Retrenchment Strategy

What is Retrenchment Strategy ?

Retrenchment is a corporate strategy that aims to decrease the scale of operations of the company. It can also involve cutting down the expenditure of the company so that it becomes financially viable. It can involve reducing the number of product lines or businesses, withdrawing from certain geographical markets so that the company becomes financially sustainable. 

For example, HUL has reduced the number of brands in its portfolio in the past so that the resulting "power brands" contribute more meaningfully to the company's profitability. A retrenchment strategy often helps the company from making a turnaround, as all the unprofitable businesses are pruned and removed.

Retrenchment, as applied in the field of personnel management, denotes employees leaving the company either because of slowdown of economy, re-alignment of work, or there is less work available. The exact word is used in the field of strategic management with a slightly different emphasis because retrenchment strategy does not always indulge in getting off the business. In the area of personnel management, retrenchment refers to the removal or benching of workers from the working place because of reduced demand due to recession. In strategic management the word retrenchment has a very different connotation. In this, the company does not always remove a business but instead focuses on the following :
  1. Focusing on cost reducing activities. 
  2. It can become a captive company by decreasing the number of tasks that it performs. 
  3. A number of markets being catered to by reduction in the number of products being offered.
A retrenchment strategy therefore offers many strategic alternatives to the company. These can be in the form of :
  • Cutback and Turnaround Strategy 
  • Divestment Strategy
  • Liquidation Strategy

Reasons to Adopt Retrenchment Strategy

The reasons for adopting retrenchment strategy are as follows :

1) Poor Performance : 
When the performance of the company is not satisfactory and it is incurring losses then it makes sense to close down the business lines or centers which are not adding value and are acting as performance laggards in the company.

2) Threat to Survival : 
When the performance of the company is hampered by sudden activities in its product markets then the company may often shut down some of its operation. Mar times such a strategy is also forced by the company's shareholders.

3) Redeployment of Resources : 
Sometimes excellent investment opportunities exist elsewhere and the company may be forced to cut down its operations in the existing business and redeploy the resources released to more productive areas. 

4) Inadequate Resources : 
The company may also be in the need of financial resources to sustain its existing market positions. The company may not have the requisite funds for this and may be forced to hive off unproductive areas of its business so that it may redeploy the resources.

5) For Securing better Management and Improved Efficiency : 
A company sometimes expands into too many areas. This affects its operational efficiency as it becomes unmanageable. A strategy of retrenchment allows the company to become a manageable size by simplifying its product portfolio.

Types of Retrenchment Strategy 

Retrenchment is a strategy that aims at reducing cost to make the company financially viable. It allows the company to regroup and arrest the decline of its sales and profits by reducing costs and re-allocating its assets to more productive uses. There are four Retrenchment Strategy Types/forms are as follows : 
1) Turnaround Strategy
2) Divestment Strategy
3) Liquidation Strategy
4) Captive Company Strategy

1) Turnaround Strategy :
Turnaround as the name suggests means reversing an adverse trend. The basic goal of turnaround is to change a company from a loss making and under performing enterprise into one with acceptable levels of profitability, liquidity and cash flow. A turnaround strategy implies the management of an under performing company in terms of its management, funding etc., and turns it into a profitable one.

In order to manage the turnaround strategy, a company needs to overcome the reasons of under performance, to rectify the financial troubles achieve financial progress, regain the confidence of the various stakeholders and also overcome adverse situations prevalent in its internal and external environments. The turnaround strategy requires an improvement in the efficiency of the company. It is most effective when it is done at a stage when the problems of the company are visible to all but not on an alarming stage. The two main aspects of a successful turnaround strategy are contraction and consolidation.

Contraction has the characteristics of a quick fix. It is an attempt to quickly "fix the problem" in the company. This can be in the form of a wide scale cut in the costs and size of the company. Consolidation on the other hand is a strategy to stabilize the operations of the already lean company which has suffered contraction. A consolidation program includes efforts to remove all unnecessary overhead costs. There is also an attempt to justify all the functions in terms of their cost. This is a very delicate situation for the company. A consolidation exercise not carried out properly can cause a lot of damage to the company. It can lead to many people leaving the company. An atmosphere of downsizing and rampant cost cutting especially where it is backed and enforced ruthlessly by top management, can lead to a lot of harm to the employees of the company and hence impact the productivity of the company.

2) Divestment Strategy :
A company which has a very week industry position and cannot turnaround its performance or become captive to another company has no option but to shut operations and close down. It can sell its operation to another entity. In that manner the shareholders of the company will get a good price for their investment in the company. The advantage of selling out another company is that the other company may have the resource and the competency to turnaround the company and make it profitable. 

(Retrenchment strategy example companies in India) For example, Mahindra and Mahindra sold off its M-Seal brand of adhesives to Pidilite (makers of Fevicol). Pidilite had the competency to make maximum use of the M-Seal brand and was better placed than Mahindra in the Indian adhesives market. A company which has a very bad competitive position and cannot turnaround its troubled business or become a captive company to another one has no other option than to sell off the entire company or divest a part of the company. Divestment is also called divestiture or cut back. This involves the liquidation of a part of the business or an SBU or a profit centre. Many a times divestiture is a fall through of a failed turnaround attempt. Sometimes a turnaround attempt may be ignored by the company because a divestiture seems more attractive.

The divestiture strategy comprises the sale of a part of the company or a major component of the company. For example, Sara Lee Corp. was a diversified company which was selling everything from Wonderbras and Kiwi shoe polish to Coffee. The new president of Sara Lee, Steven McMillan, was faced with stagnant revenue and declining profits. As a result he decided to hive off 15 businesses which added up to 20% of the company's revenue. He also laid off 13200 employees. From the resources that got generated from this divestiture, Sara Lee added more brands to its core brands and made them more powerful by bridging incomplete product lines. As a result Sara Lee was able to increase its bakery segment four-fold.

3) Liquidation Strategy :
An unsuccessful company which has none of three strategic options available has no other option but to go in for liquidation or bankruptcy. Liquidation is better than a bankruptcy because in the former case the management has some control whereas in the latter case the entire control is vested with the courts. Bankruptcy is the situation in which the management of the company is handed over to the courts who then handle the settlement of the company's debts and obligations. This is done with a belief that the company will emerge stronger than before once the debts have been settled.

For example, Global Trust Bank was a private sector bank which had a good track record and had 11.8 crore in net profits as of Dec 31, 2003. However because of adverse market conditions the bank collapsed and had to ultimately go for bankruptcy. This company was merged with the Oriental Bank of Commerce. A more recent example, is the case of the Vijay Mallya owned company Kingfisher airlines which declared itself bankrupt. An amicable solution is still to be found by the court in this case.

Liquidation differs from bankruptcy because in this case the management seeks to terminate the existence of the company whereas in the case of bankruptcy the management wants to continue with operations. In this case the company is difficult to be sold-off entirely but the management sells as many company assets as possible and the cash realized is given to: creditors and the shareholders of the company. The advantage of liquidation is that the top management including the Board of Directors still retain all the management control of the company and do not hand over the power to the court. This ensures that the shareholders get a better deal. By going for liquidation, the management concedes that it has failed and also that it requires that all the stakeholders need to go if for lot of pain. The employees of the company also have to bear a lot of hardships. That is why liquidation is considered the least attractive of all the corporate strategies. The positive aspect is that it benefits all the stakeholders of the company. In the case of bankruptcy, the company plans a long and ordered exit so that the greatest return is got for the assets of the company.

4) Captive Company Strategy :
A captive company strategy occurs when a company becomes dependent on another company for its survival. Sometimes a company with a weak competitive position may not opt for a tum around strategy since the prospects of the industry are not that lucrative to warrant the effort required to turnaround the company. The company still needs to overcome the problem of falling sales and profitability. In this scenario the company seeks an "angel" who is typically in the form of one of the larger customers of the company. The company thus becomes captive to this customer. It gets an assured business and security. It can also reduce some of its functions like marketing and help reduce costs. The benefit to the weaker company is that it gets assured sales. In return it has to lose its independence.

For example, Simpson Motors agreed to become a captive company to General Motors whereby it agreed to supply 80% of the company's production to General Motors through negotiated contracts.

A captive company strategy is suitable when : 
  • The company has a single large customer who purchases 75% of its production.
  • The customer also performs many of the functions that the company is performing. Thus by becoming the captive the company can save costs by cutting down on all common functions. 

The captive company policy is chosen because : 
  • The company is not willing or is not able to support functions like marketing. 
  • It is the best method of achieving financial strength in the company.
The moment a company becomes captive it relinquishes control of many important functions like production, marketing and quality control. The captor company gets into negotiation with the captive company and assures itself of the best deal. It may be able to avoid cost squeezes from competitors in this fashion. The risk is the captive company gets associated with the risks of the captor company. The benefit is that the captive company can now get the resources to operate in a bigger market and compete against bigger competitors. It gets access to larger budgets of advertising and promotion.

The key thing in having a captive strategy is that the management of the company should have good relationship with the acquiring management. There is a risk in the captive strategy but if managed well the captive strategy can be a win-win for both the captive and the captor companies. The case of Samsung also highlights how a company which started as a captive supplier to larger brands like Electrolux ultimately became a bigger brand than the captor company itself. The captive company thus can develop its own brands and prosper in the long-run. Though most managers do not like to get into a captive relationship because it involves giving up control, many companies still end up getting into captive strategy because they increasingly depend on one customer for sales.

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