Retrenchment Strategy

Retrenchment Strategy- Meaning & Types

Meaning of Retrenchment Strategy

In simple terms, a retrenchment strategy involves the abandonment of those products or services, which are no longer profitable for the organization. It also includes withdrawal of the business from those markets where even sustenance is difficult. For example, a corporate hospital may decide to focus only on specialized treatments, and thus, realize higher revenues.

Besides, a retrenchment strategy also results in reduction of the number of employees, and sale of assets associated with discontinued product or service line.

At other times, it involves restructuring of debt through bankruptcy proceedings; and in most extreme cases, liquidation of the firm. Retrenchment strategy is a corporate level strategy that aims to reduce the size or diversity of organizational operations. At times, it also becomes a means to ensure an organization’s financial stability. This is done by reducing the expenditure. A retrenchment strategy is a design to fortify an organization’s basic distinctive competence.

In simple terms, a retrenchment strategy involves the abandonment of those products or services, which are no longer profitable for the organization. It also includes withdrawal of the business from those markets where even sustenance is difficult. For example, a corporate hospital may decide to focus only on specialized treatments, and thus, realize higher revenues.

Besides, a retrenchment strategy also results in reduction of the number of employees, and sale of assets associated with discontinued product or service line. At other times, it involves restructuring of debt through bankruptcy proceedings; and in most extreme cases, liquidation of the firm.

A retrenchment strategy aims at the contraction of organization’s areas and the steps to resolve them. This strategy is adopted when an activities to improve performance. It is implemented to find out the problem organization suffers continuous losses. Organizations follow a retrenchment strategy for various reasons.

These include, divesting a business, or the strategic mismatch of a particular business with an organization’s core business. In addition, a retrenchment strategy is also followed when a particular business is so small that it does not make any sizable contribution to the total earnings of the organization.

Types of Retrenchment Strategy

Some of the types of retrenchment strategies are:-

  1. Turnaround:

The term ‘turnaround’ refers to the measures which reverse the negative trends in the performance indicators of the company. It refers to the management measures which turn a sick company back to a healthy one or those measures which reverse the deteriorating trends of performance indicators such as falling market share, falling sales, decreasing profitability, increase in costs, worsening debt equity ratio. getting negative cash flow, severe working capital problems etc. The strategies adopted to come out of crisis vary from case to case and from company to company.

Generally, the turnaround strategy emphasizes on improving internal efficiency and a failing company can be nursed back to health through any of the following or combination of efforts:

(a) Reducing costs may involve:
  • Layoff or downsizing of personnel
  • Strict control on general and administration overhead
  • Elimination of non-value added functions and activities
  • Modernization of equipment to reduce production costs
  • Reduce finance charges through opting low cost debt etc.
(b) Increasing revenue through:
  • Better inventory management
  • Improve the debtors collection efficiency and reduce collection period
  • Profitable investment of surplus cash and cash equivalents
  • Reduction of selling price to increase sales volume
  • Adopt innovative advertising and sales promotion methods
  • Improve after sales service
  • Enhance customer satisfaction etc.
(c) Reducing investment in assets:
  • Sell-off idle assets not contributing company’s profitability
  • Efficient use of existing plant and machinery
  • Modernization and up gradation of technology to reduce production cost
  • Adopt efficient material handling equipment
  • Invest in equipment to remove production bottlenecks
  • Improve assets turnover ratio
(d) Revision of strategy which may involve:
  • Shifting to new competitive approach to rebuild market position
  • Identify and concentrate on activities relating to core competency
  • Withdraw products and segments which are no longer profitable
  • Analyse the market environment and strategies of the competitors
  • Reorganize marketing channels
  • Penetrate into new markets
  • Establish brand image and brand equity
  • Reduce various inefficient operations and rigidities
  • Develop proactive strategies so that it could respond to the rapid changes taking place in external environment
  • Improve performance and avail new opportunities
  • Utilize the advantages of takeover/merger moves
  • Change in top management
  • Initial credibility building
  • Neutralizing external pressures
  • Bring crisis situation into control
  • Identifying quick payoff activities
  • Centralized management control
  • Better information systems
  • Engagement of services of specialist and experienced personnel
  • Better internal coordination etc.

Before evolving turnaround strategy accurate diagnoses of a distressed company’s situation and decisive actions to resolve the problem in it is needed. The various factors that influence the turnaround strategies are the management, human resources, production, finance, product mix modification, marketing and others.

  1. Divestiture :

In divestitures, the company who has acquired assets and division will make an examination to determine whether the assets or divisions into overall corporate strategy in value maximization. If it does not serve the purpose, such assets or divisions are hived-off.

Selling a division or part of an organization is called ‘divestiture. It is, often used to raise capital for further strategic acquisitions or investments. It is also used rid business units that are unprofitable.

F.R. David has suggested six guidelines for when divestiture maybe used as an effective strategy to pursue:

  • When an organization has pursued a retrenchment strategy and failed to accomplish needed improvements.
  • When a division needs more resources to be competitive than the company can provide.
  • When a division is responsible for an organization’s overall poor performance.
  • When a division is a misfit with the rest of an organization; this can result from radically different markets, customers, managers, employees, values or needs.
  • When a large amount of cash is needed quickly and cannot be obtained reasonably from other sources.
  • When government anti-trust action threatens an organization.

Divestment’ means pulling out of market. This strategy is followed when activity still continues although at a reduced scale. A company can maximize its net investment recovery from a business by selling it early before the industry enters into a steep decline. Divestment could be selling off a part of a firm’s operations or pulling out of certain product – market areas.

A company may like to resort to this strategic option when it desires to release its liquid resources. Divestment may be considered attractive when present worth of expected earnings is less than its present worth. The success of this strategy depends on the ability of the company to spot an industry decline before it becomes serious and sells out while the company’s assets are still valued by others.

When the firm does not have strengths relative to competitors, the best strategy for the firm might be to exit the industry. This strategy is used in declining industries where a firm exits the industry before other firms realize that the industry is in a long-term decline.

Types of Divestment

The three fundamental types of divestment are as follows:

i. Sell-off Hive-off:

In a strategic planning process, a company can take decision to concentrate on core business activities by selling off the non-core business divisions.

A sell-off is a sale of part of the organization to a third party in the following circumstances:

  • To come out of shortage of cash and serve liquidity problems
  • To concentrate on core business activities.
  • To protect the firm from takeover activities by selling-off the desirable division to the bidder
  • To improve the profitability of the firm by selling-off loss-making divisions
  • To increase the efficiency of men, machines and money
  • To facilitate the promising activities with enough funds by sell-off non-performing assets
  • To reduce the business risk by selling-off the high risk activities
ii. Spin-off:

A spin-off is adopted as a business strategy to separate business which doesn’t comfortably merge with each other. Two businesses may have different strategies, operational or regulatory needs which are difficult to fulfill while they are still linked. They may even be competing with each other for business.

A spin-off is a form of reorganization where business activities owned by one company are separated out into several companies. By demerging the business activities, a corporate body splits into two or more corporate bodies with separation of management and accountability. The main reason may be for making each division as a profit centered organization to make each head of the division to account for profitability of their respective divisions.

iii. Split-off:

By contrast a split-off is a divorce of two approximately equal-sized business units or divisions. Once share ownership is shuffled the two units do separate businesses.

  1. Liquidation:

A business may go into decline when losses are made over several years. The losses are setoff against past profits retained in the business (reserves), but clearly the situation cannot continue for very long. In such case liquidation may be imminent.

In case of technological obsolescence, lack of market for the company’s products, financial losses, cash shortages, lack of managerial skills, the owners may decide to liquidate the business to stop further aggravation of losses. With a strategic motive also, a business unit may be liquidated. This strategic option is exercised in a situation where the firm finds the business as unattractive to revive the firm.

Liquidation involves the selling of the entire operation. Selling all of a company’s assets, in parts, for their tangible worth is called ‘liquidation”. In liquidation, the owner’s interests are better served than in an inevitable bankruptcy.

F.R. David has suggested three guidelines for when liquidation may be an especially effective strategy to pursue are:

  • When an organization has pursued both a retrenchment strategy and a divestiture strategy, and neither has been successful.
  • When an organization’s only alternative is bankruptcy.

Liquidation represents an orderly and planned means of obtaining the greatest possible cash for an organization’s assets. A company can legally declare bankruptcy first and then liquidate various divisions to raise needed capital.

  • when the stockholders of a firm can minimize their losses by selling the organization’s assets.
  1. Captive Company:

A firm which retrenches via backward vertical integration is known as ‘captive company’. A firm becomes a captive of another firm when it subjects itself to the decisions of the other firm in return for a guarantee that a certain amount of the captive’s product will be purchased by the other firm.

A captive company strategy is followed when:

  • A firm sells more than 75% of its products or services to a single customer; and
  • The customer performs many of the functions normally performed by the independent firm.
  • This strategy may be chosen because of:
  • The inability or unwillingness to strengthen the marketing or other functions.
  • The prescription that this strategy is the best means for achieving financial strength.
  1. Harvest:

In this strategy, the firm reap maximum out of the existing firm without any additional investment being made. It is asset reduction strategy in which a company limits or decreases its investment in a business and extracts as much investment as possible. Company exits the industry once it has harvested the maximum possible returns it can.

Company halts all new investments in capital equipment, advertising, R&D etc. in order to maximize short to medium term cash flow from the unit before liquidating it. The company resorts to this strategy if the product/market segments demonstrate weak, declining but still positive profitability.

The aim of the business is for a lower market share, which will give the company its best short-run return with a longer term of eventually pulling out of the market. This strategy can be used to gather in funds which can be divested into other fruitful investment.

  1. Transformation:

A transformation occurs when a firm makes a major change in its outlook and operations, usually including moving from one kind of business to another. Changes in strategy are usually quite substantial. Such strategies are difficult to implement because they require a great deal of flexibility on the part of the entire organization.

According to Joe G. Thomas, firms may undertake a transformation when:

  • Returns on current operations are lower than desired.
  • Opportunities in other areas are especially attractive.
  • Investments needed in the current operations exceed what the firm is willing or able to spend.
  • A strong, flexible management team exists.
  • The firm has a strong financial base to support its transformation.
  1. Leadership:

The objective of this strategy is to establish a firm in a dominant position so that it will essentially have the declining market to itself. This strategy is used by firms in declining industries that involves outstaying all other firms in the industry and becoming a dominant player in the industry. This strategy requires lowering the ‘exit barriers’ that might keep competitors out in the market.

The firm pursuing the leadership position can often help its competitors overcome their exit barriers and thereby move to ensure its emergence as the last survivor. By adopting aggressive pricing and promotion policy, the leader signals the other competitors that it will not relinquish the industry without fight that will rise the costs for everyone involved.

The firm emphasizes its commitment to remain in the industry. Under this strategy, the company aims to be a market leader in declining market and so achieve above average returns for the industry.

  1. Niche:

‘Niche ‘means concentrating around a product and market. It is a strategy involving very low degree of risk and represents the typical behaviour of the small companies. Such organizations are, in general, scared of growing big, as it could entail them into legal, labour and management problems. Therefore they are content with their present position and would wish to capitalize on the superior knowledge of local conditions and choose a very narrow segment of market.

Niche marketing is the process of funding and serving profitable market segments and designing custom made products or services for them. For big firms, these market segments are too small to serve due to lack of economies of scale. A niche market may be thought of a narrowly defined group of potential customers which is not addressed by the main stream providers.

A niche marketer relies often on the loyalty business model to maintain a profitable volume of sales. The niche strategy involves identifying niches in a declining industry, that are profitable and establishing a dominant position in those niches.

Attractive niches are those that are either not affected by the decline, or niches where demand is very inelastic. The low levels of demand typical of these residual markets ire usually incapable of supporting more than one business, so it cannot be considered a solution for all competitors.

Advantages of Retrenchment Strategy

Advantages of retrenchment include reduced costs, improved efficiency, improved competitiveness and reduced reliance on the markets.

Retrenchment increases profits for shareholders and creates a strategy to survive economic downturn. The disadvantages of retrenchment include growth decline, reduced profits, smaller workforce, reduced productivity and inability to meet consumer demand.

Retrenchment, also called downsizing or rightsizing, involves a decrease in the diversity of business activities, which often requires a reduction in the workforce or sale of assets associated with terminated product lines. It may include debt restructuring through bankruptcy or even liquidation of the company. Retrenchment involves reduction of a business’s expenditures to become economically sound.

Retrenchment effects can be categorized as’ financial, organizational or human. Downsizing generates financial benefit to the company through direct increase in the value to shareholders. Cutback initiatives include reduced overheads, efficient communication, less bureaucracy and faster decision-making.

Reduction of a company’s scope of operations leads to reduced revenues due to decreased economy of scale and may cause death of the business. Laying off some employees has a cost implication in terms of compensation for the more experienced and higher paid workers who remain.

Retrenchment without withdrawing some of the products or services compromises efficiency and overloads the remaining workers who are expected to work more, leading to reduced productivity and inability to meet market demand.

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