Strategies for Getting Smaller
“In what industry or industries should our firm compete?” is the central question addressed by corporate-level strategy. In some cases, the answer that executives arrive at involves exiting one or more industries.
In the early twentieth century, many military battles were fought in series of parallel trenches. If an attacking army advanced enough to force a defending army to abandon a trench, the defenders would move back to the next trench and try to refortify their position. This small retreat was preferable to losing the battle entirely. Trench warfare inspired the business term retrenchment. Firms following a retrenchment strategy shrink one or more of their business units. Much like an army under attack, firms using this strategy hope to make just a small retreat rather than losing a battle for survival. Retrenchment is often accomplished through laying off employees.
Example 7.9 Retrenchment
In January 2019, Buzzfeed, announced it would cut 15 percent of its jobs following an evaluation of the “evolving economics of digital platforms.” This was just one of several announced media layoffs in a short period of time. Earlier Verizon Communications announced it would cut 7% of its digital-media operations including operations involving its AOL, Yahoo, and Huffington Post operations. In a separate announcement Gannett, Inc. announced it would reduce staff in several of its newspaper companies. In its announcement, Buzzfeed pointed to the need to “reduce our costs and improve our operating model so we can thrive and control our own destiny.”
Source: Bloomberg, BuzzFeed to Cut 15% of Jobs in Latest Digital-Media Retrenchment, 2019Wi
This is a common rationale for retrenchment—by shrinking the size of a firm, executives hope that the firm can survive as a profitable enterprise.
Executives sometimes decide that bolder moves than retrenchment are needed for their firms to be successful in the future. Divestment refers to selling off part of a firm’s operations. In some cases, divestment reverses a forward vertical integration strategy, such as when Ford sold Hertz. Divestment can also be used to reverse backward vertical integration. General Motors (GM), for example, turned a parts supplier called Delphi Automotive Systems Corporation from a GM subsidiary into an independent firm. This was done via a spin-off, which involves creating a new company whose stock is owned by investors. GM stockholders received 0.69893 shares of Delphi for every share of stock they owned in GM. A stockholder who owned 100 shares of GM received 69 shares of the new company plus a small cash payment in lieu of a fractional share.
Example 7.10 Divestment
General Electric divested by disposing of a unit of GE Aviation, called MRA Systems LLC, to ST Engineering. By doing this, GE will earn about $630 million in cash by the first quarter of 2019 if all goes as planned. The company made many plans in June of 2018 to restructure their company, and this is just one example of how they’re using divestment to try and increase shareholder value.
Source: Zachs, General Electric’s GE Aviation Unit to Divest MRA Systems, 2018Fa
Divestment also serves as a means to undo diversification strategies. Divestment can be especially appealing to executives in charge of firms that have engaged in unrelated diversification. Investors often struggle to understand the complexity of diversified firms, and this can result in relatively poor performance by the stocks of such firms. This is known as a diversification discount. Executives sometimes attempt to unlock hidden shareholder value by breaking up diversified companies.
Executives are sometimes forced to admit that the operations that they want to abandon have no value. If selling off part of a business is not possible, the best option may be liquidation. This involves simply shutting down portions of a firm’s operations, often at a tremendous financial loss. GM has done this by scrapping its Geo, Saturn, Oldsmobile, and Pontiac brands. Ford recently followed this approach by shutting down its Mercury brand. Such moves are painful because massive investments are written off, but becoming “leaner and meaner” may save a company from total ruin.