Retrenchment is one potential strategy that firms can use to try to turn themselves around when they are losing profitability.
A retrenchment strategy aims at the contraction of organization’s activities to improve performance. It is implemented to find out the problem areas and the steps to resolve them.
A strategy used by corporations to reduce the diversity or the overall size of the operations of the company.
This strategy is often used in order to cut expenses with the goal of becoming a more financial stable business.
This strategy involves withdrawing from certain markets or the discontinuation of selling certain products or service in order to make a beneficial turnaround.
Retrenchment involves cutting back on a firm’s activity — it can mean reducing the level of staffing in the company by laying people off or it can mean getting the firm out of some particular markets in order to concentrate on the firm’s core competencies.
One example of this would be when General Motors of the United States stopped producing a number of “makes” of automobile. GM decided that it needed to retrench by concentrating on just a few “makes.” It hoped this would help it return to profitability.
when this strategy is adopted
This strategy is adopted when an organization suffers continuous losses.
Most of the external factors because of which an organization suffers losses are follows:
- New dominant technologies
- New business models
- Strict government rules and regulations
- Changing customer needs and preferences
- Availability of substitute products
The internal factors because of which an organization suffers losses are as follows:
- Ineffective top management
- Inappropriate strategies
- Excess liabilities
- High costs
- Ineffective sales and marketing
- Poor quality of functional management
When an organization suffers losses, it faces the following consequences:
- Falling sales
- Increasing debt
- Diminishing profitability
- Shrinking market share
Types of Retrenchment Strategy
Retrenchment strategies are largely governed by the preceding consequences of organizational losses. Retrenchment strategies are of three types:
- Turnaround Strategies
- Divestment Strategies
- Liquidation Strategies
1 Turnaround Strategies
Turnaround strategies refer to the strategies that involve reversing a negative trend by making an organization profitable.
There are various danger signs, called as indicators, to point out that a turnaround is needed for an organization.
Below indicators shows these danger signs:
- Negative Cash Flow
- High Employee Turnover
- Negative Profits
- Inadequate Physical Faculties
- Declining Market Share
If an organization faces one or more dangers shown above it is referred as a sick organization. Turnarounds can be handled in three ways, which are as follows:
- Handling the entire turnaround strategy with the help of a specialized external consultant. The success of this method depends upon the credibility of the top management of the organization with the banks and financial institutions.
- Recruiting an external consultant or turnaround specialist to take the action. This method is mostly followed in case of banks and financial institutions.
- Merging the organization with a healthy organization for expansion or earning gains. This involves replacement of the existing team, specifically the top management of the organization.
In India, an organization has to prove itself as a sick organization before adopting the turnaround strategy. The declaration is done under the Sick Industrial Companies Repeal Act, 2003.
2 Divestment Strategies
The sale or liquidation of a portion of a business is called the divestment strategy.
This strategy is a part of the restructuring plan and is practiced when turnaround has been attempted and proven a failure. This strategy is also called divestiture or cutback strategy.
The alternative of this strategy is harvesting strategy, which includes a process of gradually letting an organization wither away in a carefully controlled and standardized manner.
The reasons for the adoption of the divestment strategy are as follows:
- Predicting that continuity of the business would be unviable.
- Increasing financial problems because of negative cash flows.
- Increasing competition, and inability of the organization to cope with it.
- Mismatching of resources in case of mergers and acquisitions. It happens when the resources of one organization are not useful for the other organization.
- Failure to invest in technological advancements
- Getting an opportunity to invest in a better alternative rather than in an unprofitable business
- The following two are choices available to an organization for divestment:
- Divesting a part of an organization to make it financially independent. However, partial ownership is retained by the parent Organization Selling an organization completely
Examples of Divestment Strategies
Divestment strategies adopted by some of the organizations are as follows:
- Asian Paints, India s largest paint manufacturer, divested its slake in Australian operations, as they were very small. It did not make any significant impact on the performance of Asian Paints.
- Philips divested its chip division called NXP, because of its volatile and unpredictable nature that led to stock fluctuations.
3 Liquidation Strategies
Liquidation strategies are the most unattractive and severe retrenchment strategies, as they involve closing down an organization and selling its assets. It can be referred as the last resort for the organization.
For example, Punjab Wireless Systems Limited was ordered to wind up its business under Section 433 of the Companies Act 1956, by the high court of Punjab and Haryana. The organization’s inability to discharge its debts and liabilities was the reason behind this decision.
In India, many small-scale units liquidate frequently, but medium and large-scale organizations rarely liquidate because of political reasons. In addition, selling assets for implementing a liquidation strategy may be difficult because of the difficulty to find buyers.
According to Companies Act, 1956, liquidation or winding up may be done in the following three ways:
- Compulsory winding up under the supervision of the Court
- Voluntary winding up
- Voluntary winding up under the supervision of the Court
Turnaround: This strategy, dealing with a company in serious trouble, attempts to resuscitate or revive the company through a combination of contraction (general, major cutbacks in size and costs) and consolidation (creating and stabilizing a smaller, leaner company). Although difficult, when done very effectively it can succeed in both retaining enough key employees and revitalizing the company.
Captive Company Strategy: This strategy involves giving up independence in exchange for some security by becoming another company’s sole supplier, distributor, or a dependent subsidiary.
Sell Out: If a company in a weak position is unable or unlikely to succeed with a turnaround or captive company strategy, it has few choices other than to try to find a buyer and sell itself (or divest, if part of a diversified corporation).
Liquidation: When a company has been unsuccessful in or has none of the previous three strategic alternatives available, the only remaining alternative is liquidation, often involving a bankruptcy. There is a modest advantage of a voluntary liquidation over bankruptcy in that the board and top management make the decisions rather than turning them over to a court, which often ignores stockholders’ interests.