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.
Some of the types of retrenchment strategies are:-
1. Turnaround 2. Divestiture Strategy 3. Liquidation Strategy 4. Captive Company Strategy 5. Harvest Strategy
6. Transformation Strategy 7. Leadership Strategy. 8. Niche Strategy 9. Bankruptcy Strategy 10. End-Game Strategies.
Types and Classification of Retrenchment Strategies
Types of Retrenchment Strategy – 8 Types
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 activities to improve performance. It is implemented to find out the problem areas and the steps to resolve them. This strategy is adopted when an 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.
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:
i. Layoff or downsizing of personnel
ii. Strict control on general and administration overhead
iii. Elimination of non-value added functions and activities
iv. Modernization of equipment to reduce production costs
v. Reduce finance charges through opting low cost debt etc.
(b) Increasing revenue through:
i. Better inventory management
ii. Improve the debtors collection efficiency and reduce collection period
iii. Profitable investment of surplus cash and cash equivalents
iv. Reduction of selling price to increase sales volume
v. Adopt innovative advertising and sales promotion methods
vi. Improve after sales service
vii. Enhance customer satisfaction etc.
(c) Reducing investment in assets:
i. Sell-off idle assets not contributing company’s profitability
ii. Efficient use of existing plant and machinery
iii. Modernization and up gradation of technology to reduce production cost
iv. Adopt efficient material handling equipment
v. Invest in equipment to remove production bottlenecks
vi. Improve assets turnover ratio
(d) Revision of strategy which may involve:
i. Shifting to new competitive approach to rebuild market position
ii. Identify and concentrate on activities relating to core competency
iii. Withdraw products and segments which are no longer profitable
iv. Analyse the market environment and strategies of the competitors
v. Reorganize marketing channels
vi. Penetrate into new markets
vii. Establish brand image and brand equity
viii. Reduce various inefficient operations and rigidities
ix. Develop proactive strategies so that it could respond to the rapid changes taking place in external environment
x. Improve performance and avail new opportunities
xi. Utilize the advantages of takeover/merger moves
xii. Change in top management
xiii. Initial credibility building
xiv. Neutralizing external pressures
xv. Bring crisis situation into control
xvi. Identifying quick payoff activities
xvii. Centralized management control
xviii. Better information systems
xix. Engagement of services of specialist and experienced personnel
xx. 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.
2. Divestiture:
In divestitures, the company who has acquired assets and divisions will make an examination to determine whether the assets or divisions fit 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:
(a) When an organization has pursued a retrenchment strategy and failed to accomplish needed improvements.
(b) When a division needs more resources to be competitive than the company can provide.
(c) When a division is responsible for an organization’s overall poor performance.
(d) 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.
(e) When a large amount of cash is needed quickly and cannot be obtained reasonably from other sources.
(f) 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.
The three fundamental types of divestment are as follows:
i. Sell-off or 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:
(a) To come out of shortage of cash and serve liquidity problems
(b) To concentrate on core business activities
(c) To protect the firm from takeover activities by selling-off the desirable division to the bidder
(d) To improve the profitability of the firm by selling-off loss-making divisions
(e) To increase the efficiency of men, machines and money
(f) To facilitate the promising activities with enough funds by sell-off non-performing assets
(g) 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.
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.
3. 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:
(a) When an organization has pursued both a retrenchment strategy and a divestiture strategy, and neither has been successful.
(b) 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.
(c) when the stockholders of a firm can minimize their losses by selling the organization’s assets.
4. 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) A firm sells more than 75% of its products or services to a single customer; and
(b) The customer performs many of the functions normally performed by the independent firm.
This strategy may be chosen because of:
(a) The inability or unwillingness to strengthen the marketing or other functions.
(b) The prescription that this strategy is the best means for achieving financial strength.
5. 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.
6. 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:
(a) Returns on current operations are lower than desired.
(b) Opportunities in other areas are especially attractive.
(c) Investments needed in the current operations exceed what the firm is willing or able to spend.
(d) A strong, flexible management team exists.
(e) The firm has a strong financial base to support its transformation.
7. 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.
8. 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.
Types of Retrenchment Strategy – Turnaround Strategy, Divestment Strategy, Harvest Strategy and Liquidation Strategy
A firm may defend its survival and existence, or best serve the interests of owners in the face of internal and external crises in a number of ways. These sub-strategies of retrenchment can be of four types namely, turn around, divestment, harvest and liquidation strategy.
Let us know each one in brief:
1. Turnaround Strategy:
Turnaround or cut back strategy involves those strategic actions which an organisation takes to compete in the same business in turnaround situations. Turnaround situation may be improvement in organisational lower performance caused by downward trend that is not controllable by present actions of the management.
Downward trend is caused by environmental and internal factors such as lower price realisation for outputs, lower profit margins, raw-material supply problems as to quality, quantity, tune and other cost increases, strikes and lockouts, increased competition, recession managerial laxity.
All these contribute to lower level organisational performance, by whatever criteria they are expressed, and the firm is not able to achieve its preset objectives. This calls for turnaround strategy. This turnaround strategy is aimed at giving a grinding halt to the present declining trend in performance and improving the long-run efficiency of operations.
That is, it focuses on- (i) cost reductions—cutting down excessive discretionary expenses, lay off and retrenchment of personnel and the like. (ii) revenue increases—improving sales promotion without increasing the expenditure, better collection of receivable, inventory control and the like and (iii) reduction of assets along with reduction of products or services— selling off obsolete and excessive plant facilities and other assets.
Let us take the case of Mafatlal Industries. Mafatlal Industries Ltd. (MIL) is the holding company of the Arvind Mafatlal Group, the Mafatlal Fine Spinning and Manufacturing Company (MFSMC) has been merged with this holding company with retrospective effect from 1 April, 1993.
The reasons for the poor performance of MFSMC were- (i) difficult period for the textile business largely due to sluggish fabric demand in both the domestic and international market. (ii) Liquidity crunch in the Indian economy. (iii) Increased interest burden.
The company planned to restructure to reduce the interest burden and improve performance by- (i) Cutting idle capacity in shipping division and reducing debt. (ii) Improving performance in core areas by strict managerial discipline.
When and why to go in for turnaround strategy?
Turnaround strategy speaks against growth to have streamlined growth. Turnaround strategy is more or less a must when the business firm is caught in the hot pangs of recession. Even the best managed companies were to welcome turnaround strategy to get out of rut of stagnation.
Voltas, Batas, Birla’s Tata’s, Goenkas, Chands, Lais, all were caught in business ups and downs. They followed to turn the downsizing so as to solve some basic problems—both internal and external. Downward trend in organisational performance is the result of both internal and external factors.
Internal factors are controllable while external factors certainly not.
To ascertain what turnaround strategy an organisation is to follow will depend on answers to the following two questions:
Question one is – Is the business worth saving? That is, does pay to liquidate it now? If the answer is in affirmative, the firm should go ahead with identifying what turnaround strategy the firm can follow. The point in analysing this is that the going concern value of the firm is more than its liquidated value.
In case the liquidated value is higher, it is better to adopt the divestment or liquidation strategy than investing the substantial funds and energies warranted by a turnaround for only marginal pay off.
Question two is – In case the answer to first question is ‘yes’, the other question is – What is the state of current operating health as well as strategic health? This question of “present operating health” and “strategic health” calls for an in-depth study of firm’s strengths and weaknesses with which we are familiar.
Once the analysis of strengths and weaknesses is done, the firm turns to the task of selecting the type of turnaround strategy to be adopted. Then the type of strategy to be used is to be finalised out of two varieties, one which suits most is to be taken up.
“Strategic” versus “Operating” Strategies:
‘Strategic’ turnaround involves the change in the firm’s strategy to compete in the present business. It may involve determination of firm’s share. In case of operating or functional areas the turnarounds are to do with skills in marketing, production engineering.
These emphasize increasing revenue through regaining lost position than increased penetration of the market, decreasing costs, decreasing assets or a combination of all these. It is important to note that in strategic turnaround, the thrust is on strategy changes sought and the performance becomes a derivative of the strategic changes.
In other words, in operating turnaround, the basic focus in on performance targets to be achieved while in case of strategic turnaround the focus is on change in strategy in which the firm operates.
Approach to Turnaround Strategy:
Once the firm decides on either of the broad turnaround strategies, then it is to shape the more specific aspects of its chosen turnaround strategy. These action plans rest on both current strategic and operating health of the organisation and the nature of the industry in which the firm competes and also on its strengths and weaknesses against its competitors in the same industry.
This approach clearly calls for three steps namely, change in the top management, designing strategic turnarounds and designing operating turnarounds.
1. Change in the Top Management:
Before designing and implementing the turnarounds, one should verify whether the existing top management is able undertake the bold steps of turnarounds or there is need for change in top management. This changeover in toto or in part or no change over will depend on the management qualities.
It goes without saying that different general managers have highly specialised skills for handling different types of managerial tasks. In case the present management does not have these qualities there is need for changing management.
In case a high growth strategic turnaround is possible then a strategist or entrepreneur is needed. In the same way in case operating turnaround is to be followed, then there is need for a manager who is experienced, fastidious merciless cost cutter.
2. Designing Strategic Turnarounds:
When the business firm has a present operating health and the firm has lost its position strategically, strategic turnarounds are needed. Most of the turnaround involve situations in which there has been a distinct decline in sales and market share or market share position.
Resultantly the basic method of differentiating among the turnarounds is ascertained as per the magnitude of sales and market share revival expected. There are three possible alternatives.
One – maintenance or even reduction of share followed by the spotlighting on one or more defensible product or market segment or niches. Second – one level increase in market share position. That is, moving from a dropout position to follower position; from follower position to challenger position; or from challenger position to a leader position. Third – two-level increase in a market share position. That is, moving from dropout position to challenger position or from follower position to a leadership position.
However, generally, two level increase or even one level increase or shift that involves attempts to secure leadership position is not possible unless the firm has substantial financial and non- financial resources which it has failed to catch.
Shift of such size is possible when the present leader fails to maintain leadership, when there is a major change in the stage of market or product evolution, or when the firm is the erstwhile leader which has been lost to challengers. Very common turnaround action is between one level shift in market share or a segmentation or niche strategy.
In case the firm does not have unusual resources or the industry in which it is functioning is not the development or shake out stage of product or market evolution, segmentation or niche strategy is preferred. This strategy, however, may not provide the opportunities for catching leadership position in the many involved.
It generally produces lower sales in monetary terms as compared to successful one level share shifting turnaround strategy unless the segments chosen for the new situation grow substantially.
Hence, most of the firms try strategic turnaround which involves higher monetary sales through one level shift in market share in order to catch leadership position in case competitors or other environmental conditions change.
Still another point involved is in which area, the firm will compete preferably, it competes in a segment that permits increase of sales and share and that keeps away the competitors. It is a rare possibility, unless there is a newly emerging segment in the market.
With all this, the firm has to design and develop superior products for that segment and upgrading its functional areas significant for serving that segment. Further, the firm should be able to differentiate its products from its competitors. It is certain a difficult task because competitors may have superior strategic resources.
3. Designing Operating Turnarounds:
The operating turnarounds concentrate on the firm’s internal efficiency. Therefore, any strategy wants to follow is to improve its internal efficiency.
Experts have suggested four such strategies:
i. Generating of revenue,
ii. Cutting of cost,
iii. Reducing assets and
iv. Combining these.
i. Revenue Generating Strategy:
To start with, the firm concentrates on its existing line of products though this effort is on, it may be supplemented by those products which are presently discontinued in case it is possible to do it in time and with profit. The other products may be may also be taken up on short-term basis.
That is, these are not going to continue in future. The gist of this strategy is to go in for more and more resource generating products. The highlights of this strategy are that price cutting, enhanced advertising and increased direct sales efforts are taken to bring up the current sales level.
As against this, the research and development expenditure and staffing will be at low key in short term. What is important is the firm is to identify the resources and skills that are essential to implement its long term strategy to protect its short term and long-term interests.
Whether the costs are high or low, is a matter of individual experience. In case, inter firm comparison is made in the industry, one will be able to tell whether costs are higher or lower? and to what extent? Labour costs can be reduced either by increasing their level of efficiency or asking them to leave the organisation through mutually agreeable “golden shake hand”.
Excessive advertising costs can be cut by changing its emphasis—say moving from general to specific demand or from institutional adverting to product advertising. Though research and development costs can be reduced, there is no point in reducing at least in Indian conditions.
The main reason is that, the firms spend 20 less that there arises no question of reducing it. Personnel development costs can be reduced marginally. Better inventory moment is made possible by sound inventory management.
iii. Asset Reduction Strategy:
Asset reduction strategy implies reduction or selling the assets which are not needed at present or in the near future. This asset reduction strategy is most ticklish. The question is what assets are to be sold? and what are to be retained? It depends on present and future strategy.
In general those assets are to be retained which help in short-term and long- term too. Time of sale of asset is also important. If the firm sells the assets during an inappropriate time, the price that are received are far below the expectation. Whether the firm should gain for asset-reduction strategy banks basically on the long- term prospects of the business after the turnaround is complete and the criticality of its financial position.
The firm should gain revenue generating strategy than asset reducing in case the firm’s present capacity can be used for one or two years where financial problems are not there. If the situation is such that there are financial problems but the existing capacity can be used in near future, the firm can go in for mixed strategy of revenue generating and asset reducing strategy.
However, if the long term sales potential is much less than its present capacity, then asset reduction strategy is acceptable so that assets can be sold in the short-run to support long-run needs.
A combination strategy is the practicing of all the three strategies at a time namely, revenue generating, cost cutting and asset reducing. In case a balanced combination strategy is used, the flow of cash generated by balanced effort will be higher than having only one strategy at a time.
This hybrid strategy is more suited when the organisation is operating neck to neck to break evens. However, use of a combination strategy increases the complexity of managerial jobs. That is why, this combination strategy is used only when its pay-off are higher than the managerial complexity.
A word of caution for all those who use operating turnaround. The strategists should focus their attention on actions that have deep short- term cash flow impact on the business involved. These actions relate to collection of receivables, cutting of inventories, focusing on high margin products, reducing wastages, disposal of excess assets and retrenching of surplus manpower force.
2. Divestment Strategy:
‘Divestment’ or ‘Diverstiture’ strategy is quite opposite to expansion strategy because it involves selling off or liquidation of part of SBlTs 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.
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:
i. 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.
ii. 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.
iii. 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).
iv. 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 divestitute 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.
v. 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.
vi. 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, Britania 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 Britania 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.
vii. 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.
3. Harvest Strategy:
‘Harvest’ or ‘asset reduction’ strategy is a strategy whereby the firm reduces its assets to minimum, even sacrificing the future profits for the purpose of generating enough hand cash. It is already stated that a firm has to choose between liquidity and profitability. It is because a reduction in one will lead to increase in another.
That is higher the degree of liquidity, lower will be the degree of profitability. The harvest strategy calls for systematic step by step disinvestment in a business unit to utilise best the cash-flows as the company exits from an industry.
At the starting stage, the management eliminates the new investment, cuts back research and development expenditure, reducers maintenance expenditure while encashing the benefits of past goodwill.
As the firm loses its market share, the firm tries to increase its short- run cash-flows by adopting a harvest strategy. The cash generated through harvest strategy is reinvested elsewhere in the firm. Once the cash-flows begin to decline, the firm goes in for liquidation strategy.
4. Liquidation Strategy:
The liquidation strategy is to sell off or close down the firm to avoid bankruptcy and fairly better deal for shareholders than running the risk of making the firm to suffer from losses. Thus, the liquidation strategy is the extreme step where the firm deliberates shuts of the business and gets the money to safeguard the interests of stake-holders.
Why and when to go in for liquidation strategy?
The reasons and circumstances created for liquidation strategy are both economic and non-economic. That is rational and emotional. If one wants to go by economic guidelines, the business should be sold when its present value (liquidation value) is more than the discounted present value of its future flow of income. In case of emotional reasons, it is the perceived value that has its relevance.
These reasons and the circumstances are:
i. When the future of business is not bright:
A company may have at present at its zenith point of performance with no definite future, it is worthwhile to close it for its future possible development. There is no point in crying over spilt milk. Before the milk is spoilt, the firm can use it for other purposes.
The situation is such that something is better than nothing it is because today is better than tomorrow as there signs of fast decay. The spread of gangrene should be stopped by losing a part of body that stops further decay.
ii. The firm has accumulated losses with no come back:
Due to bad financial policies, the firm gets into the pandora box which has no point of return. The firm goes on increasing losses with every extra step it takes. There are no hopes of coming out this rut of stagnation.
In case some other firms have offered to take up such a firm which is caught in the hot pangs of losses, it is worth to take advantage. The companies get tax concessions when a good business house takes over suffering company at pretty good prices. This is for the mutual benefit that this deal works a golden opportunity.
iii. When the retaining value is less than sale value:
Business is a game of ups and downs where both good and bad times are ahead. A firm might be in shambles because of mismanagement so much so that it is beyond the capacity of present management to regain the good old past. In such case, it pays to sell it off than navigating the ship which has broken hull and bottom cracked.
In a bid to diversify the existing business a good business house may come forward to acquire another business at a pretty high price than its net worth. There will be no such occasions for which it will lose its grip.
Once a firm decides to sell its business, the management should try to get better value for its assets, management, products—both tangibles and intangibles. It should be a sound closer for both the buying and selling firms.
Types of Retrenchment Strategy – Turnaround, Divestment and Liquidation Strategies
1. Turnaround strategies,
2. Divestment strategies
3. Liquidation strategies.
Type # 1. Turnaround Strategies:
Turnaround 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 organisation to survive.
They are:
i. Persistent negative cash flows
ii. Negative profits
iii. Declining market share
iv. Deterioration in physical facilities
v. Over manning, high turnover of employees, and low morale
vi. Uncompetitive products or services
vii. Mismanagement
An organisation 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:
i. The existing chief executive and management team handles the entire turnaround strategy with the advisory support of a specialist consultant. This method can be successful if the chief executive has a reasonable amount of credibility left with the banks and financial institutions. This type of turnaround is rarely attempted by companies.
ii. In the second method, the existing team withdraws temporarily and an executive consultant or turnaround specialist is employed to do the job. The consultant is normally deputed by the banks and financial institutions and the person revert the company to the team of chief executive once the job of turnaround is completed. This method is rarely adopted by Indian companies, though it is more common in western companies.
iii. The last method involves the replacement of the existing team specially the chief executive, or merging the sick organisation with a healthy one. This method is more common in the Indian companies.
When a chief executive officer (CEO) is replaced by another, the new CEO can follow two types of approaches – surgical and non-surgical. The surgical approach to turn around involves the tough attitude and pattern of action followed is same everywhere. The new CEO quickly asserts the authority by issuing orders and direction for change, centralise function, fire employees, close down plants and divisions.
Then the product mix may be changes, obsolete machinery is replaced with new one, R&D, marketing and financial controls are strengthened, accountability is fixed. This continues till the business shows sign of turnaround. The second approach – non-surgical is a humane approach which involves understanding of problem of the organisation, eliciting options, adopting conciliatory attitude and coming to negotiated settlement among different fictions.
In this approach, the emphasis is on behavioural change and improving the work culture and morale of the employee. Both the approaches may succeed, depending upon the circumstances and conditions prevailing, the second approach has higher potential of success in the long run.
Before a turnaround 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 (Special Provision) Repeal Act (SICA) 2003, which has replaced Sick Industrial Companies Act (SICA) 1985.
The act provides for a quasi-judicial body called the Board of Industrial and Financial Reconstruction (BIFR) and the Appellate Authority for Industrial and Financial Reconstruction (AAIFR) which acts as the corporate doctor whenever companies fall sick.
It is the responsibility of the company to report its sickness whenever the accumulated losses at the end of financial years exceed 50% of the peak net worth attended during the preceding five years. BIFR prepares a rehabilitation scheme for the revival of sick units, decides on the need for a change of management or amalgamation with other companies and undertake the sale or lease of the undertaking and other appropriate measures.
Apart from BIFR, banks and financial institutions also play an active role in the turnaround strategy. The RBI also coordinates with activities between commercial banks and lending institutions. The government provides tax benefits under Section-72A of the Income Tax Act to companies which amalgamate sick unit for revival.
Metal Box India Ltd. a reputed company in the packaging industry, turned sick due to its wrong strategic move of diversifying into bearings manufacture in the early eighties. Eight of its nine units closed down as results of which the BIFR and the ICICI formulated a rehabilitation package for the turnaround of the company.
Type # 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 strategy is a variant of the divestment strategies, involves a process of gradually letting the company business wither away in a carefully controlled manner. Another term common in Indian context is disinvestment.
Disinvestment involves the sale of government equity in public sector enterprise to another enterprise, institutional investors, mutual funds or to the general public, thereby diluting the government shareholding. Many government companies such as ITC hotels, Maruti Udyog, BALCO, Videsh Sanchar Nigam Ltd (VSNL) have been disinvested.
Reasons for divestment:
i. 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 unviable in the long term is divested.
ii. Persistent negative cash flows from a particular business create financial problems for the whole company, creating a need for the divestment of that business.
iii. Severity of competition and the inability of a firm to cope with it may cause it to divest.
iv. 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.
v. Divestment may be done because by selling off a part of a business the company may be in a position to survive
vi. A better alternative may be available for investment, causing a firm to divest a part of its unprofitable business.
vii. Divestment by one firm may be a part of merger plan executed with another firm, where mutual exchange of unprofitable divisions may take place.
viii. 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.
There are many examples of how companies have attempted divestment strategies.
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 detergents were not considered a core business for the Tata’s.
Similarly, the pharmaceuticals companies of the Tata’s, 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.
Asian Paints undertook an international divestment when it decided to divest its stack in its Australian operations. It offloaded its stack in Asian Paints Queensland Ltd to its international subsidiary Asian Paints (International), Mauritius.
Hindustan Unilever Ltd divested its marine food business to Mumbai based Temptation Foods which is a fruit and vegetables export company. Hence, it decided to get out of its non-core businesses. It also sold its seafood processing plant in Andhra Pradesh and shut down its operations in Gujarat.
Indian Organic Chemicals was set up by Ghai Group in 1960. It diversified into food processing in 1986 from its main business of organic chemicals. But by 1989 its food division “Future Food” reached a position where they had to divest. The reason for failure were; unfair competition from unorganised sectors, technological problems, mismatch between marketing orientation and manufacturing orientation.
VST Natural products, the food business company of VST, the tobacco company was divested to Global Green Company of Thapar groups. The reason of divestment were – non-availability of raw materials, inadequate working capital, etc.
It is clear that normally divestment is attempted when the business is not running successful or as a result of failures. It may be result of companies focusing on their core business and divesting the non-core business. When divestment does not work, liquidation is the only strategic alternative left.
Type # 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 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 of liquidation are as follows:
i. The prospects of liquidation create a bad impact on the company’s reputation.
ii. For many executives who are closely associated firms, liquidation may be a traumatic experience.
Many small sized units and proprietorship and partnership firms liquidate frequently, but medium and large sized firms rarely liquidate in India owning to a number of reasons. The company management, government, banks and financial institutions, trade unions, suppliers and creditors are extremely reluctant in taking a decision or ask for liquidation.
While the management may hesitate to liquidate due to fear of failure or stigma, the government may not easily allow liquidation due to political and other risks involved. Trade unions would resist due to loss of employment of workers. Ceasing operations does not mean organisation is freed from its contractual obligations to the creditors and suppliers, unless of course it is declared insolvent or bankrupt.
Types of Retrenchment Strategy – Classified as Divestment Strategy, Harvest Strategy, Liquidation Strategy and Capture Company Strategy
Retrenchment strategies are adopted when the firm’s performance is poor and its competitive position is weak. Retrenchment strategy is pursued by organizations when they reduce their activities substantially.
Retrenchment strategy may be classified as:
1. Divestment strategy
2. Harvest strategy
3. Liquidation strategy, and
4. Capture company strategy.
1. Capture Company Strategy:
Companies with weak competitive position enter into long term contract with big customers for continued survival in lieu of their independence. Simpson Industries permitted General Motors to inspect its engine part facilities and account books and became the sole supplier of auto parts to General Motors on long term basis.
2. Divestment:
Divestment strategy requires dropping of some of the businesses or part of the business of the firm, which arises from conscious corporate judgement in order to reverse a negative trend. It involves redefinition of the business of the corporation. Divestment is a corporate level retrenchment strategy wherein a firm sells one or more of its business units.
Divestment involves dropping of product, market and functions. Divestment may be carried out for reasons such as obsolescence of product or process, unprofitable business, high competition, industry overcapacity and failure of strategy.
Selling off a business unit to independent investors is known as spin-off. It is the best way to recover the initial investment as much as possible. The highest bidder gets the divested unit. Selling off the divested unit to its management is known as management buyout.
3. Liquidation:
Liquidation is considered to be an unattractive strategy because the industry is unattractive and the firm is in a weak competitive position. It is pursued as a last step because the employees lose jobs and it is considered to be a sign of failure of the top management. Liquidation is a traumatic experience for the executives. Trade unions object to it due to loss of employment and the government may not easily allow it due to political and other risks involved.
Under the Companies Act, 1956, winding up of a company is done under court order whereby the life of a corporation is ended and its property administered for the benefit of its creditors and members. Under the Act, the liquidator takes possession of the company, realises its assets, makes payment and debts, and distributes the balance to the shareholders.
Liquidation may be done in the following ways:
i. Voluntary winding up
ii. Compulsory winding up under the supervision of the court.
iii. Voluntary winding up under the supervision of the court. The Companies Act, 1956, under part VII, Section 425-560, deals comprehensively with different legal aspects of liquidation. The Companies Act, 1956, provides for dissolution of the company and it is kept under suspended animation for two years. Within these two years, the court may order for revival of the firm.
Liquidation is a corporate level retrenchment strategy wherein the company terminates one or more of its business units by sale of their assets.
4. Harvest:
A harvest strategy involves halting investment in a unit in order to maximize short-to- medium-term cash flow from that unit before liquidating it.
Types of Retrenchment Strategy – 3 Types
Retrenchment strategies are of three types.
These three strategies are discussed below:
Type # 1. Turnaround Strategies:
Turnaround strategies are defined as those set of strategies that help in managing, establishing, funding, and fixing a distressed organization. These strategies are applied over the regular stages of turnaround. Turnaround Strategies help an organization to regain satisfactory levels of profitability, cash flow, and liquidity.
There are three stages in a Turnaround Strategy, which are explained as follows:
i. Pre-Turnaround Stage- It depicts the period just before the profitability begins to decline. An organization may be considered profitable, but eventually it starts losing ground.
ii. Period of Crisis Stage – It starts when the organization actually feels the need for turnaround. In the period of crisis stage, a steep decline in the profits is apparent. In addition, falling market share and a deficit cash flow are the basic characteristics of this stage.
iii. Period of Recovery Stage – It measures to turnaround the organization are taken in this stage. In the period of recovery stage, important decisions are taken. These include the adoption of aggressive sales growth policies, or scaling back to production. At this stage, the organization is in a position to formulate its strategies clearly. This is because all the factors, both favorable and unfavorable, are known to the organization.
Before moving ahead, let us discuss the various causes, which entail the adoption of a turnaround strategy:
a. Declining revenues, due to a weak economy
b. Impractical sales targets
c. Inefficient execution of strategies
d. High operating costs
e. Low operational flexibility
f. Lack of adequate resources
g. Poor execution of research and development projects
h. Strong market competition
i. Burden of high debt
j. Insufficient financial control.
A turnaround strategy consists of the following steps:
i. Redefining the leadership – It refers to a change in the leadership. Redefining the leadership ensures that only those techniques and methods, which lead an organization towards the correct direction. It also helps to recognize those strategies, which have proved unprofitable in the past.
ii. Changing the strategic attention – It implies re-evaluation of the organization’s business. A decision regarding the retention or elimination of a particular business is then made. The steps adopted for this purpose are reassessment of the strategies and policies. In addition, to ascertain the long-term profitability, a portfolio review is also done.
iii. Selling or diluting unnecessary assets – It refers to divesting those assets, which are no longer profitable. The cash generated by selling these assets may be used to repay the debts of the organization.
iv. Improving Profitability – It implies that an organization may go for improving profitability by gaining control over the financial matters more tightly, by assigning profit responsibility to individual division of the organization and by investing in modern time and energy saving equipment.
v. Making cautious acquisitions – It refers to going for acquisitions, which may prove to be a delicate matter. If handled improperly, an acquisition may lead to serious consequences for the organization. On the other hand, it may help the organization to quickly reconstruct or replace its weak divisions. An acquisition should be such that it helps the organization to relate its core business with the new one.
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.
If an organization faces one or more dangers, it is referred as a sick organization.
Turnarounds can be handled in three ways, which are as follows:
i. 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.
ii. Recruiting an external consultant or turnaround specialist to take the action. This method is mostly followed in case of banks and financial institutions.
iii. 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.
Type # 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:
i. Predicting that continuity of the business would be unviable
ii. Increasing financial problems because of negative cash flows.
iii. Increasing competition, and inability of the organization to cope with it
iv. Mismatching of resources in case of mergers and acquisitions. It happens when the resources of one organization are not useful for the other organization
v. Failure to invest in technological advancements
vi. 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:
a. Divesting a part of an organization to make it financially independent. However, partial ownership is retained by the parent organization
b. Selling an organization completely.
Type # 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:
i. Compulsory winding up under the supervision of the Court
ii. Voluntary winding up
iii. Voluntary winding up under the supervision of the Court.
Types of Retrenchment Strategies
Retrenchment is a corporate level strategy that seeks to reduce the size of a firm’s operations. These strategies involve a reduction in the scope of a corporation’s activities, which also generally necessitate a reduction in number of employees (Downsizing), closing unprofitable plants, outsourcing unprofitable activities, implementation of quality controls, sale of assets, possible restructuring of debt through bankruptcy proceedings and in the most extreme situations, liquidation of the company.
The primary objective of retrenchment strategy is to stabilise the financial condition of a firm. This is possible only when firms are in less severe situation. For example, Hewlett-Packard (HP), Spun off its testing and measurement businesses into a stand – alone company called Agilent Technologies so that it could better concentrate on its Personal Computer (PC), workstation, server, printer and peripherals and electronic businesses.
In the process of improving financial soundness, companies may follow several retrenchment strategies.
The following are the major ones:
Type # 1. Turnaround Strategy:
A firm’s profits may show declining trend due to external or internal reasons. In many situations, managers believe that firms may be rescued from going crisis, if a concentrated effort is made over a period of time. This idea is known as ‘turnaround strategy’.
A turnaround strategy is needed when a firm profits move downward.
But profits may come down and move toward negative scale because of the following:
i. High turnover of employees and low morale.
ii. Increased debt in capital structure (beyond optimum preparation).
iii. Lack of sufficient working capital.
iv. Under utilisation of resources.
v. Low productivity.
vi. Declining demand for products.
vii. Declining market share.
viii. Mismanagement.
ix. Failure in innovation.
x. Selection of wrong competitive strategy.
xi. Poor implementation of right strategy.
xii. Lack of sufficient resources.
Turnaround of a falling firm may be achieved through cost reduction, assets reduction or both. Cost reduction may be achieved through workforce slimming, reducing debt, procuring equipment on lease, instead of buying outright, trying to use old equipment, minimising promotional expenses and quick recovery of receivables.
Type # 2. Divestment Strategy:
Divestment is one of the three exit strategies, the other two being liquidation and harvesting. Divestment strategy involves the sale of a firm or a part (product, division) of a firm. Divestment is usually decided when a retrenchment fails to accomplish the desired turnaround, in a planned period or when a nonintegrated business activity achieves a usually high market value. Generally companies sell the business to the highest bidder.
For fetching premium over current value of assets, the selling firm must identify the prevailing skills of management, financial, marketing, production, technological, human resources and other resources, which would be able to generate profits, and decide the price of selling business. Divesture works on the principles of “energy” which says 4-1 = 3!
PepsiCo divested its cash=hog group of restaurant business (consisting of KFC, Pizza Hut, Taco Bell and California Pizza Kitchens) to provide more financial resources for improving its soft-drink business (which was losing market share to Coca Cola) and growing its more profitable Frita-Lay Snack Foods business.
Hindustan Unilever Limited (HUL) divested its edible oil business (facilities locator in Trichy, Tamilnadu) because it has low growth potential.
‘Futura’ foods division (manufacturer of potato wafers, and banana chips) sold by Indian Organic Chemicals (IOC), because of unfair competition from the unorganised sector, technological changes, mismatch of marketing orientation between Ghai group and Futura Foods, and lack of financial resources. .
CEAT sold its Nylon Tyre Card plant at Gwaliar to SRF for Rs.3,250 million, with the idea to settle outstanding and concentrate on tyre manufacturing.
Reasons for Divesture:
The reasons for divesture may vary from firm to firm.
The following are prime reasons for adopting divesture:
i. Partial mismatches between the acquired firm and the parent corporation.
ii. Deteriorated marketing conditions of once attractive industry.
iii. Lack of strategic or resource fit-because it is a cash hog with questionable long-term potential or weakly positioned in its industry.
iv. Need of financial resources-sometimes there is a need to sacrifice high market value business to improve cash flow or financial stability of a corporation.
v. Government competition law – when an organisation is believed to monopolize a particular market.
vi. Low growth potential.
vii. Technological change-when a firm is not able to invest on new technology to survive, then the preferable option would be to sell the business.
viii. As a part of merger agreement, a part of business or division or product may be divested.
ix. Curtailment of losses.
Type # 3. Bankruptcy Strategy:
Bankruptcy involves legal protection against creditors or others allowing the firm to restructure its debt-obligations or other payments, typically in a way that temporarily increases cash flow. Top management of a company hopes that once the court decides the claims on the firm, then the firm will be stronger and better able to compete in a more attractive industry.
For example, since the airline hijackings and subsequent tragic events of September 11, 2001, many of the airlines based in the US have filed for bankruptcy to avoid liquidation as a result of stymied demand for air travel and rising fuel prices. At least one airline has asked the courts to allow it to permanently suspend payments to its employee pension plan.
The bankruptcy situation arises when a company’s financial statements have shown an unabated decline in profits for seven quarters. Company finds it difficult to pay bills as they become due, increased expenses, supplier rejecting to supplying supplies without cash payment and customers are requiring assurances that future orders will be delivered and some customers already started going to competitors.
Take another example, Global Trust Bank (GTB) established as private sector Bank in 1993 and headquartered at Secundrabad. GTB has been running its operations successfully, and it collapsed under the pressure of bad loans. It became bankrupt in 2004 and merged with an Oriental Bank of Commerce (OBC), a public sector Bank.
Type # 4. Liquidation Strategy:
Liquidation involves the selling of the entire operation. In this strategy there is no future for the firm, employees are exited, land and buildings and plant and equipment are sold, and customers no longer have access to the product or service. This is the last retrenchment strategy, which is most unpleasant and painful. Nonetheless, in hopeless situations, an early liquidation decision serves owners interests better than an inevitable bankruptcy.
Prolonging the unprofitable business merely exhausts a firm’s resources. The liquidation strategy is beneficial over bankruptcy, that the board of Directors, together with top management take the decision instead of turning them over to the court, whose decision may ignore the interest of equity shareholders or owners.
The liquidating company usually tries to develop a planned and orderly system that will fetch in the greatest possible return and cash conversion as the company slowly relinquishes its market share. For example, well planned Colombia Corporation liquidated its assets for more cash per share in the market value of its stock.
Type # 5. End-Game Strategies:
An end game of harvesting strategy guides a middle course between preserving the status quo and existing as soon as possible. These strategies involve getting bigger near-term cash flows, and deploy the same in other businesses.
In this strategy operating budget is reduced to a rock- bottom level; minimum reinvestment; capital expenditure on equipment are put on hold, slowly reduces promotional expenditure; reduction of product quality in not-so-visible ways; curtailment of nonessential customer services; and the like. These actions do not control the shrinking market share, but help in increasing profit after tax. By showing bigger cash flows if not profit, firm can harvest the business.
Harvesting strategy or end game strategy is reasonable option in the following circumstances:
i. The industry’s long-term prospects are unattractive. For example cigarette, VCRs, 3.5 inch Floppy disk, traditional cameras and CDs manufactures are examples of unattractive industries.
ii. Rejuvenating the business would be too costly or at best marginally profitable-Polaroid instant cameras and films.
iii. The market share maintenance becomes costly-film for traditional cameras.
iv. Reduced levels of competitive effort will not trigger an immediate or rapid fall off in sales – Dot-Matrix Printers or ribbons.
v. Firm can redeploy the freed financial resources in higher opportunity areas-CD players and CD manufacturers are better off by deviling their resources to the production and sale of DVD players and recorders.
vi. The business is not a crucial or core component of a diversified company’s overall lineup of business.
vii. The business does not contribute other desired features to a firm’s overall business portfolio.
A business unit is ideal for harvesting when the above seven conditions are present.