The US-based restaurant chain Applebee’s recently announced it would be closing just over 100 restaurants (a small percentage of the total), while at the same time adjusting and expanding its menu to appeal to its core demographic. This double effort is a well-chosen approach, according to a study by researchers at EHL and Columbia University.
The study, “Changing Tires on a Moving Car: Corporate Turnarounds in the Service Industry,” by Achim Schmitt, Kathryn Rudie Harrigan, and Steffen Raub, found that a strategy that involved both retrenchment and renewal from the beginning worked best for a group of European service firms.
“We’ve seen many service business turnarounds in recent years,” explains lead author Schmitt, “and the question has arisen regarding whether the best strategy is a sequential approach in which the company starts with cutbacks and then eventually starts its recovery efforts, or whether it makes better sense to include the recovery steps along with the cutbacks.”
“There’s no doubt that we see tension between retrenchment and recovery. But as we explain in our study, the simultaneous strategy worked best for the 35 firms we studied.” Schmitt points to previous studies that suggest that companies need first to staunch their losses by retrenching operations, with the idea that they could subsequently allocate resources to recovery.
Schmitt and his co-researchers wanted to test that notion: “It wasn’t clear that the companies would actually have any resources left if they didn’t begin their recovery program at the same time,” he points out. “Plus, we thought that stakeholders would become skeptical that a turnaround could occur if the firm does nothing but retrench. Instead, we thought that customers, employees, and investors would be encouraged by a strategy that intertwines cutbacks and fresh initiatives.”
To test this thesis, the researchers went directly to the source by interviewing turnaround consultants to 35 service firms that had completed successful restructuring, as well as conducting field studies of the firms themselves. Most of the companies are based in Germany, with a few in Austria and Switzerland. These are not small firms, as the average staff size was more than 200 employees.
The study divided the firms’ turnaround efforts into two phases. The initial phase was the period from the beginning of the turnaround to the year of the worst drop in return on investment (ROI). The advanced phase started after that time and continued until the firm had again stabilized. It’s important to note that none of the turnarounds in the study was an in-court bankruptcy action. Instead, these were out-of-court actions, under the watchful eye of a creditor bank that engaged the services of a turnaround consultant.
The study examined the following six retrenchment tactics:
- reducing finished goods and inventory,
- employee layoffs,
- cutting employee wages,
- shedding property, plants, and equipment,
- trimming marketing expenditure, and
- reducing maintenance costs.
Using freed-up cash flow from these tactics, companies could take any of five recovery steps:
- developing new markets,
- offering new products or services,
- implementing new production or service processes,
- seeking new competitive advantages, and
- developing new organizational structures.
The analysis found that retrenchment efforts in themselves could be effective initially, but adding simultaneous recovery efforts magnified the firms’ turnaround performance. In fact, the best outcome occurred when a firm engaged in a high level of recovery activities at the same time it was retrenching—recovery magnified the favorable effects of retrenchment. On the other hand, that magnifying effect did not occur in connection with a low-level recovery effort. However, once a firm has passed through the crucible of its worst year, and ROI begins to recover, the combination of retrenchment and recovery steps is no longer as powerful.
“What we see is that companies need to engage intentionally in both retrenchment and recovery tactics right from the start of their turnaround efforts,” says Schmitt. “Retrenchment is not accidental, and it’s more than just a consequence of a struggling company. In fact, we are concerned that an exclusive management focus on such retrenchment steps as efficiency and centralization may damage a company’s turnaround effort.”
“Instead, retrenchment tactics should be part of a full strategy, one that also includes recovery tactics from the start. In other words, management should balance the tension between retrenchment and recovery. By presenting these tactics as part of a full, coherent strategy, a company can explain its goals to stakeholders, and thereby retain their support. This improves the likelihood of a successful turnaround.”