A retrenchment grand strategy is followed when an organization aims at a contraction of its activities through substantial reduction or the elimination of the scope of one or more of its businesses in terms of their respective customer groups, customer functions, or alternative technologies either singly or jointly in order to improve its overall performance. E.g: A corporate hospital decides to focus only on special treatment and realize higher revenues by reducing its commitment to general case which is less profitable.
The growth of industries and markets are threatened by various external and internal developments (External developments – government policies, demand saturation, emergence of substitute products, or changing customer needs. Internal Developments – poor management, wrong strategies, poor quality of functional management and so on.) In these situations the industries and markets and consequently the companies face the danger of decline and will go for adopting retrenchment strategies. E.g: fountain pens, manual type writers, tele printers, steam engines, jute and jute products, slide rules, calculators and wooden toys are some products that have either disappeared or face decline.
There are three types of retrenchment strategies – Turnaround Strategies, Divestment Strategies and Liquidation strategies.
1. Turnaround Strategies
Turn around strategies derives their name from the action involved that is reversing a negative trend. There are certain conditions or indicators which point out that a turnaround is needed for an organization to survive. They are:
- Persistent Negative cash flows
- Negative Profits
- Declining market share
- Deterioration in Physical facilities
- Over manning, high turnover of employees, and low morale
- Uncompetitive products or services
- Mis management
An organization which faces one or more of these issues is referred to as a ‘sick’ company.
There are three ways in which turnarounds can be managed
- The existing chief executive and management team handles the entire turnaround strategy with the advisory support of a external consultant.
- In another case the existing team withdraws temporarily and an executive consultant or turnaround specialist is employed to do the job.
- The last method involves the replacement of the existing team specially the chief executive, or merging the sick organization with a healthy one.
Before a turn around can be formulated for an Indian company, it has to be first declared as a sick company. The declaration is done on the basis of the Sick Industrial Companies Act (SICA), 1985, which provides for a quasi judicial body called the Board of Industrial and Financial Reconstruction (BIFR) which acts as the corporate doctor whenever companies fall sick.
2. Divestment Strategies
A divestment strategy involves the sale or liquidation of a portion of business, or a major division. Profit centre or SBU. Divestment is usually a part of rehabilitation or restructuring plan and is adopted when a turnaround has been attempted but has proved to be unsuccessful. Harvesting strategies a variant of the divestment strategies, involve a process of gradually letting a company business wither away in a carefully controlled manner
Reasons for Divestment
- The business that has been acquired proves to be a mismatch and cannot be integrated within the company. Similarly a project that proves to be in viable in the long term is divested
- Persistent negative cash flows from a particular business create financial problems for the whole company, creating a need for the divestment of that business.
- Severity of competition and the inability of a firm to cope with it may cause it to divest.
- Technological up gradation is required if the business is to survive but where it is not possible for the firm to invest in it. A preferable option would be to divest
- Divestment may be done because by selling off a part of a business the company may be in a position to survive
- A better alternative may be available for investment, causing a firm to divest a part of its unprofitable business.
- Divestment by one firm may be a part of merger plan executed with another firm, where mutual exchange of unprofitable divisions may take place.
- Lastly a firm may divest in order to attract the provisions of the MRTP Act or owing to oversize and the resultant inability to manage a large business.
E.g: TATA group is a highly diversified entity with a range of businesses under its fold. They identified their non – core businesses for divestment. TOMCO was divested and sold to Hindustan Levers as soaps and a detergent was not considered a core business for the Tatas. Similarly, the pharmaceuticals companies of the Tatas- Merind and Tata pharma – were divested to Wockhardt. The cosmetics company Lakme was divested and sold to Hindustan Levers, as besides being a non core business, it was found to be a non- competitive and would have required substantial investment to be sustained.
3. Liquidation Strategies
A retrenchment strategy which is considered the most extreme and unattractive is the liquidation strategy, which involves closing down a firm and selling its assets. It is considered as the last resort because it leads to serious consequences such as loss of employment for workers and other employees, termination of opportunities where a firm could pursue any future activities and the stigma of failure
The psychological implications
- The prospects of liquidation create a bad impact on the company’s reputation.
- For many executives who are closely associated firms, liquidation may be a traumatic experience.
Legal aspects of liquidation: Under the Companies Act 1956, liquidation is termed as winding up. The Act defines winding up of a company as the process whereby its life is ended and its property administered for the benefit of its creditors and members. The Act provides for a liquidator who takes control of the company, collect its assets, pay it debts, and finally distributes any surplus among the members according to their rights.