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Divestment Strategy

Divestment Strategy

Divestment Strategy

‘Divestment’ or ‘Diverstiture’ strategy is quite opposite to expansion strategy because it involves selling off or liquidation of part of SBITs by the corporate office. It is a strategy of shedding business units or product division or segments of business operations to redeploy the resources so released for other more promising purposes.

The most common forms of divestment are- (i) Selling off a business segment or a product division to another company, (ii) Giving up control over a unit of business or businesses to the holding or subsidiary company.

Though divestment of a business unit or subsidiary by one company may be compared with acquisition of a unit divested by another firm, it is not fair and correct to take divestment and acquisition as one and the same.

Why Divestment Strategy?

The happenings in the life of a firm that make it to gain for divestment strategy. At times, it is an unavoidable decision even when the firm is still alive and kicking. The rationale of divestment strategy is not to allow any unit or segment as a drag on the entire profitability of the organisation especially when opportunities of alternative investments persist.

That is, divestment is a sensible positive decision and not a decision resulting from hopeless and helpless situation where the decision is thrust upon.

Strategists accept divestment strategy as deliberate one for the reasons given below:

  1. To Better Utilise the Resources Available:

    An organisation may have pretty good competitive position and satisfactory earnings in a product market. However, there is need for deployment resources may be financial, technical, managerial, which is present by its absence.

This situation warrants the appropriate strategy to divest or withdraw from vulnerable segment for better utilisation of available resources in some other promising product market.

  1. To Write Off the Acquisition Hidden Losses:

    Whenever the firm acquires another business or the assets in part, the firm has to accept the good assets along with some unwanted or bad assets hidden in the package. It is these unwanted assets or unwanted operations of acquired business are to be sold off at reasonable prices to recover the cost of acquisition cost.

This is a very common practice which one will have to accept. The firm is forced to sell this on the grounds of technology gap, wear and tear, high cost of operating on them, high cost of maintenance and so on. Once for all, it is worthwhile to dispose them and get hard cash which can be better utilised in operations of future.

  1. To Turn Promises into Performance:

    It is quite possible that the actual performance remains far from promises or prospects of a firm or its subsidiary because of unexpected emergence of very strong competitors, the operating costs rise and demand for products fall as competed away by the competitors. In this situation it is worthwhile to go in for divestment strategy to save the skin.

Take the case of Tata’s and HLL. The decade 1991-2000 was the decade of competition for many businesses in India. In cosmetics business, the competition was intense and got global because of globalisation. Being in cosmetics, foreign products could still be imported only through the special import license route, competition from foreign brands had already in Indian markets through joint ventures between MNCs and Indian firms. Tata’s as seasoned industrialists felt that this trend was to get still stronger and even well-established Indian brands like Lakme, would have their going tough. If Lakme were to survive, it were to be backed by big spending on research and development and advertising expenses to be shot up the Lakme unit not to lose its staying power. Unfortunately the Lakme lost power in short-run leaving aside long-run period.

Tata’s judgment was that to sustain the business which had by then become a joint venture, both partners would have been required to make huge fresh investments for brand building, new product development and landing of new brands.

Tata’s felt that the investment needed would keep rising year by year over the medium term. Hence, it was not advisable. On the contrary, HLL thought the proposal was worthwhile over the long term. With its advantage of synergy the business would generate more synergy for HLL- product folio or product portfolio. Again HLL had the much needed marketing Savvy. Having Lakme in control, it dashed to invest and gain.

In 1970’s the General Electric Corporation (GEC) and Radio Corporation of America (RCA) decided to withdraw from the US computer market as they were unable to cope with the fast changing technology and markets, and in particular, competition from International Business Machines (IBM).

  1. Firm’s Individual Size-A Mismatch:

    Taking the scale of operation of some of the units, as compared to total operations of the firm and relative markets, may be small part of the enterprise activities. At the same time, they involve disproportionately very large managerial efforts. It may also be true that the prospect of increased profit may be limited by units’ market share.

This mismatch is to be adjusted. Either the small contribution of those units must be enlarged so that additional efforts put in will be perfectly matched. This calls for either to do away with such units by divesting or increase their capacity so that the efforts put in tally with the scale. This also calls for investment though diverstitute attempts.

Say a firm has some business units producing 3,00,000 kilos of double refined oil, but the requirement of market is 30,00,000 kilograms. The firm is using the services of marketing personnel which will easily handle up to 30,00,000 kilograms.

It means that the firm is using ten times more on marketing people. If the prospect are not encouraging, the production facilities for 3,00,000 kilograms may be scraped and the resources may be used to go in for more promising lines say ‘ghee’ in place of double refined oil.

  1. To Streamline the Product Port-Folio :

    There are firms which are multi-product and multi-division firms producing traditional products side by side the modern products that have better sales helping in increase in market share. In case these traditional products and activities, can be discarded and the resources can be used in updating the new warranted products folio.

That is, the resources so for used in making low growth and low profit yielding markets, can be withdrawn and better utilized in high growth and high profit yielding products that hold better future prospects. It is the divestment policy which enables the firm to reposition-the products in markets. Thus, both short-run and long-run prospects are well protected.

  1. To Simplify the Range of Enterprise Activities:

    A firm which has diversified into new products and markets much beyond the point of viability, a strategic review or reassessment of the quality and the extent of business diversity, will reveal a strong case for simplification. In case of say, Britannia Biscuit Company, it produces, at present, more 100 varieties of biscuits.

Experts of the firm in the field of marketing, say that 40 percent of the biscuits are not wanted by the markets. In such a case, divestment strategy allows the Britannia Company to divest investment in production, and marketing efforts–so that the same can be used to enhance the output and sale of 60 percent. Too many products in the market lead to utter confusion. This confusion can be clearly wiped off for future better performance.

  1. To Manage Financial Crises:

    At times, the firm may be facing acute financial crises warranting immediate liquidation as a last resort, use the very existence and survival of the company is threatened. In such case, divestment is the only strategy.

Hence, the immediate problem of the firm is to divest those operations responsible for deterring usual cash inflows whereby the firm can deploy the resources in core areas of business or meet the financial liquidity position.

This liquidity position has come in the way of even in case of very strict and highly disciplined companies of the world, and here India. There are many companies which have not been able to pay electricity bill though fixed and current assets are running in lakhs and crores of rupees.

It is because, a company which is after high rate of profitability has to sacrifice to a certain extent liquidity. Those who prefer high rate of liquidity, are to be happy with comparatively low profitability.

In the final analysis, it can be said that divestment is a rare strategy as compared to acquisition and mergers. It is because divestment is an irreversible decision in so far as the divesting firm is concerned. A firm after having divested does no go in for acquiring it again.

However, acquisition of a business can be reversed by means of divestment. Still another reason for infrequency of divestment that it is more perceived as a mark of failure though it may not be necessarily so. It is not an open decision as such decision, often, hurts the people of the enterprise emotionally as it is an expression of a failure-a mistaken judgment, broken commitment or incompetence of people associated with it.

It is more viewed as a negative strategy and decision to divest is delayed too much is allowed to be executed by the less senior officers of the unit. To be effective, divestment should be carried out in manner and time to realise the maximum value from divestment and to see that replacement investment is worth doing so.

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