Creating long-term value for all stakeholders is a goal, if not the raison d’être, of all organizations. Profitability should be considered a natural outgrowth of value creation.
Generally, synergies can be broken down into three different components, or frameworks: financial, managerial, and operational (Oprescu, 2019). Operational and managerial synergies are usually the easiest ones for acquiring companies to scope out, in terms of revenues and costs.
An important cornerstone of value creation — mergers and acquisitions – uses the “natural law” of synergy to create value. Originating from the Greek word synergos, synergy simply means “working together to achieve more than separately”. Most people understand a synergy as meaning “…1 + 1 = 3 since synergies are business measures that increase the value of the combined business entity more than the sum of its separate units” (Oprescu, 2019, p. 233).
Now, enter the practice of creating synergies between companies. Perhaps one of the most overused (and abused) buzzwords in business history, synergistic relationships can create value through making various operations and processes more efficient and less costly, thereby helping growing companies do what they could not do alone – increase the value and profitability of the newly-created “1 + 1 = 3” company.
However, most companies grapple with creating actual synergistic relationships. Zenger (2016) argues that the creation of a synergy is more akin to an auction than a calculable risk with a definitive pay-off. Most academics back up his claim, pointing out that synergies require foresight, insight, and/or cross-sight (Zenger 2016).
Indeed, in the real world of M&A, not every synergy is beneficial, and many of them should be considered pseudo-synergies, i.e. “fake” synergies.
For instance, imagine that Company A has just acquired Company B. Company B’s customer service might be in top-notch shape. Nevertheless, Company A’s top management, seeking to cut overall operating costs, closes Company B’s customer service department without so much as batting an eye. However, Company A now finds itself in a precarious position.
Having doubled down on its decision to “consolidate” various departments, including cost-cutting and forming “synergies” across legal, human resources, R&D, and other departments, such pseudo-synergies merely create the illusion that a genuine synergy has been created.
Pseudo-synergies, then, are nothing more than the trick top hat in a magician’s stage show, a sleight-of-hand in value creation with long-term negative consequences for shareholders. Sooner or later, the bottom line will reflect the negative impact of a pseudo-synergy.
While recent business news is rife with the creation of such pseudo-synergies, the recent Kraft Heinz merger and acquisition by Brazilian-based private equity giant 3G Capital and CEO Warren Buffett’s high-performance holding company, Berkshire Hathaway, is an especially noteworthy case study.
If you did not already know, Berkshire Hathaway has become an American institution, a profit-generating juggernaut for Buffett and its key stakeholders.
“[In addition to] ranking ninth on Forbes’s list of the biggest publicly owned companies, Berkshire owned companies in a variety of industries, including insurance, railroad, and retail. Berkshire’s portfolio included several food and beverage companies, including Dairy Queen, The Pampered Chef, and See’s Candies. Berkshire Hathaway owned [in 2014] 18 percent of Coca-Cola and a portion of Mars, Inc.” (Stowell & Kawar 2019).
In 2013, Buffett found himself in an awkward position. He simply had too much cash on hand to invest in companies hampered by weak valuations – until he was approached by Jorge Paulo Lemann, a key partner and co-founder at 3G Capital (Stowell & Kawar 2014). Buffett has been a vocal critic of the role of private equity in stock purchases, but he had been looking for a company with a lot of cash as well as being a big seller, with built-in brand recognition globally (Rosenbaum 2019). Kraft Heinz fit the bill. The acquisition seemed to be a promising one for both 3G Capital and Berkshire Hathaway.
However, in February 2019, Buffett lost more than $4 billion on paper after Kraft Heinz stock plummeted, underscoring the fact that 3G and Buffett were mismatched from the get-go. With a much more “laissez-faire” ownership style, the “Buffett Way” was at odds with 3G Capital’s aggressive cost-cutting measures put into play by a ruthless management team – in stark contrast to Buffett’s preference for strategic, long-term investing. Also, last February, Kraft Heinz brands took a $15 billion hit in value writedowns (Rosenbaum 2019).
The “1 + 1 = 3” maxim for synergy creation somehow eluded 3G Capital’s grasp. Indeed, their cost-cutting was pseudo-synergistic, at best. Instead of carefully considering which fat needed to be trimmed and which waste needed to be eliminated (the Lean approach), 3G Capital relied on a slash-and-burn business model. In their zeal to eliminate duplicative processes, 3G sacrificed Kraft Heinz’s long-term potential for maximizing operational efficiencies.
Instead of a strategic investment, the PE firm only committed to a financial investment. In August 2018, they sold 7% of their Kraft holdings (Rosenbaum 2019). Moreover, they found themselves adrift in the ever-changing market of “consumer food preferences”, and Kraft Heinz was behind the curve with respect to more recent market changes such as the industry-wide shift towards organic, “natural” ingredients. Indeed, the company that gave us “57 Varieties” did not adapt quickly enough to changes in end-user demand.
Perhaps if 3G Capital had stayed the course and committed itself to the Lean journey, the ship would have stayed afloat. Instead, Buffett’s Berkshire Hathaway took a loss, but, after the dust settled, learned some invaluable lessons about creating genuine synergies.
I contend that synergies can still be created, regardless of the prevailing business climate, because they are rooted in natural law. Based on my experience, companies can pull three levers to realize REAL value:
- Cost Reduction: capture cost savings by eliminating redundancies and improving efficiencies via waste elimination and Lean principles.
- Capital Efficiency: improve the balance sheet by reducing such things as working capital (inventory, receivables, payables), fixed assets, and borrowing or funding costs.
- Revenue Growth: enhance revenue growth by acquiring or building new capabilities (e.g., cross-fertilizing product portfolios, geographies, customer segments, and channels).
To avoid the illusion of pseudo-synergies, and pull the levers above, companies must devote time and resources to develop and deploy a holistic business system in a repeatable and sustainable fashion, i.e. the Danaher Business System (DBS), Honeywell Operating System (HOS) and others. Only then can they truly unlock REAL value in the newly combined enterprise.
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