In order to compete with big players, many companies have to unite, and sometimes such a merger can cause an extra positive effect, i.e. synergy. Hereunder we are going to tell you why the majority of corporations seek to reach it.
Since the late 1990s, the large companies have begun to look for some new ways of production development and expansion, which have resulted into the M&A (mergers and acquisitions) agreements. In its turn, those agreements sometimes are considered the only option for certain companies so that to stay on the market. One of the most famous deals at the dawn of the merger era was that of Exxon and Mobil in 1998, worth $80 billion.
In the years to come, the M&A market had been expanding steadily, although not all transactions were successful. For example, America Online and Time Warner consequently lost $98.7 billion as a result of such a merger. The M&A market development was triggered by the 2008 financial crisis, due to which many corporations have bought up assets of their less developed competitors at a very low price.
Actually, 2015 has become the best year for the M&A agreements – with the size of all such transactions estimated at $5 trillion. In 2016, the market volume dropped by 24%, although this was largely due to the US elections and changes in tax legislation that had broken the largest deal in the pharmaceutical industry – that of Pfizer and Allergan, $160 billion worth.
Such agreements are mainly conducted in order to reach the access to new markets, tax inversion, technology exchange and production development. But there is another important motive – the so-called synergy effect.
Why synergy is of that much importance for the M&A market
The synergy effect is an opportunity for a company’s additional advantages. It appears as a result of combining separate parts into a single system. For instance, imagine a couple people sitting in the separate parts of a restaurant. However, if they sit together at one table, they may have a friendly conversation. And such a conversation is the synergy effect. It would not have been possible to achieve if the participants continued to sit separately. Some economists and lawyers also call it the “1+ 1 = 3” effect.
The emergence of this phenomenon is related to the scale effect when a company gains more opportunities if it increases its assets. A good example may be found in the Chevron case when the former acquired Texaco in 2001 for $39 billion. At that time the cost of oil was $27 per barrel, and such deal allowed the company to increase significantly its stockpiles just at the very beginning of the long-term growth in oil prices. As a result of this merger, the market capitalization of Chevron has reached a fourfold increase.
If the synergy or scale effect is not the main motive for concluding the M&A deal, most participants are still equally keen on it, because it is not always possible to predict what will allow for their profits increase. Sometimes such a merger of the scientific or engineering departments of different companies leads to the emergence of a new profitable product
The synergy effect and the market
The current 3.0 marketing concept suggests that there are no competitors. Thus, all the enterprises are only potential partners for the market expansion. With this in view, M&A is a natural process for the continuous synergy effect development, but not just a tool for creating monopolies or reducing the tax burden. Thus, companies should strive to merge to improve the efficiency of different markets.
In fact, synergy and scale effects are the main reasons for the merger of the two largest chemical companies - Dow and DuPont. By the way, the deal conclusion shall take place near the end of summer 2017. However, instead of creating a single large conglomerate, which would cover all the businesses, three separate companies with different orientations will be established, namely: agriculture, energy and other industries, for instance, plastic production.
Establishing such a sectoral division can lead to the formation of three different synergy effects and will facilitate the enterprise management process.
Based on data of 2016, it is hard to conclude with certainty that the era of large M&A deals is over. Even if the amounts of transactions will fall, their number will still likely continue to grow. Moreover, if the company wants to avoid being submerged by a larger player, it will have to unite with its competitors, which means that the main motive for such deals will consist right in the synergy and scale effects.