Fallacies of Cost Synergies in Automotive M&A

One of the primary drivers for an acquisition is the potential for synergies that can be achieved as a result of combining the acquired entity with those that you already own. Many acquirers tend to see cost synergies as the single largest strategy for achieving this goal. The most commonly-used tactic for reaching the desired level of cost synergies is by significantly reducing the numbers of apparently redundant employees in the acquired organization. 

Unfortunately, this often ends up being an extremely shortsighted strategy, particularly when it is performed immediately following the acquisition. There are many reasons why this seemingly obvious source of cost synergies can often be overvalued and ultimately backfire on the acquirer. First, let’s define the term:

In essence, cost synergy is the savings on overhead that is to be expected when the acquirer merges new assets into its existing structure. There can be several sources of potential cost synergy, based on the specific characteristics of the companies involved, such as:

• Layoffs or other methods of reducing the number of full-time employees
• Supply chain/purchasing economies
• Sales efficiencies (if overlaps exist)
• Improvements in operating technology
• Consolidation of operating costs (office space, insurance, etc.)
• Access to complementary products or services
• R&D/Proprietary technology (in companies that are suppliers)

Many of these synergies may look great on paper when planning an acquisition, but they can easily be overvalued. When savings do not materialize in the aftermath of the acquisition, it can call the entire premise for the deal into question. 

Let’s now review a few of the primary areas of flawed assumptions. All of these are factors from which critical mistakes can be made in cost synergy analysis:

Limits to available data: The data used to inform cost synergy projections is incomplete and directional at best. An acquirer inherently cannot have a 100% clear vision of an acquired company until the deal is done and there’s no turning back. This is why trying to lay off employees in advance, based on an arbitrary percentage that “makes the numbers work,” is a very bad idea that can lead to unforeseen, negative consequences.

Competitive advantage: The best approach for an acquirer in search of cost synergy is to do nothing until a complete analysis of the acquired company’s operational advantages is understood. This is because a significant headcount reduction upfront can severely damage the company’s Competitive Advantage Configuration, which the acquirer will not have full knowledge of until the transfer of ownership is complete.

Competitive Advantage Configuration is a company’s “secret sauce,” the unique way in which it configures technology, strategy, processes, and systems into its own, non-duplicable way of doing things. Acquirers that buy a company that thrives on its Competitive Advantage Configuration would be well advised not to tamper. Observe it and learn from it – your current employees and executives may also benefit!

Human capabilities: The defined job functions of the individuals that work for an acquired company usually only scratch the surface of what any given employee truly does for the company. This is particularly true in small and mid-sized companies, where employees are encouraged to contribute beyond their actual job descriptions, using all of their capabilities. 

Multiplied across the entire workforce, this approach contributes mightily to a company’s extremely desirable and valuable Competitive Advantage Configuration, as mentioned above. Seen in this light, making severe cuts and letting employees with many intangible strengths go based on a spreadsheet is highly misguided at best.

Knowledge of intangible factors: Even though it is possible to do a reasonable job “on paper” in terms of due diligence and the way that a deal is structured, there are many aspects of an acquisition target’s operations and performance that simply can’t be accessed through publicly available information and limited access to the target’s decision makers. Some of these intangibles are:

• The corporate culture
• Perception and true role of the leadership
• Level of employee engagement
• True potential for new value creation

Due to the nature of the process, there is no way to gain an understanding of these very important “soft” features of the company being acquired. Spending some time “on the ground” after the transfer of ownership is complete will provide much more insight, as well as better guidance as to where any worthwhile cost synergies may actually exist. That way, you can turn these intangibles into tangible benefits.

There are certainly important benefits to be derived from cost synergies, but an extreme and single-minded focus on this sole aspect of the deal can and will negatively impact the acquired business and the new, merged company. Any company worth acquiring is like an “organism” that has become adapted to thrive in its environment after a long process of evolution. This means randomly severing “body parts” in the pursuit of cost savings will not improve the company’s effectiveness, potentially even destroying its advantages.

The firm that you hire to assist you with an acquisition or a sale must be able to manage all of the issues, both tangible and intangible. Of course, you want a good deal, structured to your needs. But you also need the transaction to fit in with your business goals. 

DCG Acquisitions is a full-service mergers and acquisitions firm in every sense of the term. We will be there for you, from the beginning of the process through the final signatures on the agreement. Our decades of established resources and relationships ensure the success of your new transaction.

Our automotive M&A team has an impeccable reputation and a long track record of proven results in the automotive industry, because we’re committed to service beyond the sale. Furthermore, the DCG Acquisitions team has personally closed billions in transactions to date. Our experienced staff manages efficient, high-return acquisitions. Contact DCG Acquisitions to speak directly with an automotive M&A specialist and learn how our expertise can help you get the most out of your next transaction.