What is 'Rationalization'

Rationalization is a reorganization of a company in order to increase its efficiency. This reorganization may lead to an expansion or reduction in company size, a change of policy, or an alteration of strategy pertaining to particular products. Similar to a reorganization, a rationalization is more widespread, encompassing strategy as well as structural changes.

BREAKING DOWN 'Rationalization'

Rationalization is necessary for a company to increase revenue, decrease costs and improve its bottom line. The following are examples of rationalization.

Product Rationalization

Product rationalization is an important part of managing a product’s lifecycle. If products are not rationalized, their numbers continue to increase, adding complexity and increased support costs to the company’s bottom line.

According to the 80/20 Rule, the bulk of a company’s revenue and profit (80%) comes from a fraction of its products (20%). Therefore, when rationalizing a product line, executives needs to consider various factors.

The portfolio effect describes how a product’s addition or removal affects the rest of the company’s products. Sales may go to other products or be lost completely. Although rationalization may reduce complexity in the supply chain, as well as redundancy in both the portfolio and support costs, the costs can be difficult to quantify. The percent of sales that will not transfer to other products needs to be estimated and compensated for by new products entering the portfolio or sales of existing products growing. In addition, when products leave the portfolio, fixed costs typically remain the same; the costs must be spread across the remaining product line, increasing unit costs. Production volume must be transferred to new or more profitable products to ensure the business remains solvent. Also, customer migration becomes an issue, as sales and operations managers must create and carry out migration plans. This is especially important with customers buying multiple products who may leave a company that is no longer providing one-stop shopping.

Applications Rationalization

Engaging in applications rationalization, especially during mergers and acquisitions, helps companies reduce costs, operate more efficiently and focus on supporting deal objectives, legal and regulatory issues, systems and process integration and business continuity.

Most businesses accumulate a vast information technology application portfolio over time, especially when companies grow and do not fully integrate operations and assets with each transaction. Many applications do not support the company’s objectives after each merger or acquisition and need revision to support the new business. Examining a company’s application portfolio is important to attain more efficient operations and cost integrations, reducing stranded costs left by a seller and streamlining the portfolio to best serve the business.

RELATED TERMS
  1. Asset Rationalization

    Reorganizing a firm's assets in order to improve operating efficiencies ...
  2. Capital Rationing

    The act of placing restrictions on the amount of new investments ...
  3. Rationing

    The artificial restriction of raw materials, goods or services. ...
  4. Rational Choice Theory

    An economic principle that assumes that individuals always make ...
  5. Reorganization

    A process designed to revive a financially troubled or bankrupt ...
  6. Rational Expectations Theory

    An economic idea that the people in the economy make choices ...
Related Articles
  1. Investing

    Explaining Rational Behavior

    Rational behavior guides the decision-making process toward choices that maximize an individual’s benefit.
  2. Investing

    Understanding Marginal Cost of Production

    Marginal cost of production is an economics term that refers to the change in production costs resulting from producing one more unit.
  3. Trading

    Understanding Rational Choice Theory

    Rational choice theory assumes an individual will always make prudent and logical decisions that yield the most benefits.
  4. Financial Advisor

    How to Create a New Financial Product in 10 Steps

    The 10 steps outlined here are essential to the creation of a new financial product.
  5. Investing

    These Financial Products Are Too Complex For The Average Joe

    Structured financial products are so elaborate that investors are unable to assess costs and risk.
  6. Small Business

    Understanding Marketing

    Marketing includes all of the activities of a company associated with buying and selling a product or service.
  7. Investing

    Understanding Production Efficiency

    Production efficiency is the point at which an economy cannot increase output of a good or service without lowering the production of another product.
  8. Investing

    Contribution Margin

    Contribution margin is a cost accounting concept that allows a company to determine the profitability of individual products.
  9. Financial Advisor

    What's Behind the Decline in Productivity Numbers? 

    There are several theories and hypotheses about low productivity numbers in the American economy. This article examines some of them.
  10. Investing

    What Are The Different Types Of Costs In Cost Accounting?

    Cost accounting measures several different types of costs associated with a company’s production processes.
RELATED FAQS
  1. Do production costs include the marginal cost of production?

    Learn more about marginal costs of production and production costs. Find out how businesses can use marginal cost calculations ... Read Answer >>
  2. How is the marginal cost of production used to find an optimum production level?

    Understand more about production cost calculations, and specifically how the marginal cost of production is used to determine ... Read Answer >>
  3. Is there any way to reverse the law of diminishing marginal returns?

    Learn more about how consumer spending, supply and demand impact production decisions. Find out more about the law of diminishing ... Read Answer >>
  4. How are fixed costs treated in cost accounting?

    Learn how fixed costs and variable costs are used in cost accounting to help a company's management in budgeting and controlling ... Read Answer >>
  5. What are some ways a company can expand its product line?

    Understand what a product line is and why it's important. Learn about specific ways in which a company can expand its product ... Read Answer >>
  6. How do fixed and variable costs each affect the marginal cost of production?

    Learn about the marginal cost of production, how to calculate the marginal cost, and how fixed costs and variable costs affect ... Read Answer >>
Hot Definitions
  1. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  2. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  3. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  4. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  5. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
  6. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
Trading Center