SynergyWhat is it? Is it a factor in determining brand value?

1
Samuel J. Kursh, D.B.A.
March 2009
Working PaperNot for Quotation Without Permission
Almost every week I read about the importance of synergies in valuing beer
brands or beer distributorships. Perhaps Im a little slow. But frankly, I find the
concept quite difficult to reconcile with available wholesaler financial data or
practical economics. Further, when fair market value is the benchmark, valuing
synergies has little support in the law.
Synergy is a simple conceptthe whole is worth more than the sum of its
parts. Somehow, the theory goes, combining two companies will result in a third that
is more efficient than either of the original two. Synergies are usually classified as
operating or financial. Operating synergies result from combining operations and
achieving lower costs per unit of output usually through the saving of fixed expenses.
Warehouse facilities, salaried sales, delivery and administrative efforts are shared,
thereby reducing the fixed cost component of the cost per unit of output. Indeed, the
common breakeven model which has baffled many freshmen in first semester micro
economics illustrates exactly this point: If certain costs remain fixed and marginal
revenue per unit sold exceeds variable costs incurred per unit, profits increase as
output increases.
How the potential for operating synergies affects the value of the beer
ownership interest being sold is not clear. Even if the purchaser believes they can
operate more efficiently than the seller, I cant find any dominant economic logic to
support the purchaser beneficently sharing the value of those more efficient
operations and presumably, higher profits, with the seller.2
1

The author thanks Drew Jaglom of Tannenbaum Helpern Syracuse & Hirschtritt, LLP for his insightful
comments. The views expressed herein are solely those of the author.
2
Behavioral economists may argue that the emotional decision to sell or buy a brand affects its price and
can motivate a buyer/seller to share synergies with the seller/buyer. When non economic considerations

Financial synergies include access to larger amounts of capital and/or access

to less expensive capital. This does not appear to be relevant to the sale of
distributors or distribution rights since the industry is not highly leveraged.
Moreover, since there are no public companies in the beer distribution space, each
individual companys debt and equity relationship is determined by the risk profile of
ownership and not by overall market pressures. While certainly a topic for another
paper, it is my opinion that equity rates of return are the appropriate measurement of
risk in the business of beer wholesaling, not a weighted average cost of capital based
on ownerships appetite or aversion for risk. If the current financial crisis tells us
nothing else, we certainly can agree that the fact a lender is willing to lend money
does not prove the soundness of the risk being accepted.
The typical beer wholesaler sells one of the major brands, Anheuser-Busch,
Miller and/or Coors supplemented by multiple smaller brandscrafts and/or
imports.3 Without the distribution rights to the major brand, it is likely that the
wholesaler cannot survive.4 Typically, the sale of a major brand reflects
consolidation of distributor territories by the brewer. Consolidation is said to
improve efficiency and reduce costs. The question is for whom: the brewer or the
consolidating distributor?
From all accounts, brewers have operational synergies to gain by reducing the
number of customers while still maintaining sales volume. For the consolidating
distributor, operating synergies can only exist if excess capacity is available. With
excess capacity, the consolidating distributor can increase output while incurring
lower operating costs than the seller. Whether this true is a matter for case by case
(no pun intended) analysis. A twenty thousand foot view of the data, however, does
not generally support the existence of operating synergies.

are factored into the price, the result is investment value, the value to a particular person or group and not
fair market value. As always, one must carefully distinguish between price and value.
3
These smaller brands are often referred to as marginal brands. Marginal brands can be quite small, e.g.
less than 1000 cases or, in some instances, over 500,000 cases. The comments in this paper are directed
toward the larger selling marginal brands.
4
Accountant prepared financial statements will often include a note to the effect that there would be a
material adverse effect on the company if the major brand distribution agreement were to be canceled. The
note may go further and postulate that without the major brand, the company could not continue as a going
concern.

For Pre-Sell and Tel-Sell wholesalers median per case cost of selling,
delivery, warehouse and administration increases as sales volume increases.5
Economists refer to this type of revenue-cost behavior as decreasing returns to scale.
That is, increases in output (marginal revenue) are accompanied by larger increases in
per unit costs (marginal costs). Or, in simpler form: counter to the conventional
wisdom, distributors apparently become less efficient as they get bigger.6
Basic microeconomic reasoning concludes that in order to maximize profits,
firms will expand until marginal revenue is equal to marginal cost. In practical terms,
larger distributors make more money because they sell more cases, not because they
make more money per case sold. This is the economic explanation for consolidation
and expansion from the distributors view point, even if it doesnt reflect operating
synergies.7 The table below illustrates typical wholesaler operating data from the
Distributor Productivity Report published by the National Association of Beer
Wholesalers.8

2007 NBWA Distributor Productivity Survey. p. 108.

In dollar terms, they may make more money. This is more a function of increased case volume than
reduced costs per unit.
7
To be sure, all distributors would like to have the rapid growth marginal brand. The growing niche
nature of the industry, however, may create situations where distributors will have to make a choice: sell
the marginal brand or the niche brand from the major supplier. One might argue that the recent success of
the lime flavored offerings of the major brewers is a result of pirated market share from similarly
perceived marginal brand offerings.
8
Data shown is for Pre-Sell and Tell-Sell wholesalers. Combination wholesaler data exhibits the same
pattern of increasing cost per case equivalent as volume increases.
6

Pre-Sell and Tell-Sell Distributor Sales Volume $ and Cost per CE

Less than $20

$20 to $35

$35 to $60

Over $60

million

million

million

million

$13,214

$25,956

$46,500

$94,798

1,047

1,914

3,135

6,558

Sales Department

1.07

1.14

1.18

1.15

Delivery Department

.65

.66

.70

.66

Warehouse Department

.44

.47

.52

.53

Administrative Department

.51

.50

.47

.44

$ 2.67

$ 2.77

$ 2.87

$ 2.78

Revenue Category
Average Net Sales (000)
Annual Case Equiv. (000)
Expense Category9

Total Per Case Costs

Across the NBWA size categories, the median average total per case cost
increases as sales volume increases.10 For the first three size categories the addition
of approximately one million cases does not result in increased operating efficiencies.
Comparing the largest two revenue categories, even essentially doubling the number
of cases only reduces per case cost to the mid point of previous levels. This would be
indicative of the absence of synergies.11 Second, given the relative stability of costs,
one can infer that the median wholesaler in each group operates at reasonable
capacity utilization rates. Therefore, the ability to reap benefits from reduced costs
associated with increased volumes appears quite limited. Finally, average cost per
case is approximately constant or increasing as volume increases. The incremental
per case cost of adding quantity is at least as large as the average per case cost
incurred at lower volumes.

Costs shown are exclusive of depreciation and executive payroll.

The predictable exception being administrative costs.
11
To be fair, these data do not illustrate changes in expenses within the size categories. It is possible that
wholesalers within a category can exhibit economies of scale as they expand within their unique capacity
limitations. To my knowledge, there has been no empirical analysis of this issue.
10

Given this high level view of distributor operations, it is difficult to

quantitatively support the existence of operating synergies. However, for the
purposes of discussion, lets assume a detailed analysis of the transaction was
performed and indicated the acquiring company could reap the benefits from
operational synergies. As a matter of proper valuation theory and practice, they
would not be considered in determining the fair market value. With few exceptions,
the determination of fair market value does not consider operational or financial
events potentially occurring after the valuation date. Since the benefits of operating
synergies occur after the valuation date (If at all, and with what integration costs?),
they are not considered. As of the valuation date, their realization is speculative. If
they were assumed to exist, however, they would be subject to greater risk than cash
flows in general and require a separate and higher discount rate. It is interesting to
note that research on public market transactions indicates that synergistic buyers,
those in the same industry as the seller, do not pay higher acquisition prices than pure
financial buyers. This research observation is consistent with economic reasoning
which provides no answer as to why a purchaser would pay more to a seller because
the purchaser has unique qualities which may increase cash flow from the purchased
asset. It also is consistent with the definition of fair market value which presumes
hypothetical buyers and sellers, each having access to relevant information and
neither under compulsion to act.12 The hypothetical buyer and seller are assumed to
be acting by purely market supported financial motives, not the motives of an
individual, specific buyer or seller. When individual transaction participant
motivations are considered, the resulting value is investment value, not fair market
value. Since virtually all of the statutes governing transactions of beer distributors or
beer brand rights contain a fair market value standard, it is inappropriate to consider
the buyers potential synergies in determining value.
12

Some readers are no doubt thinking, No compulsion to act..This cant apply to beer brand values.
We were not willing to sell...The brewer made us do it. From my research and experience there does
not appear to be a difference between values of brands sold under brewer encouragement or those sold
simply as a business decisions. I also observe that virtually all brewer/distributor contracts impose a fair
market value standard in the event the brewer decides to buy back the brand rights. One can logically
conclude that a stated standard would set the floor (and perhaps, the ceiling) for any transaction and any
distributor selling (buying) brand rights for less (more) than fair market value would be behaving
irrationally.

Surprisingly, at least with the sale of marginal brands, the sellers synergies
are a factor in determining value. Economic and financial theory tells us that a
rational seller will engage in a transfer of assets if the proceeds received exceed the
future benefits of ownership. By extension, a buyer will only pay less than the
benefits of ownership to be gained by acquisition.
The general model for determining the value of a marginal brand is to
calculate the present value of lost cash flows associated with the sale of the brand.
Cash flow is defined as the difference between brand revenue and incremental costs
incurred to sell, deliver, market, warehouse and administer the brand.13 By only
considering incremental costs and not offsetting revenues by total allocated costs,
brand cash flows are larger, increasing the calculated value of the brand.14 Using
incremental costs effectively recognizes, but does not charge, for other valuable
distributor assets such as assembled work force, customer list, delivery fleet,
warehousing and, most importantly, other brand rights. If, as discussed above, the
typical distributor has a major brand and additional minor brands, the value of the
minor brands is enhanced by using minor brand incremental cost as the offset to
minor brand revenues. In other words, by using incremental cost as opposed to fully
allocated costs, the distributor is receiving compensation for the unique set of
attributes ownedthe synergies provided.
These synergies, however, do not affect the fair market value or the price at
which a brand will change owners. All distributors have the same basic set of assets:
assembled work force, delivery fleet, and other major brand rights with similar
market penetration.15 It is difficult to differentiate the assembled assets of one
distributor versus another. The A-B distributor may have an average drop size of 50

13

Incremental costs are those costs which are directly affected by changes in volume. Typically, they
include sales commissions but not sales salaries, delivery commissions but not delivery salaries, etc. Rent,
trucking cost, and administrative costs are considered fixed and generally not included in incremental costs.
As the time period of analysis expands, however, the character of costs can change. For example, if the
sale of a brand results in a consolidation of delivery routes, the number of delivery vehicles required would
be reduced. Leasing commitments may make this difficult in the short run but cash flows at lease
expiration date would reflect the reduction in delivery fleet costs. Similarly, high projected brand growth
rates may increase delivery fleet or warehouse requirements and necessitate an adjustment to cash flows
reflecting the need for expanded facilities.
14
The NBWA costs discussed previously are median costs and represent fully allocated costs.
15
As measured by points of sale.

percent more than the Miller/Coors distributor, but they both generally serve the same
customers.
Why then is there debate about the value of brand? Its probably the old
adageit depends whether you are buying or selling. Differences in value exist
because of different buyer/seller perceptions of brand growth and risks associated
with that projected growth. Actual major brand transactions are at comparatively
lesser per case values due to agreed upon limited growth horizons, somewhat offset
by higher predictability of cash flows and the recognition of the cost structure
necessary to successfully serve the market. Similarly, relatively higher values for
marginal brands can be attributed to higher potential growth rates muted by
recognition of higher risks and the recognition that the actual costs of brand
marketing are subsidized by a distributors major brand.
While perceived synergy may be an important motivator for the buyer, I cant
find any basis in practical economics or accepted valuation practices to consider their
anticipated contribution to fair market value.