The meaning of synergy in strategic management contexts is the additional benefits which are gained due to complementary activities and resources that reinforce and enhance the effect of each other. This is because the interaction and combination of these individual parts lead to improved results which exceed what each could achieve individually.
To express it plainly, this is a situation where 2 + 2 = 5
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Importance of Synergy in Strategic Management
The main importance of synergy in strategic management discourse lies in the fact that it opens the room for exponential growth and advantage over competition. Strategic management theorists push companies to pursue synergies because this elevates the value of the resources and capabilities which they have at their disposal. This is frequently described in strategic management texts as the whole being worth more than the sum of individual parts. Synergy theory is also particularly significant in the case of mergers and acquisitions. This is because there are many moving parts to such initiatives. When these parts reinforce each other, the result is much stronger than without such synergies.
Types of Synergy in Strategic Management
Strategic fit synergy
This is one of the most important types of synergies expected in mergers and acquisition. The company, which is being acquired, or the companies that are merging together must be able to ‘fit’ together to give rise to synergy of strategies. A perfect fit situation would be when each company is able to improve the other through reciprocal synergies.
This is when companies gain a positive result through interlinking of resources and capabilities either internally, or with other companies. Resource synergy can be obtained from intangible resources such as brand recognition and technology or physical resources, like plant and machinery. Interlinking of intangible resources like knowledge and human resources is better achieved through an alliance between companies. On the other hand, mergers and acquisitions might be more suited when combining tangible resources as plant, machinery, or finance.
This is when the product range of a company or multiple companies within a group complement each other. The result is a synergy in product offerings which fulfill the overall needs of customers more effectively. By expanding product ranges to meet end-to-end requirements, companies can keep customers within their own sales funnel. Naturally, this increases the revenue potential for the company. The biggest example of this is Apple. The different products in Apple’s line-up reinforce the need for each other through the push for a shared ‘Apple ecosystem’. For a consumer looking to use a phone, laptop, and smartwatch, buying all of these from Apple would provide a much better overall experience than buying only one of them from Apple and the rest from competitors.
This happens when value-adding processes of separate companies or business units are integrated and interlinked to enhance or optimize performance. This results in operational efficiencies which benefit both the individual entities and the overall group performance as well. One of the common examples of this kind of process synergy is the creation of overlapping or common business processes across different business units.
An example of this is the concept of vendor-managed inventory. Allowing suppliers some level of control over the management of inventory allows a more streamlined and efficient process. This benefits both parties as they achieve higher levels of combined performance through process optimization.
This is a specific type of process synergy where a task or project needs to be completed by one of the collaborative partners before passing to others. This is seen in the case of companies which use collaborative partners for after-sales services.
An example of this is retail companies which used third-party logistics providers to distribute their products, or handle product returns. Since these service providers have strong capabilities in these functions, the retailing company can focus on sales while leaving these functions in the hands of reliable channel partners.
In contrast to the above scenario, modular synergy is when companies manage their resources or capabilities independently and then combine only the results for better overall results. An example of this is companies in the hospitality sector which synergize with each other through cross-selling of one another’s services. As an example, airline booking websites often cross-sell rent a car or hotel booking options. Similarly, hotel concierge services often have a tie-up with local tour operators and limousine service providers to make suitable recommendations to their guests.
Synergy of skills and expertise
This refers to the synergies that arise from a transfer of skills or sharing of knowledge and expertise. For example, Gillette and Olay, which are both brands under Proctor & Gamble benefit from this kind of synergy. It has been reported that Gillette coordinated closely with Olay to benefit from their skincare expertise and use that to design better razors for women.
Financial synergy is often a key main basis or justification for mergers and acquisitions. Companies expect to be able to drive down their wage bills by eliminating overlapping positions and departments. This is particularly expected at the management level where the redundancy of top-level positions can lead to significant cost savings. There could also be cost savings through sharing of office space, warehousing and distribution. Additionally, when companies merge together, a key financial synergy they gain is the ability to negotiate better prices with their suppliers. In mergers and acquisitions, this is even more straightforward as the working capital of the companies can be combined together. This allows greater flexibility to make moves in these market, which further enhances the market position of the companies.
Synergy of technologies is a key source of competitive advantage in today’s business landscape which is continuously impacted by cutting-edge technological advancements. The sharing of patented technology and other important intellectual property enables creation of products which are superior to the competition. This is not limited to only product technologies though. Even innovative process capabilities can be shared to achieve greater operational efficiencies.
We can look at Microsoft’s acquisition strategy to understand this easily. It continues to add synergistic companies to its portfolio, helping it consolidate its position as a provider for office solutions. For example, it acquired Skype Technologies in 2011 and this enabled it to enhance its video chat service technology. This allowed the company to push the Teams application.
When two companies which have different geographies and customers merge or collaborate, they can each take advantage of the access to a greater geographic area or customer demographics. This would produce higher revenue for each of them.
Market synergy is often used as a basis for cross-selling efforts as well. This can be when companies which have their own branding, marketing, and sales networks collaborate to achieve better overall sales. Co-branding is another form of market synergy in which companies collaborate to improve their combined sales of certain products or services. The Apple Watch Nike+ is an example of this.
Negative synergy is simply one where the overall results of combining resources or capabilities leads a result that is less than what would be achieved individually. This is often used as a driver for pursing diversification strategies.
Benefits of Synergy in Business
Opens the possibility of backward or forward integration
Many companies would like to increase their profit margins by expanding vertically, either through backward or forward integration. However, this is often a difficult and expensive task to accomplish without having some strong synergies to rely on.
Helps achieve economies of scale
Synergy between businesses can also lead to better economies of scale. This refers to a situation in which companies are able to acquire resources at a much lower cost due to higher purchasing power and volume. This is achieved by pooling in the resources and expertise of the synergizing businesses. This helps the company negotiate better rates with suppliers and other relevant parties. This is often the case when one or more of the organizations in the merger has a high-cost profile.
Enables low-cost strategies
On the other hand, it could be the case that some of the organizations in the merger have a low-cost approach. In this case, the new merged company can pursue low-cost strategies that synergize between this low-cost footprint and the expertise of the other companies. A very common example of this is how manufacturing companies in the Western markets outsource most or even all of their production to low-cost organizations. The logic behind this is to benefit from the low cost of labor and factors of production, while relying on the design and branding expertise of the original company. Another example is the case of companies which act as solutions providers who aggregate many components sourced from various suppliers. These companies create synergistic value through optimized product design, or efficient service delivery.
Disadvantages of Synergy in Business
Difficulty in identifying and capitalizing on synergies
Synergies are usually hard to identify in real-life situations. Even when identified correctly, taking the necessary steps to utilizing these synergies may not always be feasible.
Unpredictability in achieving the expected benefits
There is also the risk that potential synergies which appear to exist on paper or in theory, may not actually work out in practical application. Apart from the risk of fraudulent misrepresentation of company information during a merger and acquisition drive, the value of skills or resources of other businesses may genuinely be overestimated. This kind of situation is usually observed in the case of managers trying to eagerly push their new venture or acquisition initiative to go through. This may also arise out of a desire to justify the acquisition costs.
Possibility of expected costs exceeding expected benefits
When looking at expected synergies from integration, we should not neglect a proper cost benefit analysis. Undertaking integration activities with the aim of achieving synergies often requires investment of time, money and efforts. It is not a straightforward task to manage synergistic relationships. This is because it typically requires extensive time and involvement at the level of higher management. The biggest example of this drawback is the fact that many companies seem to ignore the cost of acquisition. Even if there are significant synergies to be achieved, if the cost of acquisition far exceeds the market value of that deal, it will not be beneficial when looking at the long-term outlook.
Competition between the players involved
In the context of synergy between different business units within an organization, the question of overcoming self-interest becomes very important. If the managers of different business units have an incentive to achieve higher results for their department over others, they may not be willing to sacrifice this for ‘the greater good’ of the company.
Synergy between internal departments
Synergy between internal departments refers to the integration and interlinking of the activities of different business units and offices within a company. One of the key roles of the corporate parent company is to facilitate such kinds of synergies. This is because such a synergy is easier to manage than pursuing synergies with external parties. Improving the level of cooperation and sharing across internal offices and departments can help amplify the performance of each individual team. This leads to better group performance too.
An example of this how the design centers of Samsung Electronics in London, Tokyo, San Francisco, and Seoul are responsible for the product design for all its different business units. This helps the company concentrate its pool of key talent in fewer locations, which should enable better knowledge-sharing and innovation.
How to Create Synergy in Business?
How to identify synergies?
To identify synergies, we should identify the potential for interactions between two or more businesses. These linkages should be established in such a way that they mutually reinforce the competitive advantage of each other. To do this, you can start with an internal analysis of each of the players involved to better identify their individual strengths and weaknesses.
Synergies are expected to be more significant in situations where new activities are tied closely with the core business. Establishing synergy in value-creating activities can be achieved by one or more of the following approaches.
- Aim and work towards a common purpose
- Remove barriers to facilitate easier cooperation among business units
- Provide a central pool of resources and services for collective benefit
- Compare value chains of different business to assess whether there are compatible activities which can be interlinked further
- Consider whether any shared activities such as research, procurement or distribution can be integrated and combined for better efficiency and effectiveness
How to achieve synergy in business?
To ensure that you will achieve synergy in business, it is usually better to understate the potential outcomes of an M&A imitative or new venture. Always try to ground your decision-making based on realistic synergies rather being over-ambitious.
Of course, justification of synergy is not usually an end-goal on its own. It is very important to capitalize on the identified synergies as fast and effectively as possible. The best way to go about this is to concentrate on the synergy results which are easier to accomplish. Often, this would be integration of sales and marketing channels, followed by greater coordination of supply chain efforts.
The synergies which are more difficult to accomplish are ones that involve tough decisions. This includes tasks like laying off employees or shutting down redundant or overlapping departments for better financial synergy. Such difficult decisions should be taken as the next order of priority. This is especially because they will be much more difficult to manage if initiated during the initial transition period.