Asset Rationalization: Improving Efficiency & Bottom Line

What Is Asset Rationalization?

Asset rationalization is the process of reorganizing a company's assets to improve operating efficiency and profitability. It can involve divesting assets, closing underperforming facilities, or streamlining operations to focus on core activities and reduce losses. While often used during economic downturns or mergers, the process can carry risks such as restructuring costs and job losses.

How Asset Rationalization Enhances Efficiency

Rationalization is all about making a company and the way it operates more effective. The goal is to increase operating efficiency and arrive at a peak level of performance by eliminating any waste and ensuring that the least amount of inputs are used to achieve the highest amount of output.

Asset rationalization is a common business practice. Well-managed companies periodically take stock of what they have and how they are run to determine whether any improvements can be made to become more efficient, boost sales, reduce expenses and pull in more income from revenues. Companies are ultimately judged by how much profit they generate, so it's important that opportunities to maximize the bottom line aren't squandered.

Asset rationalization paths often follow three steps. First, the company purchases a cash-flowing production asset and lowers its overall financial commitments by divesting other assets.

After that the company might look to streamline its operations by cutting costs and reducing headcount. It may then evaluate possible financing alternatives for the company's short- and long-term plans, seeking out better interest rates or borrowing costs and maybe even engaging in share consolidation by reducing the number of shares held by existing shareholders.

Pros and Cons of Asset Rationalization

Reorganizing an asset base can help to bring a company more in line with its core competencies, optimize returns, and weed out loss-making ventures. It's important that too much fat isn't trimmed, though. Efforts to aggressively cut costs and shift strategy could endanger the company, leading to hefty restructuring charges, alienated customers, and insufficient staff and resources to cater to demand.

Detractors of asset rationalization argue the strategy focuses on short-term business gains at the expense of human capital since widespread job losses will foster a sense of uncertainty and lead to lower productivity among the organization's remaining employees. However, in challenging economic times, companies may have little choice but to continue on the asset rationalization path to stay competitive in the global marketplace.

Examples of Asset Rationalization

In 2018, PentaNova Energy, a Canadian exploration and production energy company focused on proven Latin American oil and gas plays, dropped a bombshell. An announcement was made that the company’s board of directors, following a review of annual financial statements and ongoing commitments, charged senior management with a mandate to reduce the company's asset portfolio, and introduce significant cost reductions. Assignments were dished out to the new management to deliver on this goal and rationalize assets.

Elsewhere, in August 2016, Ruby Tuesday revealed it would close approximately 95 underperforming restaurants. The embattled chain had been struggling with falling foot traffic in shopping malls, tepid demand for bar-and-grill style eateries, and a string of unsuccessful marketing campaigns. In 2017, Atlanta-based private equity firm NRD Capital acquired the struggling restaurant chain. Due the impact from the 2020 crisis, the company filed for Chapter 11 bankruptcy on October 7, 2020. Research firm Technomic estimated Ruby Tuesday had closed 118 restaurants between 2017 and 2019.

The Bottom Line

Asset rationalization aims to improve efficiency by realigning assets with a company's core operations. While it can strengthen performance and reduce ongoing losses, it often brings restructuring challenges and job reductions. Companies such as PentaNova Energy and Ruby Tuesday illustrate how this process is applied in practice.