# Understanding Rationalization: Types, Pros, and Cons for Businesses

![Rationalization](https://www.investopedia.com/thmb/Pk6dh9tS0eh9PpvtMX2wA7XdzPQ=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Rationalization-c795fae39b2d411d9ea1be4858353910.jpg)

*— Michela Buttignol / Investopedia*

## What Is Rationalization?

Rationalization [reorganizes](https://www.investopedia.com/terms/r/reorganization.asp) a company to boost [efficiency](https://www.investopedia.com/terms/e/efficiency.asp). This reorganization can expand or shrink the company, change policies, or adjust product strategies.

Similar to a reorganization, a rationalization is more widespread, encompassing strategy as well as [structural changes](https://www.investopedia.com/terms/s/structural_change.asp). Companies use rationalization to increase revenue, cut costs, and improve [profits](https://www.investopedia.com/terms/b/bottomline.asp).

Rationalization may also refer to the process of becoming calculable. For example, [financial models](https://www.investopedia.com/terms/f/financialmodeling.asp) and technologies make markets more efficient. The [Black-Scholes](https://www.investopedia.com/terms/b/blackscholes.asp) model improved efficiency in the Chicago [options](https://www.investopedia.com/terms/o/option.asp) markets in the late 1970s.

### Key Takeaways

*   Rationalization in business refers to reorganizing a company to increase efficiency, which may lead to changes in policy, strategy, or company size. This process can expand or reduce company operations and often includes structural changes.  
    
*   Common forms of rationalization include product rationalization, which manages product life cycles to reduce costs, and application rationalization, which optimizes IT assets, especially during mergers and acquisitions, to support the company's objectives.  
    
*   Rationalization can lead to improved operational efficiency, reduced prices, and higher-quality products for consumers. It helps standardize business processes and can improve working conditions and pay for employees.  
    
*   The emphasis on efficiency can negatively impact human capital, leading to job losses, increased workloads, and potential loss of employee initiative. Additionally, rationalization is often costly, requires ongoing monitoring, and does not guarantee improved returns.  
    
*   Financial models and technologies can rationalize markets by making them more calculable and efficient, reducing human emotional errors and increasing market transparency and price efficiency.  
    

## Why Rationalization Matters in Business

Businesses often consider rationalization to boost efficiency. That’s because it’s aimed at improving efficiency, getting rid of waste, standardizing processes, and ultimately boosting the bottom line.

Rationalization can either expand or shrink a business, depending on its strategy. It can also lead to structural changes.

Rationalization can include selling or closing weak segments, expanding strong ones, restructuring finances, and modernizing operations.

In a large number of cases, asset rationalization results in the loss of hundreds of jobs.

> **Important**
>
> Reviewing a company's application portfolio improves efficiency, cuts costs, and aligns it with business needs.

## Reasons Companies Opt for Rationalization

There are several reasons that a particular organization might need to go through the process of rationalization. They include the need to:

*   Reduce costs
*   Maximize profits
*   Conserve resources
*   Unlock shareholder value
*   Improve transparency and governance
*   Simplify the business model
*   Eliminate unnecessary products and idle capacity
*   Update old machinery and other business processes

> **Fast Fact**
>
> Companies often rationalize during recessions or after mergers, acquisitions, or new CEO appointments.

## Exploring Different Forms of Rationalization

The following subheads are examples of rationalization.

### Products Rationalization

Product rationalization is an important part of managing a product’s life cycle. 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](https://www.investopedia.com/terms/r/revenue.asp) and [profit](https://www.investopedia.com/terms/p/profit.asp) (80%) comes from a fraction of its products (20%). Therefore, when rationalizing a [product line](https://www.investopedia.com/terms/p/product-line.asp), executives need 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](https://www.investopedia.com/terms/s/supplychain.asp), as well as redundancy in both the portfolio and support costs, the costs can be difficult to quantify. The portion of sales that will not transfer to other products needs to be estimated and compensated for by new products entering the portfolio or the sales growth of existing products.

In addition, when products leave the portfolio, [fixed costs](https://www.investopedia.com/terms/f/fixedcost.asp) typically remain the same; the costs must be spread across the remaining product line, increasing [unit costs](https://www.investopedia.com/terms/u/unitcost.asp).

Production volume must be transferred to new or more profitable products to ensure that 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](https://www.investopedia.com/terms/m/mergersandacquisitions.asp), 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.

## How Rationalization Transforms Market Structures

 Financial models and technologies make markets more calculable and efficient, following the [efficient market hypothesis (EMH)](https://www.investopedia.com/terms/e/efficientmarkethypothesis.asp).

As more information of various types is able to be processed by information technologies, transmitted and disseminated using communications technology, and incorporated into the market microstructure, prices become more efficient and the market appears more rational.

The increased use of mathematical formulas and financial models also helps with the rationalization of markets, as they become dissociated with human emotion and fallibility.

## Pros and Cons of Implementing a Rationalization Strategy

Rationalization helps companies standardize business processes in order to become more efficient and boost productivity.

It lets management introduce modern techniques and systems, allowing workers to improve their efficiency levels. In turn, rationalization can lead to better working conditions and higher pay for the workforce, ultimately leading to a higher standard of living in society.

Additionally, rationalization can translate into both reduced prices and a higher standard of products for consumers.

On the other hand, rationalization often focuses too much on efficiency at the expense of human capital. The emphasis on modernization and standardization often has negative consequences such as mass layoffs, a loss of initiative from the workforce, a significantly increased workload for the workers that remain, and a worse-off work environment.

Moreover, the process of rationalization is costly, requires consistent monitoring, and provides no guarantee of improved returns.

Pros of Rationalization

*   Helps companies become more efficient and boost productivity
    
*   Allows management to implement modernized techniques and systems
    
*   Lowers market volatility
    
*   Can provide the workforce with better working conditions and higher pay
    
*   Translates into a higher standard of living in society
    
*   Can lead to lower prices and better products for consumers
    

Cons of Rationalization

*   Emphasizes efficiency at the expense of human capital
    
*   Often involves large layoffs
    
*   Can lead to a significantly increased workload for the workers that remain
    
*   Loss of initiative from workers due to the mechanization of processes
    
*   Costly and requires consistent monitoring
    
*   No guarantee of improved returns
    

## What Is Asset Rationalization?

[Asset rationalization](https://www.investopedia.com/terms/a/asset-rationalization.asp) is the process of reorganizing a company’s assets in order to increase operating efficiencies and, ultimately, improve its bottom line.

## What Are the Dangers of Rationalization?

Dangers of rationalization include focusing too much on optimization at the expense of human capital, the possibility of negative cultural changes, and allocating capital in an ultimately inefficient manner.

## What Is Rationalization in Economics?

In economics, rationalization is the process of changing a preexisting workflow into one that’s more goal-oriented and based on a specific set of rules.

## The Bottom Line

Rationalization is the reorganization of a company to increase its operating efficiency. It may lead to an expansion or reduction in company size, a change of policy, or an alteration of strategy pertaining to particular products offered.