Q.2 What are the sources of operating synergy?Answer:
Sources of Operating Synergy:
Operating synergies are those synergiesthat allow firms to increase their operating income, increase growth or both. We wouldcategorize operating synergies into four types:1.
Economies of scale
that may arise from the merger, allowing the combined firm tobecome more cost-efficient and profitable. Economics of scales can be seen in mergersof firms in the same business.
two banks combining together to create alarger bank. Merger of HDFC bank with Centurian bank of Punjab can be taken as anexample of cost reducing operating synergy. Both the banks after combination canexpect to cut costs considerably on account of sharing of their resources and thusavoiding duplication of facilities available.2.
Greater pricing power
from reduced competition and higher market share, whichshould result in higher margins and operating income. This synergy is also more likelyto show up in mergers of firms which are in the same line of business and should bemore likely to yield benefits when there are relatively few firms in the business. Whenthere are more firms in the industry ability of firms to exercise relatively higher pricereduces and in such a situation the synergy does not seem to work as desired.
of limiting competition to increase pricing power is the acquisition of universalluggage by Blow Plast. The two companies were in the same line of business and werein direct competition with each other leading to a severe price war and increasedmarketing costs. After the acquisition blow past acquired a strong hold on the marketand operated under near monopoly situation. Another example is the acquisition of Tomco by Hindustan Lever.3.
Combination of different functional strengths
, combination of different functionalstrengths may enhance the revenues of each merger partner thereby enabling eachcompany to expand its revenues. The phenomenon can be understood in cases whereone company with an established brand name lends its reputation to a company withupcoming product line or a company. A company with strong distribution networkmerges with a firm that has products of great potential but is unable to reach the marketbefore its competitors can do so. In other words the two companies should get theadvantage of the combination of their complimentary functional strengths.4.
in new or existing markets, arising from the combination of the twofirms. This would be case when a US consumer products firm acquires an emergingmarket firm, with an established distribution network and brand name recognition, anduses these strengths to increase sales of its products.Operating synergies can affectmargins and growth, and through these the value of the firms involved in the merger or acquisition.Synergy results from complementary activities. This can be understood withthe following example
Consider a situation where there are two firms A andB. Firm A is having substantial amount of financial resources (having enough surpluscash that can be invested somewhere) while firm B is having profitable investmentopportunities ( but is lacking surplus cash). If A and B combine with each other both canutilize each other strengths, for example here A can invest its resource in theopportunities available to B. note that this can happen only when the two firms arecombined with each other or in other words they must act in a way as if they are one.