Synergy is the benefit that results when two or more firms together achieve something either one couldn’t have achieved on its own. It’s the concept of the whole being greater than the sum of its parts. For example, if firms A and B merge and the value of the combined entity— V(AB)—is expected to be greater than (VA+VB), the sum of the independent values of A and B, the combined entity is said to be benefitting through synergy.
Synergy can take place in two forms:
1. Operating synergy: This refers to the cost savings that come through economies of scale or increased sales and profits. It involves raising scale of production by changing all factors of productions of the firm. It leads to the overall growth of the firm.
2. Financial synergy: It is the type of synergy which is due to financial factors such as lower taxes, higher debt capacity or better use of idle cash. When a loss making firm merges with a profitable firm and the combined firm can set off such losses against its profits, a financial synergy, known as tax shield, occurs.
