A Theory of Synergy

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!J1Jl- 4(1)

UNlVERSIDADE NOVA DE USBOA

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Faculdade de Economia

INP,

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1/8

A THEORY OF SYNERGY

Jorge Vasconcellos e

Sa

. Working Paper NQ 77

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UNIVERSIDADE NOVA DE

~ISBOA

Faculdade de

Economia

Travessa

Estevao Pinto

Alto de Campolide

A THEORY Of SYNERGY

I - INTRODUCTION

Several scholars hove recently stressed the importance of the concept of synergy (Anker. 1934; Singh una ~l(\ntgcmery. 19d7; Lubatkin, 1987; Hill and lloskbsOD, J987). Two reasonS have been

advflnced~ First. increHsing levels of ecoHomic t technologic dlld

competitive c01nplexity impose the :1eed to achieve higher strategic benefits un urganizatiocs (Ansoff. 1984; Thomas, 1(86). Second. i t is becomin::;:; ir:creasingly accepted that corporate strategy must go beyond' t:le cash Ilk10agerncnt of EGG and similar models in orcer to creati':l a C01:lpctitive advaotage for the organit:.ation B:-" a 'Whole (Scherer, 1986; pnts~ 1985; Hammer mesh.

1986).

Synergy remains t however, an elusive concept.

Accortling to Porter (l985J, l1ill defined notions of what constitutes synergy underlay many companies' acquisitions problen::/' (PP.318)~ Besides this conce;>tual problejJl,"ChattvrJee (1986) has. a Iso indicated tll~t, "A more r igorQus ft'iurework shou] d

be developed which links the potentii-il for cr~'oting econou:ic value not only to the decision to diversify. but also to the type of acquisition (related or unrelated) and the ffiudc (de novo or acquisition) of diversification"

(PP.138).

Consequently, in order for the ,~oncept of syn<;rgy to be useflll

one 2lust possess .1 t.heory

of

syrergy which states lJ, c€tailed terms it.s causes and the circ.umstances under which those causes are predicted to Pt> cspec iully strong (Singh and :·Iontgo!aery. 1987). Such a detailed theory of syner3Y will lead to com:] usions about which acqul.s~tlon strategies greatest potential for creeting economic value (Salter and 11eiahold, 1979i

Porter t 1987).

Presenting such a theory of synergy is the aim of this paper. This paper wiiI:

lst - devele'!J a ,-'ctailcd list of the causes of synergy_ 2nd. - aggregate the dHferent causes, according to their nature into broader categories.

3rd - predict when synergy will or ..ill not be created.

II - THE Cm;CEPT 0, SYXERGY

A conct'pt should be defined by its roots and by its CO!l;;:lOfl

• "S . .. (. . . ) . . h

usage. Synergy comes f rom t he :;1t"eeK ynergr.a JOlnt \-taCK WJue is derived from "syner,sein". LlA<-)oing. to work togetaer. rlcc*,pted sources such as the \;'eLster dictionary define. synergy i>b the combined or cooper-ati ve action of different forces, such as drugs in the human body I or the action of 'sever<ll orgillls to

perform cQ1nplex -movement""

From the roots and common usage of the word synergy two

basic points emerge: •

1st - Synergy requires diversity, involving two or more agents, orgkl\\S, drugs, divitiioo$. etc. That is, one may speak of synergy only if there 1s diversity (Pitts, 1985; ;!Ul mid Hoskissol!. 1987) ,.

2nd - There is nothing in the concept of synergy which -requires that the overall effect !}e greater t:hc;n the sum of the

.

parts •

The

concept

of synergy

requires

werking

together, it

does

not specify the end result,' Indc~tl. in ::nedicine two dru:;s can be used simultaneous] y, so thnt the effect of one,Pf t.he drugs partially ,offsets SONt: undesirable effect of thE' other drug. In the organizat ions field. Ansof f I 1965 and 198/.; ::ew;nan and Logan. 1985; Scott 1980, ' and Sch~rer J979, r.ave all Pointed Olit t.hat synergy can be nega'tive (2+2:0;3) as welJ os positive (2+2=5).

Consequently, syr:ergy should be defined as the coperative work of different PiJrts towards ,) common end (1). 1':l(S definition is in accord<lnce with that of authors suc-h as Day, J077, Haugen, 1975; Ansoff, 1965; and Hill and liQskisson I 19B?~ _

This definition enhances:

A - Cooj?eratiun \;hich is related to resource sharing and consequentlY the parts cannot be totally autOl:omous.

B - Parts of. eot the ~reater whole. to w:'1ich the parts belong

c -

Different t r.ot equal~ and consequently the concept of synergy de;r.arks itself from experience and size effect:,..

D - C9~

J:2J!

and so synergy is distinct fror~ situations

of parasitislr. suc!~ as one Si3U receiving funds frw:;' :mother SllU. One cannot speak of synergy unless the benefit of the first SoU is

greater tha:1 the loss of the second "51m, so that the overall net effect is positive.

H9re s;lccical1y. syncr3Y exists if over a certain period of time the performance of a diversified corporation is different from what the i;JVerage perfor;nnnce ot its (livisions would be 1£

they were ir,cc;:tende,H. busir.esses.

(1) - implying a net result which can he greater or smdller than

the

sum of the ports.

Schematicolly, in the case of a corp>')ration with two equally sized divisions, one may speak of synergy. i f

LA

+ LIl

LX

= ..- - - ­

(A,B) 2

•

where

LX - Performance of a c!:iversified corporation :x: with divisions A

and B (A,B).

LA - Perform,mce of the division A if i t was an independent business.

LB - Performance of the division B i f it was an independent business

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How can we demonstrate that the performance .'0£ a diversified

organization is be different from whClt the pt:!r'formance of its divisions would be- if, they were independent businesses?

Let's hypothE>size that an organization i.s speduHzeu in

market A at IT'.oment one, ;ind at mow_cnt . two, diver~Hies into

market E· (through internal development or Bquibition}. Th"

difference

between the organization at moment on£: UWl t .. "t) can bl!"

seen in:

1 -,VQlur.e - the organization at moment two has a greater sales

volume

2 - lliversity - tht) organization has no.... built diversity into its operations,

. If synergy exists it ~ust therefore be explained in terms of the consequences of th.e changes· in volu,l1l? and diversity

experie:1ced by the oT...I'!anization. Concerning the impact on "voluCk', can distinguish she effects {w:lich are a consequence of sales per year) frO'll ex?erience effects (which def,end on the cu:nul ati ve vol urne of sules).

Size and. experi.encc ef.fect~ will be observed as long as the organization (liversifies into related market::;, making possible

the shlflring of rt~sourc-e.s

_C.

warehouses, distribution systems, ­ mac.hinery, sales force etc.). ihese types of llffects: ('ould also

FIGURE ONE

1 reliance" on'

rreater

productivity

strengths . ~ ...

twer

training costs

'

~uanti

ty

di

scounts

.

2 input effects .. prl.ce

greater

bargaining power.••

~[tnOnopsony/oligopsony

shopping around

lknowledge/expertise

C

acc~5s

fco

py

rights

property rights' patents

ADVANTAGES • ~ "

..

_{, • f}

leases

l'

p>ubl1c goods ••

4

Lcrademarks

goodwill and

yisibility

[

'

geometric law

discontlnvities

4 economies of

machinery.

~

. . . .

w H

price

1 M ~

1\1ore operations are

mecanized

sea e

«-•

fixed costs ..•..••

~

•• (discontinvities in acessory resources)

t

i

5' low of qreat

SIZE

,..;

numbers •.••

~

... impact on inventory

costs

'"

6 k t (POli tical mark.et

~

mar e 'power.. larger sates

1

, .

[lOWer

threat

of bankruptcy

X

~tlP.tficlency

'!?oli tics - coalition formation

DISADVANTAGES • • • •

2 Higher transportation costs

3 More complex' information processing

4 Lower motivation

5 Antitrust threat/Consumer groups surveillance

6 Decision making problems

in

terms of:

{~~~i~iiy

occur in the_ organization if it chose to remain specialized and grow in a single market.

Diversity effects, on the other hrmct.· cun never he achieved within a sing:e mnrket. They re(',uire diver.sity within the organization in order to occur. gxar::ples are transfers of

know-how among clivision~. reciprocal buying (where a division induces a supJ!1ier to bt:y from another division of the S8r:le compa:1Y), interdivisional cash managcr:\(mt,· and the trans/Jort

of

image from one It.arket to another.

Since i t is tbe joint effect of si.ze~ expeHence and diversity which explaiqs synergy. we shall next analyze these three

effects in detail.

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III • I - SIZE SFFECTS

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Table one presents a typology of size effe(ts~ l;,1hen a firm diversifies, if i,ncreases its siz",. and conse'quently certain

advantages and d:isadv8fJt{1ges occur. He call both of these size

effects.

There are six main types of size advantage8: 0) reliance on strentghs. (2) inp',lt effects,(3) public gcoc.s,(4) econo;:lles of

scal~. (5) ti1e law of great nUl:'.bers and. (6) market power.

(l)Adam Smith. in bis work the

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ca lth of Nations". observed that the amount of sp0cializatv.m is limited by tte size of a market. The same happens inside or-ganizations. Contrar{ to smaller organizations where workers tend to perform a lu-:ger nu:uber of

tasks~ larger organizations allow for gr'1!Jter w-orker

specialization. Since speCialization ....ill be bd",CU upon the workersf strentghs. prod UC' ti vity w111 increase * Al so I due to

specialization. .. training are now

the tice and therefore the cost

}Q\.Jer

C

~obinson, 1978)

required fOT

(2) Size can also have a positive impact in terms of inputs. Larger firms pay lower price!l due to quantity discount$ from suppliers, greater ba'rgaining power due to monopsony. oligopsony. (lr the use of specialists in procuring various_

types of raw :rlaterials nnd If.et"chamlise. Shopping around is more feasible when bl.ying large rather than small quantities due to transaction CQsts~ lis a consequence, l~rgcr firms have greater access to suppliers.(Pfeffer and Salancikt 1978; Archer nnd

faerber, 1966 ).

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(3) Economists define puhlic goods (as opposed to private goods) as the ty?e of goods \':hich cJn b'e used. by one entity (person. division), without affecting the usage that another

entIty may make of the same goods.

Exampl~s of. public goods within organizapons are property rights (copyrights. pate:1L:,.. trademarkB, leaseholds) and the visibility or -goodwill

0::

the organization. Sinc.e the marginal cost of using these types of goods is zero, size will represont :a benefit here too.(Abell and !iar:r.1ond. 1979)

(4)

As

size increases, economies

of

scale occur. There

are

several reasons for this.

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(A) First, there is the geometric law which states that as the area ( of a bujlding, warehousL'. etc) doub"le-s, its volume

increases threefold. Since cost is related to the area and the output to volume. a net benefit occurs as size increases {!Ialdi ane i~'hitcomb-. 1967 ).

(B) The second cause of economies of' scalr~ refFlr(;s certain dis·:mtinuities between -cost and machinery ( Shephtf.r.:i. 1979); th.' price nf machinery increases less than propol'tio[,:"lly to its cap-acity (Scherer. 1979); and in larger orbanizat~ons it is economically conpensalor:l to mechanize SO':le operatior,s which are perfomed manually in smaller organizations (Pitts, 1986).

(C). Fixed costs are a third cause of economies of scale. h'ith higher volume, the cost per unit of production of

ancilatory' activities (such as security, medical department, food services, secretariill department. ~tc. ) decreases.

These fixed costs are called accountants as indir.~:.:t expenses~

(5) Another size advantage camps from the statistical law of great numbers. As the number of buyers increases their variances in tents of idyosi:Jcracies and special characteristics diCiinish. Lo.ler variance among buyers means lower variance of _sales. The probnbility of, stockoJt is consequently lO\t,'er. 111eaning

that costs of inventory will increHS~ less th;ln proportionallj to sales; (Whitin and PesLon, 1954 )_

(6) Harket power is a final advi:lntagt:: of size. Larger firms influence their enviroo'IJents to n gteat extent. They can influence both thei r politicol environment (throup.J luwer probaBty of bankruptcy-Dooley. 1969) and their economic environment (by l)ushilli! thc·ix products more strotlgly into the market a.nd by charging higher pri<:es fat the!'.l) ~ ,There is evidence tnat with all else equal t larg(-! firms benefit from a superior

image when compared to smaller fir;:,G a benefit which can be

translated into premium prices.(Cooper. J979).

Besides advantages, an increase in size can also bring some dlsadvantages'to organizations.

(1). Larger organ'izations experience a lower sense of the need to survive. The int.err.al environr.lent of the f'rg.n.nizatioll b02cwrt!$ 'increasingly ;>oHtic.81 as well (Blair. 1972. Towscnd. 1970). Consequently x -inefficiency arises ( Leibenstein, 1966).

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(2) Transportution costs tend to be higher for )arger firms since they must go farther to obtain rdW ;nateri;)~s: components, energy and labor (Scherer ct. l;ll. 1975).

(3) Size also means that information processing is increasingly conplex, requiring more elahorate infornation. control anJ structural Hrra:1gements~(Kotz and KBhn, 1978).

(4) Hotivation can be more difficult in lar'~f2'r· organizfltiol'3 because workers tend to identify and prefer tv wr:rk :in

slI'.aller work units (Porter and Lowler, 1965; Quinn Gnd ;'langione, 1913).

(5) . The greater visibihty ex[)erienced by larger organizations may put them under Special surveiLl<Jnce of (:oll$umer groups and under a hiSher threat of antitrust. It ca:-J therefore be said that a certain type o f ' risk increases :.,ilh size. ( Druckel'. 1973; Porter. 1.9(0).

(6) Finally, as firms grow, th hierarchy between decision makers and the market Decomes ::)Ore conplex. Doth the speed and the quality of decision maldng can, i.n Elccordnnce. suffer.

'(Starr, 1975; Williamsoll, J9(7)

The inflllcnce of both size advantages and disRdv.clntuges is a concave profitability (rettru cn aSbets) curve where profitability .first increases to 3 certain level <'lno then starts dQcrcnsing. Profi,tubility ir:crease!ct as 101;g <.IS the

advantl1ges of size out\·,eiBh its ;;!isadn'(ltages. After a certain level of si~e, however J th.e dismh'[mtages !:>tart incn:Msing and ­

the advantoges beeo!!:e exha'Jsted~

FIGURE TWO

r

r::::

efficiency 1

Learning

curve_~

•...

organization

ADVANTAGES • . • ••.

Z.

Better use "of equipment

3

Process

innovation

4

Product redesign

5

Image/Goodwill

.... :_.-,,-~

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EXPERIENCE

..

_~ Attachment to routines emphasis on hierarchy

DISADVANTAGES;

Lower adaptability ..•

The specific sha:;e of the concave profitability curve (the behaviour of 'its first and second d..,riv3tes), varies consicier.;J.bly from rr.arket to market depending upon tbe exte:1t of the presence

of

the size advantages and t1i5advan~a2es in those markets.

III. 2 - EXP~J\IEtlCE EFFEG'S

When diversifying into a new market, there is an increase in

sales per yearf as well as an incre41se in the cU:Julativ"e sales

volume of the oq,ani.zotion (experience effect). Experience has severa) advant3ges:(1)' the learning curvt;;(2) better use of equipment.(3)· process innovation.(4) prod::lct rr,odiHcations (better knowlEcg.e of how to adapt the product to customer nefds),

ami (5) bet-ter imc,.ge .(HeddJeYt 1976; Henderson, 1980t tho:npson,

1981).

Indeed, ceterjs paribus. older firms benefit from u better

image than younger ones~ since cusi::on:ers tend to nss0s-iate firms the age of a firm with survival of the fittest.

fIGOHF, T\-:O AB{)CT HER£

It has beer: point~d out that experience may also bring some

disadvantages. Indeed, as experience increaACS, the adnptnhility of 'the firci a~ a '..hole n:ay decrease. .\5 eXjler ience grows, organizations tcr:d to revelo!; stri(tcr routin~s, h; !:lOre attache,! to hiear'chical rC:!2tiofls and ~o be>'::o:ne less flexlhle (Blair~ 1972; Albernathy and \"'aync, 1974).

DIVERSITY r~,FECTS

Besides siz€ and ~xperience effects, there is a third type of effect which occt:rs ",:-:e:-, a firm diversifies. \,'p shall call this

type diversity effects. Diversity effects ar0 those which cannot be achieved by an increase in sales i:1 till:" sume product market cannot flchiev~. This distinguishes diversity effects from size a:1u exp€':rience effects which may occur both vith an increase in size in a sin3le Froduct 'Harket or with diversification (AS long as the markets which the fin:: diversifies into arc related, and therefore alJow for resource sharing, tnmsfer of knowJedge, and other benefits).

. FIGURE THREE

I

Lower personnel costs

1

Risk decreaSE!

j

Lower capital costs

(in terms of both\

critical .

~

..

~

..

_{Higher R&D benefit.}

contingencle,s and '-

"<

•

Hi9he~

motivation

variance)

Cross subsidization

-

Monetary· . .

~

•

~

_{Vertical integration related}

Reciprocal buying

2

Externalities.~~.~ L­

ADVANTAGES _~

...

m

Technolog1cal ••••

~(Transfer

of knowledge/Knowhow)

H

Consumption . . .

~ ~ranSfer

of

I~age

.

Costumers perception

..

High risk. R&D projects

3

Greater organi­

High risk business ventures

zat~onal

possi­

DIVERS.ITY

_bilities

. Access to retailers

1,

Specific to vertical

integration,(~ncrease

in'risk)

DISADVANTAGES ••••

Figure thtee Dtesents the advantages and the disad'vantoges of diversity. The advantages can he divided' into four main

cathegorie5~ .

(1) Risk rlecrease

(2) Externalities _•

(3) - Greater organizat.ional p{)ssibl~lities.

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FIGURE 'r.:REE ABOuT IiERE

(l) D~versity brings a decrease in risk in terms of both critical contingencies u:1d variance (AI~ihud and Lev,1981). Lower risk ... ill~ in -its turlJ, ir,iplles! •

A - lower personnel costs { workers can be transferred from

one SBU, fa another~ illstead of being hired and £:ired as each

divisions sales go up and down.)-i'lechlin. 1980.

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B - lower capital costs (being risk 3verst),,'invcstors demand lower interest from less risky firms)­

C - higher R ,&·li benefits (Te.rrYt 1981i Pitts, 1985) due: to!

higher probability that

Cl a given R&D project will bo useful to one of the di visions

C2 within the organization there is all the required knowledge to complete the R&D project

C3 - the' failure and success of projects will offset each other (lUI'J of Jarge nU;li>ers)am: therefore the organization can

undertake projects of higher risk.

D ~-It has also heen ~ointed out that to tho extent that

employees are transferred dffiong SBUs rather than hired and fired, their motivation level >lill increase.(tiechlin~ 1980)~

(2) The second type of diversity advantages are externalities. Economists u>?fine ext!?tnalities as the bencfi t of i3 second

party due to the wGrk of a first p3rty~ Inside Fin oTt;:anizl:'Ition .three types of externalities rnay occur! w~netary, technological

and consumption.

(:\) Honetary externalities result. from Ci'OSS subsidization

at:lQng SBUs (:ihplying tax adventdeeS 3n,_ JT<·nter fr~C'do1!1 to finance market share buiJ tHil!; as ccmvarct'

to

a situation where funds ....·ere su~plied by external sources) and vertical int0grvtion_ {lower transaction costs, savings tn energYl transportation and

distribution j et.c) - Kitching, 1974; ~inn and Hchagell~ 1981;

Harrigan, 1985.

(D) 'fechnologici:ll externalities regard the transfer, of :Zouw-how among

snus,

That know-how can respect to hoI<.' to set up a distri­ bution channel, how to train the sa10S fo!"cc j ?low tu advertise u

given product, hm. to Bolve a w8chine breakdm.n. which type of supplier is more reliablt' in terms of fluality I'md d~)ivery. etc.( Bere.1979; Yavi!::z, ~e\"man 1932 ).Techno1ogicdl cxter:-;a'.d-ties (yay

also involve a specific skUl of the l~6.D, engineering, manufactur lng or any other deP<lrtn:cnt \1hicn the orgBnization possesses, and which will be useful in the new market (h'clls.

1984).

ee)

Consu.~ptiQn (>xter::alHies nrc related' to' the market pL:.H::e.

They are lwither ~Lonet8ry in their cssenct:' 001: based in knQt.I-how.

Two main types of consumption externalities exist: transfer of image among SHUs (where

onc.snu

benefits fro,,, th~ image .another

sau

enjoys in the market) a:,d externalitius rc1<:.ted to consu21ers'

perceptions.(Lor~ng€, eLul. 1986; Hells, 1984) / ...

. .

­

Sometimes the cllstor1f'r perceives the product "purch;]sed 8S being larger than what,l& supplieu by an organizdtiof\. This leads firms to add net·! 'i

tems

to their product line so that the total offering is as brano as the C\l?ton~rsr perct:j)tion ·of the product. That' is the .paBon behind the broadennin::;. of thC" off(.'r of computer orga;)iz'Jtions, [ron hardware into service. software and cowlUlmicat.ions :,-etworks. .SimiLul y, auditing firms h:we diversified into bc~rvices suc::-, £is taxation, '-!cCotmting. management consultir:.g and managc~lent recrultin;;;.

(Hiles and Snm,', 1980).

(3) Finally a diversified orgiDnization can do thtn~;s that no speCialized organizat ion can without thrci.ltenning its very exist<lnce. Exr.Hnple:: are the engage;r.ent in high risk

rV:,;)

Vr:>jects

or business v(;,!lturt-;;. Another eXd::1ple is E'asier aeces;. to retailers when they prefer to deal with suppliers whi:::::' offer a broad line of products such as in the autonob1Je and the 2,fOcery products induEitry (Porter. JS~'~O e 1985). Still diver::>ified 'organizatiml;;" Cdn also impose rec-iprocd] lJuyin; ....here one 5!3U buys from;1 given Sll;'plier if 0"': only if the supplier burs froM another SElf of the same organization. (A))e!!. 1975; SLeiner. 1975).

Besides advantages, diversity can gIso bring two maio types of disadvantazes. So:ne di;;Ddvantagcs nre specific to vel:"tical

integration (higher risk duc to concentration of resources). Other disadvanta!'es o pertain to diversity - in Bene-ral. Since

diversity imp;les an increUBe,in infort:lf}tion processin2: needs, it

requires more cDmplex structure,. infor::<ation, control and coordinatioTi syste'l"S (Gn] braitn and :iathason. 1979; Hal'~brick 1983); rUII and H03kisson. J987).

It is the jQint. effect of size, experience and diversity which explains hCM the overall -perfoYnsnce af an ort:,anization can be different f:om the average performance a.f its division if they were independent 7lusinesses (tlwt is how synergy can occur).

Positive synergy will exist only i f a certain "\ divel'si f ieation move implies size I expcr ience and di versi t y advantages which outweisth their disadvantages. :;:egnUve synergy will exist whe:l. the advantages 3!?soc;i.ated with sizif. experience a'nd divers'ity are less i"IPOrt8:1t than their." f1isadynntages

111

Scheme _•

I.

, t'l-:rease {advantage

in size- disadvantages of size

diversificatio~ increase advantage of Level

(1) in ...

experience

.. of

experience { disadvantages Synergy

of

diversity

As a consequence~ the syperglstic potentiu] of any

diversificution tnove :lll1st De evaluated Oll a case by case basis by

assessing the extent of the size. 0xp!!rience and dh'Cfsity advantages and dis3Jvantagt's ihlplied by that diversification move

(Allen ct al. 1<)81; Salter o,.ci ~\Cin;'o\JJ 1981)

(1) means ~implies.

.FIGURE FOUR

SYllergy effect

,

"

,

,

v

.

I

~

o

1 2 N

N:;;;::::

Ditersi ty ano

volume level

• -I • , • , \ l , ._~

1

2

3

4

5

6

7

8

9

Y Number of markets

(di

visions)

NOTE: One assumes that:l - each diversification

st~p

(through'internal

development or acquisition)

..

leads to a new division specialized in a given market; 2 - each diversificatIon move brings

the

It is I?os$ible~ ho...evcr I to develop certain general rules

regarding synergy., The next section will present a model which in general tenr.s indicates when synergy

is

expected to be positive and large. positive sad low, and I~egative.

IV SY~JERGY

.Mill.

DIVEil.SIFiC,\:'10N

Let's suppose that an organization specialized in' a sing,le market starts a process of civersification Kllien over time* will lead the organization' to ado new market.s (through inten,:>l developnent or acquisition) to its operations.

We shall assume that each division handles £l single mar~et

and that consf''1uC''::t1Yt as the nutlDor of mark~':.s the orgadzation operates in increases, so does its number of divisions. For simplification purposes i t .will also be as",w:led that each new oorket (division) brings a similar amount of increase in diversity and volume (sdles) to the organizP-tion. FJnally. it is l1ypothesized that the organization does not function tiS a simple

holding~ buying and selling £inns which remain totally autonomous from each other.' but as an integrated e:otity where the heed office perfor;ns some functions for the divisions and there is an exchange of resources a~ong th~m.

The questicn is As the or9;anizatioll kee;>l:' on adding new markets (afld divisions) to i~s opt~rations. ~()W .'1hould we ex[,cct the overall organiz'J: 100 to perform conpDred to the overage performance of its divisions if th..ey were independent businesses?

Based on the model of synerg)" developed above and on the existant empirical evidence, one should expect the fo110\>l10g relationship should be expected between synergy find di yersification. sholJl d be expee ted.

(see figure fou~)

INSr::::T FIGi]~f. FOU;~ ABOU;' :mRE

The vertical axis of figure four represents the level of

synergy. tn3t is, the q'Jotient betv:een the ELlA or tbc diversified organization ancl the average of its divisions. The horizontal axis represents the dLversifitution process. ,,:here c~ch step in the process represents the introduction of a now market and ­

division to the realm of the organization.. For simplification reasons, one vssumes that the increase in volume and diversity implied by each new market division is bi;nilar.

As can be seen. the diagram has three nain zones. In the first zone, t.he SYIlC'rgy level is po.siti'le a:)(j increasing. in the secon.d

zone, synergy is decreasing, and in the third zon~. synergy is negative. yle will next expJain why one should expect a curve. of

such n shaVe in the diagram of synergy.

•

FIRST ZO:;E (Synergy positive and increasing).

Two reasons lead to expect that in the- early stages of a diversification _move (Jow level of size and div,.?rsity) synergy ...-ill be positive aoci incr('asfng~

First,

by

increasing

its total

voluMe

of sales

and

diversity? the corporation LS able to exploit

> the size, experience and diversity advantagqs which we~.e discllssed above.ObelL .. ) Since diversity is low, there is little difficulty in exploiting experience and size.' benefits. Low diversity (high relatedness) means that c-xperience and knm-:-how is transferable from'one'division to another. Quantity discounts occur because (li visions purchase the same type of inputs. Fixed costs are shared ;;::::lOng divisions. t;arer.\>uses harbour [)ro£:llcts

from various divisions, and so on,.(J\aker? i9'34; L~!.'ange et a1 1976) •

. Second, the disadvantages of size and diversity are expected to be relatively sinal I at this stage since as has been pointed out, -they tend to occur ot high levels of size and diversity.

(Scherer, .1979; Shepherd. 1979),

For these reasons i t should be expected that as firms

add volume and Jiversity to their operations. s;'aergy will

increase~

After a certain level of diversity and volume however, synergy

will

start decreasing.

seCOND ZOirE :Synergy positive and decreasing

Several reasons contribute to this. First as has bt>etl pointed out (Pfefier and Sal,;l:ncik, 1977) after a certain Jevel,

marginal increases in volume and diversity will brin:; diminishing returns (law of diminishin;t, ret;lrns): Savings in machinery hi1:1t; fixed costs become variable; the leArning ~urve frntt~urs;

augments b specialization bring no fur,thcr significunt benefit!:>; discontinuities in resources are exploited to their full extenL (3aio, 1954 :;:lnd 1956) 1:i:;h levell'> of diversity also mcan that the ilr1<:lgc, the knowhow cnd 'expcrtise and the in[1ucnc;c 'Jpon

the various stakeholders is now more difficult to transport from one

oi

vision to another. The consmler perceives the divisional products as iJJlrel{Jted and therefore he is less induced to buy one when he buys another of the same

organizatio~;

and so on.

(Tare,

1977;

Brock~

1975).

High levels of

diversity have

a

negative effect 00 the pos~ibility of exploiting site:e Hod experience benefits, High diversity (Low relatedness) among the narket ,,'hich the organizution is in, means that the divisiondJ inputs are dlfferent. Therefore. theft' is less room for quantity rli,sccounts. the activities of fewer departments car: be share:! 3hlOHg the divisions. maddnery differs from division to division. each divisio:l has its 0",'[1 learnIng curve, and so on • (Wells? 19H4;

Porter. 1987). .­

/'

/

!

Finally, at, high levels of volume and d'iversity, their disadvantages be~O)fle'l Significant. The complexity of the information processing requi.res e] aborate strut;.; tures ~

inforrJation, control and coordination systems (Hann<:ln and Freeman. 1977). Decision ::laking becomes slot.'er and its qual it Y

SUiftTS fror.: the ,":'l:nbcr of hicn:rchical layers belween decision

makers and the murkct;O':ilJi':L:lson, . Fn6). T:-Ie -orgdnizatioo

develops attachE',ent. to routines and hierarchy losing flexibiJ i ty (Albernathy and i>iclYflO, 1974). ::otivation is ::.lore difficult (Quir:fl end Nangione, 1973). the organization environment becol::es highly political and prone to the formati.on of coalitions (Tot.'send,

1970}.

THIRD Z():~E n<:fgative synergy .

Three reasons contribute to the existance of negative

< synergy.

At high levels of vQlume and diversity t e adv~otage

of size,

experience and diversity <re eXhclli.'::>tt'd or minimal du~~ to t.he 18\1

of diminishing retur:1S ( Rcbicson~ 1954; 13; int 1956).

Furtherl:!Ofe. as has hee:1 pointed out, ( Terry, 1981i Aaker j

1984; Porter, 1985)the advantuges 0': diversity beco!re

disadvantages. That is, both consunption and technQlogical positi.ve externallties may become neg?tive ~ externalities. For instance, the i:nage of one division may nann another division (e.g. pharmaceutical ;:-roducts and food, subcompacts and luxury cars, low price items and high quality products), ar.d the

experience and kno~~how of one narket may be pernicious when _• applied to another rl1ar~et. (1)

Third, since volume and diversity are now very large, their disArlvontoses prevail (x ir:eficiency. low motjvation~ decision making proble!r.s. cOr.lplex information and control s),stt,ms I

coalitio:1 :ormation for political purposes, etca).(Arrow, 1974j Williamson. 1975; A!drich~ 1950).

As a C'onscquenct? of the experience, size and diversity advantages being low and t!wir disadvfmtagcs being

importal1t, synergy can be expected to be negatiVE! (Scherer.

1986; Ansoff, 1984)

(1) In such a case tr.e best option for an organization is to

grant corr,plete autonomy to its divisions and achieve

_,

zero

( and not negative) synergy.

f

CONCLUSION

There has recently been a rene~~d interest in the concept

of synergy - to predict success in mer?,.Pts, and to advise ,.ihich

diversification strategies organizations shopld

follow. Tbis requires advancements in the exploration of the

concept of synergy. Such has been the purpose of thjs ortic] e.

The basic contributions of this articl~ can be summarized

as follows!

1 - There are lIot one, but three t:lain causes of synergy: . size, experience a:ld diversity effects. '\]1 three contribute to

the possibility that the pcrfQrmanct of n diversified corporation will be difl crent from the Plera;:;e performance of its divisions i f they were independent' bus .nesscs. That is. all three i:nply the possibility that a diver ;ificatiun r:1()ve

creates econo~ic

value.

2 - Size and experience advnntages can be culled by an o'rganization either throllgh spc<:ializa~ion in a single pr.oduct market or by related diversification. Diversity advantages are those lhhich only diversity among If'..drkets can bring about.

3 - There are several types of size, experience and diversity effects. It is the level of thelr presence when an organization diversifies inLo a new market w~)ich '.dll determine the amount of sYj-lergy tbat will' be created. As a consequence, the synergistic potenlinl of <l diversification move must be evaluated

on a case by case basis.

4 - It is possible however. to develop certi::1in general rules regardine synergy. Based on the caus.es <;>f synergy and its behaviQr as a function of slze j experience and divcrsity, it can

be expected th:it ~s 'nn organization st;;Jrt.s <1 -diversification

process. the amOU:lt of synergy will first increase, then

decrease alld f i noll y be zero ~

4'

5

- Resour::e s!turing. arid synergy are not synony[l:ou$~

Resource sharing is only one oE the causes of synergy, the others

being:

_-

,

risk decreasals ( vhich dim'tnishs personna], capital and

R&D costs. "

an increase in the orga:1izatiofl" s possi bilities (in terms of market power. accest; to rQtai]er.s~ etc).

input ef[ -'-cts (lo~/eL price, ]O\ver tran.sportut.lon costs,

etc)~

higher productivity of the r<)SOUrCi;$ due to employees' specialization und learning, mechanization of activities and the geometric Jaw.

6 - There can be t.hree basic categories of resource sharing; Public resourcC's (leases, patents, imnge and

visibility of the organiZ3tion as a whole) half public resources (implyinG technologL:al, cOrlsu!::ption and ;notletary external Hies) - o.nd private resources (such as machinery I

warehouses, sales force, trucks. etc.).

7 - Last, at high levels of diversity ,:m:1 vol ume. the d1sadvantGses of sizl.!t experience and diversity vill prevail over their 8dvantages~ Consequently, syt1ergy ~ill be neg;ltive.

In such a

CUSE.

the best option for ao orgaoizatioo woald

be

to give complett? autonomy to its div:islons. and by becoming a

pure holding, ilchicVQ

zero level

of

synergy.

,,­

/

!

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l!l

Action, Free

Press, New York.

.I'

,

/

LIST!;,

DOS

ULTIMO;; WO?J:ING P6l:ERo

n'

62 - BAROS", Jose Pedro:

"Technioal

Progress,

Wages

and

Emploment

~n

a Contraotual Eoonomy

w~th

Inoomplete

lnformatlon". (Ag06to,

1986).

n'

63 - BALEIHAS,

Rui

Nuno: "FunQaes

d.

Produoilo

Enoadeadas

para ..

Industria TransformdQra

Portugueca", (Feverelro"

1966) .

n'

64 - NUNES,

Luis

Catela:

"0

Consumo

de

Energia

Para

Usos

Domestioo6 em

Portugal:

Uma

AphoaQao da FU~Qao

Trans log" . (OUtubro, 1986).

n'

65 - MACEDO,

Jorge. Braga

de:

"Lo

Portugal

et

L'

Europe :

La Trantntlon

la Plus Longue", (Abrll,

1987),

n~ 66 - LUZ. Silvia ¥.ar~a Dias: "Merca:lo de Futuros e Establl1'ZZlcao

de Precos;

Introduq~o

a Literatura",

(Novembro.

1186). ..

.

n'

67 - BARCIA,

Paulo e

COELlIO,

J. Dia8: "Constructive

Dual Methods

for

Nonlinear

Disorete

Programming

Problems" .

(Haio,' 1987).

'. nt

_{6S - LEITE,}

Ant6n~o

P.

M,: ,"Prio:lpg of Network Systems and

Consumption

Extern.liUe.". (Junho,

1957),

,/

n' 69 -ABREU, Orlando

Crespo:

"Ajustamentos Salariais". (Maio,1981)

n~

_{70 - LUCENA,}

Diogo : ~Environment Monitoring and Organization

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,

nO

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1 Diogo ; "Environment Monitoring

and

t"':rganization

Struoture

II".

(Setembro. 1997).

ANTUNES,

Antonio

Pa,. e

GASPiIH, Vitor " Trib1.ltZly ao •

InoentlvoB e InveetimentOB: Analise

OUalitativa" .

tNovembro. 1987).

•

.

n' 74 - BAROSA,

JOG$ Pedro: "OptJ.ICal Wage RigldJ.ty· A Suggested Methodology to Test the Theory and an

Applicatlon".

(OUtubro. 1987).

n' 75 - CABRAL,

L, M. B.: "Three

Notes

on Symmetrio Games

,nth

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(Novembro,

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nt

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Oualguer inforrt..lc~o scbre os Working P:t;a:rs j£\ pub1ic-ados

s,era

prestada palo Secretarl&do de

Apo~o

aos Docentes, podendo os mesmOB

ser adquiridos na Seot;';'~o de Ven:J::..s cia faculdade de Econcela. UNL.