Define synergy. Is synergy a valid rationale for mergers? Describe several situations that might produce synergistic gains.

Explanation

Synergy is created when the combined value, power, strength, resources, productivity, and efficiency of two entities is greater than their sum if added separately.
 
Various assumptions, factors, and scenarios are taken into account for estimating synergistic gains, but a significant potential synergy is the main motive behind most of the mergers.
 
Synergies are created in various situations:

Operating costs per unit of output is reduced due to economies of scale in production, marketing, distribution, and management.
The combined cash reserves and financial resources of two companies provide leverage in doing any transaction; this results in reduced transaction costs, low interest rates, and favorable terms in a business transaction.
The more experienced and well-trained management of the bigger company can turn around the operations of the smaller company and increase productivity and efficiency.
The new company will be bigger because of increased market share and reduced competition. Mergers that reduce competition are often viewed as socially undesirable and illegal.

Sample Response

A synergy is the additional value created from merging two entities, wherein the new entity as a whole has a greater value than the sum of the two entities separately.
 
Although it is difficult to accurately estimate the synergistic value, potential synergy can be a valid rationale for a merger.
 
Synergistic gains can be created in several forms:

Operating economies due to economies of scale in management, production, marketing, etc.
Financial economies due to lower transaction costs, high cash and other financial reserves, and better analyst coverage
Differential economies due to the fact that the management of the bigger company will be able to increase the productivity of the assets of the smaller company
Increased market power due to fewer competition and increased market share and resources