What are synergies, and which kind would you trust more?

Synergies are the extra profit two companies can earn together that they couldn't earn apart. They're the main reason a buyer can pay a premium and still come out ahead. There are two kinds. Cost synergies come from removing duplicated spending. Examples are closing one of two head offices, combining overlapping sales teams, and getting better prices from suppliers on bigger volumes. Revenue synergies come from selling more. Examples are cross-selling one company's products to the other's customers, or entering new regions through the other's distribution. I'd trust cost synergies more. They're in management's control, because the buyer decides which costs to cut. They're also easier to measure, because the costs are already in the two income statements. Revenue synergies depend on customers buying more, and customers don't have to cooperate. So in a model I'd give cost synergies most of the credit and treat revenue synergies as upside.

Synergies are the extra profit two companies can earn together that they couldn't earn apart. They're the main reason a buyer can pay a premium and still come out ahead. The test is that the synergies, after what it costs to get them, have to be worth more than the premium, or the buyer's shareholders lose. There are two kinds. Cost synergies come from removing duplicated spending. Examples are closing one of two head offices, combining overlapping sales teams, and getting better prices from suppliers on bigger volumes. Revenue synergies come from selling more. Examples are cross-selling one company's products to the other's customers, or entering new regions through the other's distribution. I'd trust cost synergies more. They're in management's control, because the buyer decides which costs to cut. They're also easier to measure, because the costs are already in the two income statements. Revenue synergies depend on customers buying more, and customers don't have to cooperate. Some may even leave during the integration, which works against the deal. There's a second reason. A dollar of cost saved goes almost fully to pre-tax profit, while a dollar of new revenue only adds its margin. Cost synergies aren't free, though. They take a year or two to arrive, and they come with one-time costs like severance and combining systems. Cuts that go too deep can also hurt service and cost revenue. So in a model I'd give cost synergies most of the credit and treat revenue synergies as upside. I'd phase the cost synergies in over time, net out the one-time costs, and check that the deal still works if the revenue synergies never show up.