Strategic Management - Downsizing

Companies often need to downsize themselves to be lean and compete better against stiff competition. The idea is to make a more productive company incur lesser costs. There are mainly two major ways to downsize, known as Retrenchment and Restructuring.

Retrenchment

In the early 20th century, battles in World War I, occurred in series of parallel trenches. If an attacking army forced the enemy to abandon a trench, the defenders used to move back to the next trench. The handy adjustments were far more preferable to losing the battle completely. Retrenchment, a popular business strategy now, owes its origin to this trench warfare. Firms that follow retrenchment strategy generally shrink one or more business units.

Retrenchment is accompanied often by laying off employees. This reduces the overall cost of management and provides a better way to manage the employees more productively. This type of strategy is best applicable to a saturated and low margin market such as groceries where retailers look to add non-food merchandise to their stocks to improve the bottom line.

Restructuring

Some better and more effective strategies are needed for some firms to survive and become successful in the future. Divestment means selling off a portion of the firm’s operations. Sometimes, divestment usually reverses a forward vertical integration strategy, such as in the case where Ford sold Hertz. Divestment can also lead to reverse backward vertical integration.

General Motors (GM), once turned their parts supplier, called Delphi Automotive Systems Corporation, from the original GM subsidiary into a newly formed and independent firm. This was done via a spin-off, which includes creating a completely new company the stock of which is owned by investors. This often accompanies stock splits for large companies.

Divestment can also help the company to undo diversification strategies. Firms that have engaged in unrelated diversification find the diversification strategies more useful. Investors, however, often find it complex to understand the process of diversified firms, and this can result in relatively poor performance by the stocks of such firms. This is called diversification discount.

Executives sometimes break up diversified companies to derive the stock value. Sometimes, the operations of a firm have no value at all. When sale of a part of business is not possible, the best option may be liquidation. In liquidation, the parts that generate no value are simply shut down, often at a tremendous financial loss.

GM has liquidated its Geo, Saturn, Oldsmobile, and Pontiac brands. Such moves are painful as large portions of investments have to be written off, but becoming “leaner and meaner” may at least save the company from becoming obsolete.