Source of Synergy
Tax benefits are not a factor in this scenario since both firms are assumed to be in the same tax category and both operating with positive incomes. The other potential synergies are cost and growth. In examining the potential for cost savings, consider the existing cost of sales for General Foods, Phillip Morris' food division. According to financial summaries provided, their cost of goods sold was 94% - not too far off from Kraft's 93%. Since General Foods only accounts for 36% of the Phillip Morris business mix, the potential gains are minimal. Another reason for discounting any potential cost synergies, however na�ve it may be, is the comment by Phillip Morris' CEO that Kraft would remain wholly intact as its own business unit.
Growth, on the other hand is a potentially valuable synergy. In light of the growth assumptions above, it appears that Phillip Morris sees growth in the tobacco industry trailing off in the long term. On the other hand, strong firms in the food market, such as Kraft, appear to have a bright future - particularly in the immediate future. Given the fact that Phillip Morris is already diversified, in that it owns General Foods, growth synergies appear to be a leading motivator in the bid for Kraft. By acquiring Kraft, Phillip Morris in effect buys growth. That said: forecasted growth of the combined firm is anticipated to be greater than the weighted average of the sums of the two individual firms' growths. This is the fundamental idea behind valuing synergy.