What Is a Shakeout?

A shakeout is a phenomenon that takes place within an industry when smaller companies are either acquired and absorbed by larger competitors, or forced to go out of business altogether. The term is also sometimes applied to a set of circumstances that lead investors to selling certain key investments as the result of being unsure just what will happen in the market associated with those investments. In both scenarios, the actions make significant changes to the marketplace that leave the larger entities with greater financial reserves in a good position, while companies that are less fortunate will cease to exist.

The likelihood of a shakeout increases when a market that has been enjoying a bullish period begins to shift more into a bear market. With a bull market, stocks are increasing and the companies associated with that market are enjoying a fair amount of prosperity. As the trend begins to change and a bear market is created, a decline begins to take place. Larger companies with the resources to spare can use this time to monitor the fortunes of smaller competitors who were chipping away at their sales during the more prosperous bull market, note when they reach a point of becoming especially vulnerable, and take action to eliminate the competition. This may be managed by acquiring the weaker company as a means of gaining hold of their assets, or by applying pressure in the marketplace that effectively drives the smaller business out of the market altogether.

One of the contributing factors that leads to a shakeout is a phenomenon that is known as panic selling. Essentially, this is a situation in which an investor or company is unsure of how the market will progress and feels that getting out now would be the best approach in the long run. At this point, investors may choose to sell stocks and other securities as a way of avoiding incurring a loss, or at least preventing any further losses. With smaller companies, the idea is to sell the business now before the market declines further, hopefully making enough to prevent the owner from having to absorb a loss or keep the loss to a minimum. During a shakeout, buyers can often acquire the smaller businesses or the securities for bargain prices, owing to the desire of the seller to make a deal now rather than wait and risk losing even more money.

Typically, larger companies with greater resources can ride out a depressed period in the marketplace. Smaller businesses with limited resources may not be able to hold on long enough for business volumes to begin increasing once again. In the interim, the shakeout effectively thins the herd, leaving behind the companies who were able to weather the storm, poising them for riding the wave a renewed marketplace, at least until others begin to enter that marketplace again and resume efforts to offer meaningful competition to those older established entities.