a synergy.

Revenue Dis-Synergies

Revenue dis-synergies are caused when the combination of two companies in a merger results in total pro forma revenue that is less than the sum of the two standalone businesses.

In the example below, each company has standalone revenue of $100M. Logically, combining the two businesses should result in revenue of $200M. Unfortunately for them, revenue dis-synergies of ($20M) occur and total pro forma revenue is only $180M.

What Causes Them?

There are a few different potential drivers of revenue dis-synergies.

One common cause is failure to execute. Perhaps the two merging companies bungle a technology platform migration and lose client data for the newly acquired customers. This is a drastic example, but large-scale integrations are rarely seamless.

Another common cause is overzealous efforts to reduce costs. Occasionally acquirers are so focused on realizing cost synergies that they are too heavy-handed in their approach.

For example, let’s consider another enterprise technology company. The acquired company had an extensive client service team with individual-level relationships to customers. The acquiring company handled support via an entirely off-shored chat team in India. Upon acquisition, they saw the client service team as superfluous and cut them. The newly acquired customers saw drastic declines in their level of support. Turns out the actual product was so-so, but they really valued the high-touch support from the old client service team. As a result, they begin cancelling contracts and revenue attrition goes through the roof.

While some of these examples sound like hyperbole, research from McKinsey does show that the average merging company loses 2-to-5% of its combined customers.

More drastic still, the Financial Times has dubbed the phrase revenue dis-synergies as corporate speak for “unfortunately we have paid top-dollar for some rubbish businesses that now have to be closed.”

Cost Dis-Synergies

Similarly, the term cost dis-synergies refers to a scenario in which it is more expensive to run the combined business than it is for each on a standalone basis. The impact can be felt both at the direct expense level or the indirect expense level (corporate overhead).

In the scenario above, notice how both pro forma direct and indirect expense are greater than the sum of the individual components. This causes a significant drag on margins.

Imagine a situation where a healthy juice company bought a natural foods cereal company. Sounds like a good fit, but reality doesn’t agree. The acquiring company has an exclusive manufacturing agreement with a third-party packer. Now, however, the packer has to produce both juice and cereal. This involves significant prep time changing the production lines for each product, and drives up the cost of production for both parts of the business.

The increased size of the business now bumps them up into a more burdensome regulatory threshold with the FDA. To cope, the business needs to hire an internal general counsel and full legal team. This drives up combined indirect expense.

How to Avoid Dis-Synergies

Dis-synergies are clearly a nasty scenario and should be avoided whenever possible. That’s easy to say, but what are concrete steps that firms can take to sidestep these issues?

The primary issue is a lack of complete information in an acquisition process. Buyers typically have limited data about the target company and lack full transparency on its suppliers, customers, employees, and day-to-day operations. Too often synergy estimates are based on high-level financial analyses completed by investment banks or corporate development teams, both of whom have various incentives driving them to get a deal done.

Awareness of the issue, more methodical information gathering in the M&A process, and realistic targets for post-merger integration can all help avoid bad deals and costly mistakes.

The other key solution is to more fully involve mid-level operational personnel in the deal process. They have the level of granular detail required to identify both potential issues and potential upside. Too often they are only involved post-merger, by which point it may be too late to escape dis-synergies.

Closing Thoughts

Failure to achieve projected synergies is a hallmark of any acquisition. But any prospective buyers need to ensure they’ve done their homework to prevent dis-synergies and avoid looking completely donkeybrained. Deeper diligence and a protracted M&A process is never enjoyable, but it could mean the difference between a successful outcome and years of clean-up.