Retrenchment Strategy

What is Retrenchment Strategy? Definition, Types, Adopting Reasons, & Pros/Cons

What is Retrenchment Strategy?

A retrenchment strategy can be defined as the process to retrench weak business units with the aim to maintain a stable financial position.

Retrenchment here refers to cutting down or reducing. Firms retrench products or services that are no longer profitable as they increase only expenses. Retrenching also goes for employees when there are more employees but the productivity is low.

A retrenchment strategy is one of the corporate-level strategies in which the main objective is to cut down or reduce business activities that are only generating excessive expenses in order to achieve financial stability.

Usually, firms pursue retrenchment strategies when it has a weak competitive position in some or their entire product lines resulting in a poor performance like sales down, and profits becoming losses. In such a situation, a company attempts to reduce its scope partially or fully.

If the environment is highly competitive as there is cut-throat competition, this strategy may be suitable. Under this, the existing market, products, and activities of an organization are retrenched (cut down or reduced).

This strategy may be useful when the firm’s product is in the declining stage of the product life cycle. Following this strategy also results in organizational activities decreasing and cash flow also gets negative.

Types of Retrenchment Strategy

There are four main strategies under the retrenchment strategy. They are:

Turnaround Strategy

As we discussed retrenchment means partially or fully leaving the poor-performing units. Here, the turnaround strategy refers to an attempt to decrease the rate of negative performing business units and make improvements.

This is also referred to as a management measure where weak performing say-activities are turned around for a healthy position. Under turnaround strategy, such weak business units are selected that still have the potential to bring positivity i.e. some profits to the organization.

As so, this strategy emphasizes the improvement of operational efficiency. This also is achieved by cutting costs, expenses, and selling assets. It is suitable when a company’s problems are pervasive but not critical.

Captive Company Strategy

The captive company strategy involves giving up independence in exchange for security. A firm with a weak competitive position may not be able to take the turnaround strategy in such a situation it has to opt for a captive strategy.

As the firm is continuously facing declining sales and declining profits, it desperately seeks to increase sales and profitability. In such a situation it makes an angle with one of its largest buyers who then will buy its products.

As such the firm becomes captive to this customer. In doing so, the firm may get assured of sales and security and its marketing costs also got reduced. But in return, it has to lose its independence.

Sell-Out/Divestment Strategy

If a company has a very weak competitive position and is not able to adopt a turnaround strategy or captive company strategy, it is better for it to go for a sell-out/divestment strategy.

This strategy makes sense if management can still obtain a good price for its shareholders and the employees can keep their jobs by selling the entire company to another firm.

If the company gets a good price from its sales the shareholders of the company get a good return for their investment. And, employees may also get a chance to stay in their current jobs.

The best part of the sell-out strategy is that if the firm still has some possibilities the buying company having a good resource base and competency can effectively turnaround and generate reasonable profits.

Bankruptcy and Liquidation Strategy

This is the worst situation for a firm. This situation comes when the firm can not adopt any of the turnaround, captive, and sell-out strategies.

Bankruptcy involves giving up management of the firm to the courts in return for some settlement of the company’s obligation. The management believes that once the court decides the claims of the company, the company will be stronger and better able to compete in a more attractive industry.

And, liquidation is the termination of the firm. When the industry is unattractive and the company is too weak to continue, liquidation may be a viable option.

Reasons for Adopting Retrenchment Strategy

No firm wants to be in a condition of bankruptcy or liquidation. Every firm’s goal is to grow and sustain itself in long run.

But due to some reasons, they have to go through this strategy. The major reasons for companies to adopt a retrenchment strategy may be the following.

  • When a firm’s one or more business units (activities) are performing weakly.
  • When a firm wants to retrench its weak-performing units or activities.
  • When the product is in the decline stage of PLC.
  • When there is cut-throat competition in the market.
  • When the environment is highly uncertain.
  • When the management is no longer able to manage the company.
  • When a firm wants to make improvements on its weak-performing business units.
  • And, when the analysis shows sell-out or liquidation is better than managing the existing operation.

Advantages and Disadvantages of Retrenchment Strategy

Following are some of the notable advantages and likely disadvantages of retrenchment strategies.

Advantages:

  • If the present performance of the organization is not satisfactory and opportunities lie in other businesses, this strategy is considered suitable.
  • This strategy may also be suitable when the environment is highly uncertain.
  • It is also a suitable strategy if an organization is going through a deep crisis.
  • Through this strategy, the overall profitability can be enhanced by concentrating the business activities on only profitable products.
  • Retrenchment may lead to improvement in business efficiency.

Disadvantages:

  • Due to the retrenchment of business activities, the profit may decrease.
  • Retrenchment may also affect the existing economies of scale.
  • The organization may not be able to serve customer demand with a smaller (reduced) workforce.

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