3.9 Strategic methods

• Retrenchment


  When a business decides to significantly cut or scale back its activities, and use their resources more effectively/carefully
• Factors that cause retrenchment

  • Uncompetitive cost structure
  • Inadequate returns on investment
  • Poor competitive position
  • Financial distress (e.g. decline in sales revenue)
  • Market decline – more people buy online rather than going to department stores
  • Failed takeovers
  • Economic downturn (e.g. during a recession, a firm will reconsider their options)
  • Change of ownership
• Methods of retrenchment

  • Reduced output and capacity
  • Product and market withdrawal
  • Downsizing/rationalisation
  • Disposals of business units
  • De-mergers
• Why businesses grow


  • Profit
  • Costs – economies of scale in the long run increase the productive capacity of the business whilst also leading to lower average costs
  • Market share
  • Risk
  • Managerial – motivational theories of the firm predict that business expansion might be accelerated by the demands of senior and middle managers whose objectives differ from major shareholders
• Organic (internal) growth


  Expansion from within a business, for example by expanding the product ranges or number of business units and location
• Types of organic growth

  • Developing new product ranges
  • Launching existing products directly into new international markets (e.g. exporting)
  • Opening new business locations – either in the domestic market or overseas
  • Investing in additional production capacity or new technology to allow increased output and sales volume
• Advantages of organic growth

  • Less risk than external growth (e.g. takeovers)
  • Can be financed through internal funds (e.g. retained profits)
  • Builds on the firms strengths (e.g. brands, customers)
  • Allows the business to grow at a more sensible rate
• Disadvantages of organic growth

  • Growth achieved may be dependant on the growth of the overall market
  • Hard to build market share if business is already a leader
  • Slow growth – shareholders may prefer more rapid growth as they will receive lower dividends
  • Franchises (if used) can be hard to manage effectively
• External growth


  Expansion from outside the business mostly through mergers (where two company's work together usually because both are starting to become unsuccessful) and takeovers (original company no longer exists)
• For positive synergy to occur, the result should mean higher revenue or profits than the two individual businesses achieved
• Barriers to growth


  • Economies of scale (including technical, purchasing, and managerial) and diseconomies of scale
  • Economies of scope
  • The experience curve
  • Synergy
  • Overtrading
• Economies of Scope


  It is cheaper to produce a range of products rather than specialise in an handful of products
• Experience Curve


  A curve showing the theory that the more experienced the firm is at making a product, the better, faster, and cheaper it is able to make it
• As firms grow, they gain experience which provides an advantage over the competition in the industry
• The 'experience effect' of lower unit costs is likely to be particularly strong for large and successful businesses (market leaders)
• Evaluative factors of the experience curve

  • Market leaders often become complacent
  • Experience can cause resistance to change and innovation
  • This could cancel out cost benefits of experience
  • The experience curve concept is a relatively old theory that is less relevant in a competitive environment that changes is rapidly
• Synergy


  The value of two businesses brought together is higher than the sum of the value of the two individual businesses
• Cost synergies


  • Eliminating duplicated functions and services (e.g. combining the two accounting departments)
  • Getting better deals from suppliers which might be possible if combining two businesses gives them improved bargaining power
  • Higher productivity and efficiency from shared assets; can capacity utilisation of the combined businesses be improved, perhaps by closing down spare capacity
• Revenue synergies


  • Marketing and selling complimentary products
  • Cross selling into a new customer base
  • Sharing distribution channels
  • Access to new markets (e.g. through existing expertise of the takeover target)
  • Reduced competition – more control over the market
• Overtrading


  When a business expands too quickly without having the financial resources (capital employed and working capital) to support such a quick expansion
• Symptoms of overtrading

  • High revenue growth but low gross and operating profit margins
  • Persistent use of a bank overdraft facility
  • Significant increases in the payables days and receivables days ratios
  • Significant increase in the current ratio (current assets and current liabilities)
  • Very low inventory turnover ratio
  • Low levels of capacity utilisation
• Managing the risk of overtrading

  • Reducing inventory levels
  • Scaling back the pace of revenue growth until profit margins and cash reserves have improved
  • Leasing rather than buying capital equipment
  • Obtaining better payment terms from suppliers
  • Enforcing better payment terms with customers (e.g. through prompt payment discounts)
• Greiner's Model of Growth


  Suggests and attempts to predict that there are six phases and five crises that businesses may experience as they grow

  
• Greiner's growth model phases

  • Direction – crisis of leadership
  • Delegation – crisis of autonomy
  • Coordination – crisis of control
  • Collaboration – crisis of red tape
  • Alliances – crisis of growth

  
• Evaluative points of Greiner's growth model

  • Growth is a difficult thing to achieve
  • Growth poses many management and leadership challenges (crises) that firms have to overcome
  • Leadership and organisational structure have to evolve to reflect the growth of a business
  • Businesses that don't adjust as they grow will experience lower growth than those that do

  
• Disadvantages of Greiner's growth model


  • It is simplistic
  • Not every business will suffer crises as it grows as many adapt easily without enduring any obvious panics or crises
  • The model doesn't really take account of the pace of growth, particularly in an increasingly dynamic external environment
• Constraints on growth


  • Resistance to change by employees and unions
  • The cost of implementation
  • Availability of finance
  • The time period required
  • The effect upon the brand image and marketing
  • Types of organisational culture
• Cost of implementing growth

  • Short term owners (shareholders) may not see the need for the change which undermines their profit and dividends
  • Fixed costs in terms of an increase in salaries and management systems
  • Variable costs in terms of an increase in payments to reward performance
  • Sunk costs in terms of reorganising employees and training
• Availability of finance to implement change

  • Banks may be unwilling to lend to a business that needs to change as the risk may be deemed too high
  • The returns from the growth are difficult to quantify and hence justify finance
• Time needed to implement growth

  • Individuals need time to adapt to the change
  • High labour turnover may undermine successful implementation of growth
  • Short term objectives must support the overall strategy rather than undermine it
• Marketing implications of growth

  • Bad social media or press reviews may undermine the morale of the employees as the organisation changes
  • Marketing campaigns may need to be adapted to signal a change in the organisation of the business and how it affects customers
  • Attention must be paid to the quality of service and the goods to ensure that they meet the expectations of the customer
  • The change may cause an aggressive response from competitors
• Backward Vertical Integration


  Acquiring a business operating earlier in the supply chain (e.g. a retailer buys a wholesaler)
• Conglomerate Integration


  The combination of firms that are involved in unrelated business activities
• Forward Vertical Integration


  Acquiring a business further up in the supply chain (e.g. a vehicle manufacturer buys a car parts distributer)
• Horizontal Integration


  Businesses in the same industry and which operate at the same stage of the production process are combined
• Merger


  A combination of two previously separate firms which is achieved by forming a completely new business into which the two original firms are integrated
• Takeover (or Acquisition)


  One business acquiring control of another business
• Positive synergy

  When the net profit would be much more than what it was before
• Merger


  Combination of two previously separate firms into a completely new business
• A merger can be seen as a decision made by two businesses that are broadly "equal" in terms of factors such as size, scale of operations, customers etc.