What is Retrenchment Strategy? Types: Turnaround, Divestment, Liquidation Strategies

What is Retrenchment Strategy?

A retrenchment strategy is a corporate-level strategy that aims to reduce the size or diversity of organisational operations. At times, it also becomes a means to ensure an organisation’s financial stability. This is done by reducing the expenditure. A retrenchment strategy is designed to fortify an organisation’s basic distinctive competence.

In simple terms, a retrenchment strategy involves abandonment operations that are no longer profitable for the organisation. It also includes withdrawal of the business from markets where even sustenance is difficult.

For example, a corporate hospital that generates highest revenue from the cardiology department and very less revenue from the neurosurgery department, may decide to focus only on cardiology and eventually shut down the neurosurgery department to maximise the revenue.

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 organisation.

A retrenchment strategy aims at the contraction of an organisation’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 organisation suffers continuous losses.

Organisations follow a retrenchment strategy for various reasons. These include divestment of a business, or the strategic mismatch of a particular business with an organisation’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 organisation.

Basically, retrenchment strategies are a response to decline in industries and markets. Most of the external factors that lead to such decline are as follows:

• New dominant technologies
• New business models
• Adverse government rules and regulations
• Changing customer needs and preferences
• Emergence of substitute products
• Demand saturation

Apart from the external factors, there are several internal factors that may cause decline in industries and markets. Some of the major internal factors leading to decline are as follows:

• Ineffective top management
• Inappropriate strategies
• Excess liabilities
• High costs
• Ineffective sales and marketing
• Poor quality of functional management
• Wrong organisational design

The consequences of decline are often seen in several problems faced by an organisation. The major consequences of decline are:

• Falling sales
• Increasing debt
• Diminishing profitability
• Shrinking market share
• Loosing goodwill and credibility
• Declining cash flow

These consequences may give rise to the following situations:

• Non-recoverable situation: It refers to a situation where there are no chances of recovery for the organisation. In this, there is no scope of improvement as costs are increasing and the demand of products is declining.
  
  
• Temporary recovery situation: It involves a recovery for a minor period. In this situation, repositioning of the product, cost reduction and revenue generation is possible.
  
  
• Sustained survival situation: It implies a situation where a little potential for growth is possible. The industry may be on the verge of slow decline.
  
  
• Sustained recovery situation: It means a situation where longterm recovery is possible as decline is caused by the internal factors rather than external factors. It is normally implemented through new product development or market repositioning.

Types of Retrenchment Strategies

Retrenchment strategies are largely governed by the preceding consequences of organisational losses. Retrenchment strategies are of three types, which are shown in Figure:

• Turnaround Strategies
  
• Divestment Strategies
  
• Liquidation Strategies

Turnaround Strategies

Turnaround strategies are defined as a set of strategies that help in managing, establishing, funding and fixing a distressed organisation. These strategies aim at reversing the negative trend and turning around the organisation to profitability. In other words, turnaround strategies help an organisation to regain satisfactory levels of profitability, cash flow and liquidity.

There are certain conditions that necessitate the usage of the turnaround strategy if the organisation wants to survive.

Some of the major conditions for turnaround strategies are as follows:

• Declining revenues/market share
• Persistent negative cash flow
• Negative profit
• High turnover of employees
• Lack of adequate resources
• Poor execution of projects
• uncompetitive products/services
• Burden of high debt
• Insufficient financial control

An organisation that faces one or more aforementioned conditions is often declared as a ‘sick organisation. The management of the turnaround often involves replacing the existing team, specially the Chief Executive Officer (CEO), or merging the sick organisation with a healthy one.

When the CEO is replaced by another, the new CEO follows one of the following two turnaround approaches:

• Surgical approach: The CEO following the surgical turnaround approach follows a tough attitude. He/she may quickly assert his/ her authority by issuing orders for changes, firing employees, closing down plants and divisions, changing the product mix, controlling marketing and financial activities, etc. He/she may keep following this approach until the business starts showing the signs of turning around.
  
  
• Non-surgical or humane approach: The CEO following the non-surgical turnaround approach focuses on understanding problems, eliciting opinions, adopting a conciliatory attitude and coming to negotiated settlements. This approach focuses majorly on behavioural change and improvement in the work culture and employee morale.

Apart from this, turnaround strategies, in order to be successful, also require to focus on short-term and long-term financing needs along with other strategic issues. The action plan for turnaround should include:

• Analysing product, market, production process, competition, etc.
• Understanding the market place and production logic
• Implementing plans based on set-targets, feedback and remedial action

Divestment Strategies

A divestment strategy is another form of retrenchment strategy and is used to downsize the scope of a business by selling or liquidating a portion of the business. This strategy is a part of the restructuring plan and is practiced when a turnaround has been attempted and proven a failure. This strategy is also called a divestiture or cutback strategy. The alternative of this strategy is harvesting strategy, which includes a process of gradually letting an organisation wither away in a carefully controlled and standardised manner.

The reasons for the adoption of the divestment strategy are as follows:

• Predicting that continuity of the business would be unviable
  
  
• Increasing financial problems because of negative cash flows
  
  
• Increasing competition and inability of the organisation to cope with it
  
  
• Mismatching of resources in case of mergers and acquisitions; it happens when the resources of one organisation are not useful for the other organisation
  
  
• Failing to invest in technological advancements
  
  
• Getting an opportunity to invest in a better alternative rather than in an unprofitable business

The following two are choices available to an organisation for divestment:

1. Divesting a part of an organisation to make it financially independent. However, partial ownership is retained by the parent organisation
   
   
2. Selling an organisation completely

Liquidation Strategies

Liquidation strategies are the most unattractive and severe retrenchment strategies, as the strategies involve closing down an organisation and selling its assets. It can be referred as the last resort for the organisation.

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 in 2008. The organisation’s inability to discharge its debts and liabilities was the reason behind this decision.

Selling assets for implementing a liquidation strategy may be difficult because of the difficulty to find buyers.

According to Companies Act, 1956, liquidation or winding up may be done in the following three ways:

• Compulsory winding up under the supervision of the Court
• Voluntary winding up
• Voluntary winding up under the supervision of the Court