CORPORATE RESTRUCTURING: DOWNSCOPING
The contemporary business environment requires businesses to restructure in order to meet the changing market needs, increase their operational efficiency and effectiveness. Corporate restructuring entails divesting, exiting business lines and spinning off assets. Restructuring refers to the reorganisation of a firm with the aim of attaining greater profit and efficiency or to acclimatize with changes in the market (Hitt, Ireland & Hoskisson 2016). It entails bringing about fundamental or drastic internal shifts that changes the links amid different elements or components of a firm. Restructuring is an approach through firms alters their set of business operations and financial structure. It involves making shifts to the set up of a firm where these shifts hold an effect on the flow of information, responsibility and authority across a firm. When making decisions for restructuring of a firm, managers consider restructuring histories because prior experiences can be drawn upon to reduce mistakes, enhance decision-making and reduce the anxieties of stakeholders. Corporate restructuring is utilised to downsize, downscope or refocus diversification strategy. The focus of this brief overview is on downscoping restructuring strategy.
Reasons for Downscoping
Most business organisations cannot continue to operate in the same way perpetually. With changing business circumstances and changing times, firms opt for restructuring as it entails one of the options for firms to be productive and remain on track. However, businesses employ restructuring differently from growth and diversification to lowering losses and reducing costs (Liao 2004). Firms restructure because of external facets such as acquisition or merging with other firms. More so, firms restructure for internal aspects such as increased costs of productions or operations. Restructuring of a business aims at improving the structure of the firm as well as its operating effectiveness. Although firms employ restructuring strategies to deal with acquisitions that do not attain the expectations of the firm, they sometimes employ these strategies because of other shifts detected in their external business setting. For instance, when opportunities surface in an organisation’s external environment, firms employ restructuring strategies to help them pursue these opportunities and integrate their operations. In addition, firms restructure to position themselves in a way that creates more value to the stakeholders. Business restructuring handles the business portfolio shifts that firms undertake in order to address problems being faced by the firms or to establish a more profitable enterprise (Liao 2004). Environmental shifts causes organisations to revise their mental models and assumptions. As a result, restructuring is done at different levels so that firms and their implemented strategies are aligned with the environmental realities. Firms restructure through downscoping in order to reduce their level of diversification. Organisations divest unrelated businesses in order to reduce the level of diversification. Getting rid of unrelated businesses makes it easier for firms and their top management to refocus the core businesses. According to Hitt, Ireland and Hoskisson (2016), the principal goal of restructuring is to gain or re-establish effective strategic control of a firm. Of the three major restructuring strategies, downscoping is associated the most closely with developing and utilising strategic controls.
According to Bergh and Lim (2008), business restructuring is used to downsize, downscope or refocus diversification approach conducted via different modes or alternatives that include equity carve-outs, spin-offs and sell-offs. The most popular modes for executing restructuring are the spin-off and sell-off. A sell-off takes place when assets are sold from one organisation to another in exchange for securities or cash. A spin-off, on the other hand, takes place when a firm distributes all its shares in a subsidiary to its shareholders and in the process establish a separate publicly traded organisation from the spun-off assets (Bergh & Lim 2008). Spin-offs and sell-offs represent different means of restructuring. While sell-offs are utilised to transfer assets to other firms that may realise higher value from their acquisition and calls for liquidation process and how restructured assets will marketed and transactions managed, spin-offs are used to separate assets that hold promising and high growth potential prospects. Spin-offs involve assets that reside in or are linked to the restructuring firm’s core business lines. Downscoping is a form of a spin-off. According to Hitt, Ireland and Hoskisson (2016), downscoping entails spin-off, divestiture or some other means of getting rid of businesses that are not linked to the core businesses of a firm. Downscoping hold impacts that are more positive on the performance of a firm compared to downsizing. According Geiger and Gashen (2007), downscoping is employed to describe programs of strategic divestiture carried out to refocus the firm on its core businesses and back to a more optimal diversification level. Downscoping demonstrate positive effects on a firm’s performance because it allows firms to retain employees who are key to the core businesses of the firm. It lowers the level of a firm’s unrelatedness.
Effective downscoping may involve both continued growth and divestitures in the firm’s principal core businesses. Therefore, downscoping is different from downsizing. While downsizing involves strategically laying-off workers during periods of economic stress, such actions are different from downscoping. Downscoping focuses on refocusing to capture appropriate strategic control of a firm (Jun & Sali 2013). Downscoping is advantageous to firms because lowering the diversity of businesses in the portfolio allows top-level managers to manage more efficiently because they are in a better position to tackle the related and core businesses. Indian firms use dwnscoping as their most preferred restructuring strategy (Jun & Charles 2011). Through downscoping, both the parent and spin-off firm usually demonstrate increases in shareholder value and accounting performance after the spin-off. However, downscoping can only be successful when it results in refocusing a firm’s core businesses and in turn on its core competencies.
Antecedents of Downscoping
According to Geiger and Gashen (2007), numerous explanations have been provided to explain why firms reconfigure their assets portfolios. Five major facets have been provided as key antecedents of downscoping. These factors include poor governance, which makes firms to over-diversify, poor overall firm performance, poor formulation of strategy, changing regulatory and business environments and the desire to gain novel cash flows. Management buyouts and managerial incentives compared to whole-firm buyouts and employee buyouts are triggers of downscoping. According to Liao (2004), macro-environmental factors that instigate downscoping include the desire to take advantage of core capabilities, increasing global competition, deregulation of some industries and turbulence prompted by demand change and technological innovations. The environmental aspects may make firms to re-examine their business ideas and reconsider capabilities, and restructure their business portfolio in order to be productive. Organisational factors that prompt restructuring include poor corporate governance and an increased size and scope of a firm that does not increase the shareholder value.
Consequences of Downscoping
Downscoping instigates positive effects on a firm. These consequences include the reassertion of strategic controls, increased Research and Development expenditures, increased overall market value and performance. These upshots linked to downscoping impacts CEO compensation. Downscoping instigates fewer and more akin operating units that are centred around a firm’s core resources. As a result, firms can establish constricted spans of flexibility and control for top executives, which consequently enable them to reassert strategic controls. Strategic controls centre on the long-term performance where the formulation of business-level policies and the strategic activities of unit managers are assessed instead of the specific upshots of such actions and strategies. Organisations that stress financial controls assess and reward their managers on the objective financial principles that include return-on-investment (Liao 2004). When employing strategic controls, top managers are in a position to control the strategic behaviours and actions of the various units’ executives rather than focusing on financial outcomes. However, strategic controls are most productive when accompanied by practical operating sovereignty for the different units in a firm.
As indicated earlier, downscoping instigates increased costs in R & D. According to Geiger and Gashen (2007), multiple divestitures that lowers the level of diversification in an organisation instigates greater R & D investments because R & D helps managers to reassert strategic controls and augment managerial risk-taking. Geiger and Gashen (2007) confirm that managerial risk-taking weighed through R & D intensity is essential because research shows that R & D activity is a crucial contributor to an organisation’s competitiveness. With respect to increased organisational performance and the overall market value, downscoping can be viewed as a change process that brings over-diversified companies closer to their optimal diversification level that promotes overall efficiency. Although the relationship between profitability and diversification is not linear, low level of diversity instigates positive benefits to a firm, but over-diversification leads to negative outcomes. In this view, downscoping is considered a strategic move to a more optimal diversification level that leads to increased performance of a firm. According to Liao (2004), reduction in business diversity may enhance the performance of a firm by establishing narrow lines of businesses that use related firm resources.
A good example of a firm that successfully employed downscoping and attained enormous benefits in terms of increased performance is Time Inc. In 1983, Time Inc spun-off its forest products operations in order to concentrate its managerial skills on its video and publishing businesses. The forest products operations accounted for seventeen percent of Time Inc’s profits and thirty-three percent of revenue of the company. After downscoping its business lines, the company return on assets augmented by twenty-eight percent in 1984 with the post spin-off return on assets of the novel forest-product company, Temple-Inland, attaining its highest mark in more than six years. Drawing from this example, divested resources siphoned resources and attention to core businesses. Therefore, downscoping strategy instigates a more focused company thereby producing higher gains for downscoping firms. Besides increasing organisation performance, downscoping lowers the demand for information process on top management and accords a firm the prospect to reconfigure the structure of governance thereby allowing the management to devote more time and energy in augmenting the efficiency of the remaining assets. Therefore, downscoping promotes the opportunities for enhanced long-term performance via augmented focus in core businesses and enhance corporate governance. Reduced business diversity instigates a reduced span of control that assures corporate executives an improved strategic understanding of units operations and markets. As a result, top managers reassert strategic control and augment managerial devotion in innovation that augments investment in R & D and champions novel product ideas.
Errors to Avoid
During process of restructuring, a firm’s future is usually at stake. Therefore, firms should avoid errors such as focusing their restructuring efforts on financial restructuring only. Corporate restructuring instigates changes that not only involve securing refinancing, but also aimed at ensuring generation of sustainable capital flow. Firms should also plan adequately and be sufficiently prepared for negotiations. A restructuring procedure entails a negotiation procedure. Therefore, the management should ensure an apparent and logical negotiation policy. The negotiation strategy should highlight the potential economic worth of the restructuring and how risks should be shared. The management should avoid presenting unrealistic negotiation strategy and inconsistent plans. The management should present a credible and coherent business plan aimed at improving the liquidity of the firm. In addition, the management should provide open communication that provides pertinent information on all aspects of the changes. The management should also not fail to involve the workers of the firms involved in resolving the operating and strategic problems. More importantly, the management should not rush the restructuring processes but should be clear as to what is being acquired. The steps needed and legal formalities should be well in place.
Corporate restructuring has been a great area of interest in helping to comprehend the limits of a firm’s growth, the effects of the shifts in the organisation’s business portfolio and the productivity of changes in capital and organisational structures. Downscoping is a spin-off, divesture or some other forms of getting rid of businesses that are not linked or core to a firm’s overall mission or business. Downscoping focuses on refocusing a firm on those activities that are crucial to a firm. It allows firms to concentrate on those activities that add direct value to a firm and sustain a competitive advantage. When a firm makes a major change to alter its set of businesses, the benefit to shareholder value increases drastically given that the divested businesses attracts investors. However, downscoping firm should develop practical negotiation strategies, effective plans and provide pertinent information on all aspects of the changes.
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