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Friday, January 25, 2013

TURNAROUND STRATEGY


TURNAROUND STRATEGY
 

Turnaround is a strategy adopted by firms to arrest the decline and revive their growth. A turnaround situation exists when a firm encounters multiple years of declining Financial performance subsequent to a period of prosperity (Bibeault, 1982; Hambrick & Schecter, 1983; Schendel et al., 1976; Zammuto & Cameron, 1985). Turnaround situations are caused by combinations of external and internal factors (Finkin, 1985; Heany, 1985; Schendel et al., 1976) and may be the result of years of gradual slowdown or months of precipitous financial decline. The strategic causes of performance downturns include increased competition, raw material shortages, and decreased profit margins, while operating problems include strikes and labour problems, excess plant capacity and depressed price levels. The immediacy of the resulting threat to company survival posed by the turnaround situation is known as situation severity (Altman, 1983; Bibeault, 1982; Hofer, 1980). Low levels of severity are indicated by declines in sales or income margins, while extremely high severity would be signaled by imminent bankruptcy. The recognition of a relationship between cause and response is imperative for a turnaround process and hence, the importance of properly assessing the cause of the turnaround situation so that it could be the focus of the recovery response is very important. 
 

Turnaround Process 
 
The Turnaround Process begins with a depiction of external and internal factors as causes of a firm’s performance downturn. If these factors continue to detrimentally impact the firm, its financial health is threatened. Unchecked financial decline places the firm in a turnaround situation. A turnaround situation represents absolute and relative-to-industry declining performance of a sufficient magnitude to warrant explicit turnaround actions. A turnaround is typically accomplished through a two stage process. The initial stage is focused on the primary objectives of survival and achievement of a positive cash flow. The means to achieve this objective involves an emergency plan to halt the firm’s financial haemorrhage and a stabilization plan to streamline and improve core operations. In other words, it involves the classic retrenchment activities: liquidation, divestment, product elimination, and downsizing the workforce. Retrenchment strategies are also characterized by the revenue generating, product/market refocusing or cost cutting and asset reduction activities. While cost cutting, asset reduction and product/market refocusing are easy to visualize, the idea of revenue-generating is best captured by a strategy that is characterized by increased capacity utilization, and increased employee productivity.
 


Retrenchment is an integral component of turnaround strategy. The critical role of retrenchment in providing a stable base from which to launch a recovery phase of the turnaround process is well established.. Many firms that have achieved a reversal of financial or competitive decline inevitably refer to the presence of retrenchment as a precursor or prelude to the implementation of a successful recovery strategy (Bibeault,1982; Finkin, 1985; Goodman, 1982; Hall, 1980). The question remains, however, as to why retrenchment is so frequently an appropriate first step in an overall turnaround process. One possible explanation is that economic decline diminishes the firm’s resource slack. Cost retrenchment helps to preserve the residual resources. Resource flexibility provides additional slack and is achieved through asset redeployment Resource flexibility must be substituted for slack that has been largely depleted, or when the heightened requirements of strategic redirection place additional demands on the firm for resources. These heightened requirements stem from concurrent demands on the firm to overcome the destructive momentum of the established strategy and to cover the high start-up costs of implementing the new strategic initiatives. Consequently, retrenchment may be necessary to stabilize the situation by securing or providing slack regardless of the subsequent recovery strategy that is chosen.
 

The second phase involves a return-to-growth or recovery stage (Bibeault, 1982; Goodman, 1982) and the turnaround process shifts away from retrenchment and move towards growth and development and growth in market share. The means employed for achieving these objectives are acquisitions, new products, new markets, and increased market penetration. The importance of the second stage in the turnaround situation is underscored by the fact that primary causes of the turnaround situation have been associated with this phase of the turnaround process- the recovery response (Hofer, 1980; Schendel et al., 1976). For firms that declined primarily as a result of external problems, turnaround has most often been achieved through strategies based on an revenue driven reconfiguration of business assets. For firms that declined primarily as a result of internal problems, turnaround has been most frequently achieved through recovery responses that were heavily weighted toward efficiency maintenance strategies. Recovery is said to have been achieved when economic measures indicate that the firm has regained its pre-downturn levels of performance.
 

Between these two stages, a clear strategy is needed for a firm. As the financial decline stops, the firm must decide whether it will pursue recovery in its retrenchment reduced form through a scaled-back version of its pre-existing strategy, or whether it will shift to a return-to-growth stage. It is at this point that the ultimate direction of the turnaround strategy becomes clear. Essentially, the firm must choose either to continue to pursue retrenchment as its dominant strategy or to couple the retrenchment stage with a new recovery strategy that emphasizes growth. The degree and duration of the retrenchment phase should be based on the firm’s financial health.
 

Turnaround Situations: Severity and Speed of Strategic Response
 

The nature, extent and speed of the appropriate strategic response depends primarily on two dimensions of the turnaround situation: severity and causality. Severity of the turnaround situation is a measure of the firm’s financial health; it gauges the magnitude of the threat to company survival. Since the immediate concern to the firm is the extent to which the decline is a threat to its short-term survival, severity is the governing factor in estimating the speed with which the retrenchment response will be formulated and activated. Of course, performance that declines relative to that of competitors, but not absolutely, may necessitate almost no retrenchment. Rather, a reconsideration of strategy with a probable reconfiguration of assets would usually be deemed appropriate.
 

When severity is low, a firm has some financial cushion. Stability may be achieved through cost retrenchment alone. When the turnaround situation severity is high, a firm must immediately stabilize the decline or bankruptcy is imminent. Cost reductions must be supplemented with more drastic asset reduction measures. Assets targeted for divestiture are those determined to be underproductive. In contrast, more productive resources are protected from cuts or reconfigured as critical elements of the future core business plan of the company, i.e., the intended recovery response.
 

In addition, Robbins and Pearce found that the severity of the turnaround situation was the best indicator of the type and extent of retrenchment that was needed, although an immediate cost cutting response to financial decline (absolute and relative to the industry) was consistently found to be of value. The researchers also presented a model of turnaround based on evidence that business firm turnaround characteristically involved a multi-stage process in which retrenchment could serve as either a grand or operating strategy. Hofer (1980) conceptualized a link between severity of the downturn and the degree of cost and asset reductions that a firm should include in its recovery response. He referred to cost and asset reduction activities as operating turnaround strategies. Operating strategies designed for cost reduction were recommended for firms in less severe turnaround situations. Drastic cost reductions coupled with asset reductions were recommended for firms in more severe turnaround situations i.e., more severe problems require more drastic solutions. Usually, asset reduction is more drastic than cost reduction.
 

As the importance of external environmental factors assume importance relative to the internal factors, effective and innovative activities are more appropriate in the recovery phase of the turnaround process. If the reverse is true, efficiency maintenance activities are more appropriate. In either case, the recovery phase of the turnaround process is likely to be more successful in accomplishing turnaround when it is preceded by proactively structured retrenchment which results in the achievement of near-term financial stabilization. Innovative turnaround strategies involve doing things differently whereas efficiency turnaround strategies entail doing the same things on a smaller or more efficient scale. Revenue generating through product reintroduction, increased advertising and selling efforts, and lower prices represent modifications in existing strategy and can, therefore, be classified as innovative turnaround strategies In other words, innovative turnaround strategies involve product or market based activities while efficiency strategies focus on the production and management systems within the firm.
 

O’Neill (1986) investigated the relationship of contextual factors to the effectiveness of four primary turnaround strategies:
 

1.   Management (new head executive, new definition of business, new top management team, morale building among employees),
2.   Cutback (cost cutting, financial and expense controls, replacing losing subsidiaries),
3.   Growth (new product promotion methods, entering new product areas, acquisitions, add markets), and
4.   Restructuring (change in organizational structure, new manufacturing methods).
 

His model predicted a negative relationship between growth strategies and turnaround success where there were strong competitive pressures. Where firms were in weak market positions, success was found for cutback and restructuring strategies. For firms competing in mature or declining industries, efficiency or operating recovery strategies offer the best prospects for successful turnaround. Retrenchment (cost cutting and asset reducing) are sufficient under certain circumstances to reestablish the long term viability of the firm 

Refer to turnaround case study of Kirloskar Pneumatic Company limited below:
 

Kirloskar Pneumatic Company Limited-Turnaround Success 

 
Kirloskar Pneumatic Company Limited (KPC) was set up in 1958. It started operations with the manufacture of air compressors and pneumatic tools in collaboration with Broom and Wade Ltd., U.K. and then diversified into Airconditioning, Refrigeration and Transmission. Currently its activities are grouped into four major divisions: Air-Compressor, Air-conditioning and Refrigeration, Hydraulic Power Transmission and Process gas. 

During the recession in the late 1990s, the sales bottomed out and the management realized that the business could not grow any more. This triggered a period of introspection and the company started looking inwards. Every time any business hits the bottom, there are two perspectives – external and internal. Since the management had little control over external factors, it focused on managing the internal working of the company. Fortunately, even on the external front, the company had a chance to buy out one of their major competitors – K G Khosla. The move started in 1994 when KG Khosla Company became sick and the ICICI requested the Kirloskars to manage this business. Subsequently both the companies, KPC & KG Khosla, were merged in the year 2000.
 

The first thing KPC management team did was to understand the business of KG Khosla - their product lines, style of business, etc. Then it started leveraging the synergies between the two companies. Since the sales of the KPC were already bottoming out and the Khosla product line with its manufacturing facilities was added to its plant in Pune, the company was left with no other option except to cut costs across the board. By the end of 2000, the management of KPC had through an understanding with the staff at Faridabad plant of KG Khosla reduced the employee strength considerably. The VRS at Faridabad was introduced with a total understanding with the parting staff. KPC then shifted 90 people from Pune to Faridabad for about three months during which time the company saw to it that the production continued at Faridabad with these workers. After this activity at Faridabad, the company also restructured its Pune plant by reducing the strength by 650 people. The final strength of employees at both the plants after this whole downsizing exercise finally stood at 800.
 

The company then turned its attention on restructuring its debt to bring the interest costs down. The third element of improvement was adding new product lines to its existing range while concentrating on improving the efficiency of its existing products. As a result, KPC turned around after successful implementation of all these well planned initiatives during the period 1999 – 2002.
 

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