The decision to implement wholesale staff cuts can exemplify the law of unintended consequences. Or, mass layoffs, for the most part, don’t really work. In fact, this author states that downsizing has only a 50-50 chance of reducing costs. And while the alternatives to downsizing he describes may not be new, there is documented evidence that they maintain employee engagement and the firm’s competitive standing.
In both Canada and the United States, stories abound of organizations in distress as a result of the underperforming global economy. In Canada, thousands of jobs have disappeared, especially in manufacturing and construction. In the U.S., where the picture is even bleaker, the number of impacted employees has increased by orders of magnitude compared to Canada. Of course, this is a global phenomenon that is being mirrored in Europe, where whole economies have crashed (e.g., Iceland) or are on the verge of crashing.
Reducing numbers to remain competitive in these difficult times has been a common tactic, adopted by management ostensibly to reduce costs, demonstrate increased flexibility, reduce bureaucratic structure, increase efficiency regarding decision-making, improve communication and cultivate entrepreneurship. But it is a knee-jerk response and one that begs the question of whether it actually delivers the benefit(s) that are expected. This article will examine downsizing and the conditions under which it is implemented, with a specific focus on whether it actually works.
What is downsizing and when is it used?
Downsizing is a business tactic that aims to improve the financial standing of a firm by reducing and changing the structure of the workforce. This practice has been prominent in the U.S., and has become commonplace in other countries such as Canada, Japan, and Korea. Companies in the United States have downsized to improve business since the early 1970s, according to Professor Boris Kabanoff, Head of the School of Management, Queensland University of Technology, Australia. Downsizing got its bad name in the late 1980s and 1990s, when it became synonymous with the massive job cuts in the two recessions. Nonetheless, since the 1980s, downsizing has gained legitimacy. Indeed, recent research on downsizing in the U.S., United Kingdom, and Japan suggests that downsizing is being regarded by management as one of the preferred tactics for improving organizational performance (The American Management Association annual surveys since 1990; Chorely, D., 2002. How to manage downsizing, Financial Management, May, p. 6; and Ahmakjian, L. C. & Robinson, P., 2001. Safety in numbers: downsizing and the deinstitutionalization of permanent employment in Japan, Administrative Science Quarterly, 46, pp. 622–658).
Some cuts are driven by decreased demand for a firm’s products or services. Firms, however, may also reduce jobs even in environments in which demand is robust, seeking increased operating efficiencies (as technological changes provide opportunities to substitute capital for labor, or to organize work in new ways, for example). This second type of downsizing came to prominence in the 1980s and, as the economy boomed during the 1990s, many firms with strong product demand engaged in it. Why this happens can be explained by what has been called the “sociocognitive perspective” (see William McKinley, Jun Zhao, and Kathleen Garrett Rust , A Sociocognitive interpretation of organizational downsizing. Academy of Management Review, 25(1), 227 – 243). The fundamental assumption of this perspective is that managers, like other actors, impose schema onto information domains that need interpretation. One such schema is an assumption that recognizes downsizing as being effective. The socio-cognitive perspective argues that this belief has evolved from a combination of cognitive simplification processes, ideological influences, and social interaction between managers. The outcome of this complex socio-cognitive process is a shared cognitive orientation toward downsizing, namely, that it is inevitable and that any responsible and competent manager will use it under conditions identified by those that hold the shared orientation. This perspective has not been dictated by the financial benefits of downsizing so much as the cognitive order that accompanies adoption of the institutionalized practice. Nonetheless, it is still practiced today, even in these demanding conditions.
It is also possible to posit that Wall Street’s prevailing overemphasis on the achievement of positive quarter-by-quarter financial performance contributes to large employee dismissals during challenging economic times, or even when profitability does not meet arbitrary targets. Shareholders and stockholders share culpability in that they demand to see profits from their investments in as short a time as is possible, certainly within one, or no more than two, fiscal quarters, no matter the cost. Since any effective change requires longer time horizons to demonstrate valid results, the expectation of quick turnarounds is unreasonable. The markets and the shareholders need to be weaned from their untenable expectations and become more focused on longer-term performance.
Does downsizing really work?
Reports suggest that the results of downsizing are illusory. Jeffrey Pfeffer, the Thomas D. Dee II Professor of Organizational Behavior at the Graduate School of Business, Stanford University, said in the February 9, 2009 edition of the Washington Post, “There are two things to say about downsizing: It seldom works and is often done incorrectly.” Downsizing has a negative effect on corporate memory and employee morale, disrupts social networks, causes a loss of knowledge, and disrupts learning networks. As a result, downsizing risks handicapping and damaging the learning capacity of organizations. Further, given that downsizing is often associated with cutting costs, downsizing firms may provide less training for their employees, recruit less externally, and reduce the research and development budget. Consequently, downsizing could “hollow out” the firm’s skills capacity. Some researchers draw attention to the “obsessive” pursuit of downsizing to the point of self-starvation, marked by excessive cost cutting, organ failure and an extreme pathological fear of becoming inefficient (see Wilkinson, A. . Downsizing, Rightsizing or Dumbsizing? Quality, Human Resources and the Management of Sustainability. Total Quality Management, 16[8-9], 1079 – 1088). In fact, an increasingly growing body of research is indicating that downsizing does not even reduce costs. The reason for this is that sometimes the wrong people leave and the company has to later bring back laid-off employees as contractors.
Downsizing has become common in European countries and in some emerging markets. Literature on this issue has centred not only on its causes, but also on the tactics implemented to reduce the labour force as well as their consequences. As regards the latter, a variety of methods and datasets have been used. While some studies have provided evidence of the stock market reaction to downsizing, others have focused on the effect of downsizing on profitability. On the whole, however, there is no general consensus so far on the performance implications of downsizing. While one research stream has found that downsizing improves economic performance, another has shown its effects to be either negative or neutral. Since the performance implications of this widely-used practice remain an unresolved issue, more evidence is needed on the relationship between downsizing and financial performance (Fernando Munoz-Bullon and Maria Jose Sanchez-Bueno  Does downsizing improve organizational performance? An analysis of Spanish manufacturing firms. Working Paper 08-30, Business Economic Series 07, Departamento de Economia de la Empresa, Universidad Carlos III de Madrid, pp. 1 – 33).
Notwithstanding that there are circumstances in which downsizing may be an appropriate response to business conditions (e.g., organizational survival), there are many others when, instead of facing the challenge inventively, corporations have reacted as has been their habit for decades. That is, they have bet that the one best way to ensure their future survival and prosperity is to put their faith in “tried and true” control-based practices like reduction in numbers. Most analysts perpetuate these traditional and unoriginal attempts at turnaround by praising organizations for “doing the right things” such as downsizing. These analysts ignore the fact that downsizing is a narrow-minded, one-dimensional response to what is a complex issue. Furthermore, there is evidence to indicate that significant restructurings are likely to be successful only in the long run, and when combined with more participatory practices.
It has been argued that successful firms actually pursue a contrarian strategy of increasing investments and building stronger relationships with other industry stakeholders during periods of a downturn (e.g., Rigby, D. . Moving upward in a downturn. Harvard Business Review, 79, 99-105). In other words, successful organizations invest in their human and social capital. A notable example of this contrarian strategy is the story of Malden Mills and its socially conscious CEO, Aaron Feuerstein. In spite of a devastating fire that essentially destroyed the mill in Lawrence, Massachusetts in 1995, Feuerstein continued to pay his employees, provide medical benefits, and have the plant rebuilt at a cost of some $300 million, instead of collecting the insurance and retiring with a substantial amount of money. He was nationally recognized in the United States for his selfless behaviour and commitment to his employees. In 2007, Malden Mills was sold to Polartec, LLC.
Over the past decade, and even during the current recession, a number of companies have resisted the downsizing fad and made alternative arrangements (e.g., Nucor, Southwest Airlines). These alternatives typically exploit the skills and expertise of their employees, instead of placing increased pressure on the survivors of downsizing, by asking them to take on the responsibilities of dismissed employees. This fails to take into account the fact that survivors often suffer significant increases in stress and guilt, which negatively impact their performance. The central paradox of downsizing is that the very people who are likely to be cut are expected to be the source of accurate information about what to cut. But anyone fearful that their job is at stake is sure to develop good rationalizations about why their jobs should be safe in the coming downsizing.
Although alternatives to downsizing do exist, managers need to be reminded of them, since the decision to lay off has become almost unconscious. Some alternatives follow.
- Adopt a compensation system similar to that used by many large Japanese firms. A base salary is coupled with a bonus based on profitability and exceeding performance standards. If the bonus in the most profitable year is about 20 to 25 percent of base salary, then in years in which the firm is not profitable, a major cost saving can be achieved without layoff. This tactic requires the organization to be proactive. The new compensation scheme has the best chance of adoption when the firm is fairly profitable, not when cost reductions are imminent. In situations where employees are unionized, the scheme can be negotiated as a way of ensuring job security — a priority with today’s unions. However, this tactic is unavailable to public sector managers.
- Share the cuts across the organization. Rather than firing 10 percent of the workforce, all members of the organization can take a 10 percent cut in both hours of work and pay. Perhaps surprisingly, this is the alternative employees often vote for, given the chance. It raises a number of objections:
- If coupled with a reduction in the number of functions performed, or in the services and product lines delivered, it may be necessary to reassign and retrain employees from the discontinued work areas.
- Fringe benefit costs will not be proportionately reduced (they represent semi-fixed costs) so that a larger salary cut may be required. However, in the short run, these costs are likely to be less severe than the costs of downsizing.
- Reducing wages makes the firm uncompetitive in the labour market.
There are three responses to these objections. First, if the firm is considering downsizing, then allowing some people to leave for another firm helps achieve that aim; although it is the good people who have the most mobility, these are the same people who typically leave when the firm downsizes anyway. Second, it is often better to retrain some of the existing workforce than to go through the expensive and risky process of hiring. Third, the compensation cut is temporary: it can be restored when the firm recovers from the current crisis. Such an action can enhance the attractiveness of the firm in the labour market.
- Adopt the “hour bank”, a tactic recently adopted by BMW in Germany. A variant of flexitime (also first introduced at BMW), employees who are asked to work overtime, probably when the economy is booming, can, instead of receiving overtime pay, bank those hours. Then, if the firm has to go to a shorter work week, the employees can draw on their banked hours and receive full pay for working a partial work week.
- Instead of contracting out, the organizations can reduce the amount of work contracted out and bring the work “in house.” For example, certain components usually bought outside can be manufactured in house, and services bought outside can be performed in-house. The feasibility of this approach will depend on the skills and competencies of the current work force, as well as the status of existing contracts with suppliers.
- Services or products currently provided to in-house departments can be sold to external customers, for example, the cash-management services provided by banks, or internal consultants in MIS who sell their services externally.
- Be more flexible in deploying staff. As some parts of the business expand and other parts decline, employees can be transferred from one to the other. This, of course, requires additional training to ensure that the transferees have the knowledge and skills to do the new tasks. Skilled employees can be assigned as trainers, to keep training costs down. This may also require the geographical relocation of employees. This tactic of using employees as trainers has been followed by IBM for forty years, but it was recently abandoned. Nonetheless, it is still used by companies such as Hallmark Cards, Hewlett Packard, Federal Express and Toyota. In some case (e.g., Hallmark Cards) factory employees are retrained for office jobs. This ability to escape conventional views of which person is suitable for which job enables the firm to develop creative solutions to the cost-containment problem. In addition, the payoff to the organization from retaining and retraining workers, in terms of increased loyalty from employees, is incalculable. If people believe that there will still be a job for them in the organization, they will be more likely to develop innovative cost-cutting ideas. Absent the belief in the ultimate security of their position, such suggestions are unlikely to be broached.
- Make more use of part-timers, sabbaticals and leaves of absence. Not every employee wants to work full time. Employees can be polled on the kinds of flexible arrangement they prefer. Some full-time, later-career employees can welcome the chance of a part-time, part-pay schedule. Others might opt to take a leave of absence for a year. Yet others might prefer a deferred compensation arrangement in which they work full time at 80 percent salary for a number of years and then take a full pay sabbatical.
- Freeze hiring. Again, this means reassigning people to new positions with concomitant retraining costs.
Paradoxically, there are even advantages to hiring when the rest of the world is downsizing:
When firms are downsizing and jobs hard to find, the quality of applicants is much higher than at other times in the economic cycle. This is manifested in two ways: first, in the skills and competencies of the employee; secondly in their commitment to work. By comparison, at the peak of the economic cycle, good people are harder to find, more expensive, and more readily lured away by better offers elsewhere.
The demographic mixture of organizational “survivors” is not skewed severely. Under most downsizing scenarios, older people leave the organization, taking their experience with them. Counter-cyclical hiring can replenish the pool with persons with experience in other organizational settings and avoid dramatic “bulges” in certain age groups, which plays havoc with succession planning and hiring patterns.
The firm is better placed to exploit any upturn that occurs at the end of the depressed phase of the cycle.
These techniques are not new as they are all in use today. But the pervasiveness of downsizing has pushed them out of favour, to the back burner, and the risk is that they will be considered when it is too late, if at all (Martin G. Evans, Hugh P. Gunz, & R. Michael Jalland . Alternatives to Downsizing. Financial Post, Apr. 27, 1996).
While organizations may claim that their decision to lay-off employees is economically driven, downsizing is not carried out solely to meet cost-reduction targets. Many times it is also a consequence of a management agenda unrelated to cost control. Furthermore, the decision to downsize at any organization is, for the most part, not legitimized by blaming the current economic conditions, and is certainly not justified by the standard reason provided by their executive management, spokespeople and PR people – the need to cut costs – except under the most extreme conditions, such as has been seen in the North American automotive sector. Even in this latter case, alternative solutions to wholesale downsizing have been seen (for example, the painful concessions and alternative work arrangements made by the CAW in recognition of Chrysler’s near bankruptcy). Neither is any statement of duplication of jobs a valid excuse, since in those conditions management has generally not considered new work practices and structures that could minimize the number of employees dismissed as noted earlier.
Generally speaking, downsizing has at best a 50-50 chance of providing the cost reduction and flexibility benefits that management expects that it will. Research has shown that the decision to downsize is a political one rather than one based on any valid financial rationale. That is, downsizing decisions undertaken by organizations are taken because that is what managers have decided to do rather than because they expect to realize any real financial benefits. Often, another, preferred management agenda is in the background. So, while organizations such as Bombardier Aerospace, Bombardier Recreational and Pratt & Whitney may claim that their decision to lay-off employees is economically driven, the reality is that in both the short- and long-term, they are exposing themselves to more risk and consequences, in the guise of potentially increased turnover, “survivor’s syndrome,” negative company reputations that are reflected in poor performance, reduction of share price, reduction of trust of management, severance costs, and outplacement and recruitment costs. The so-called “right-sizing” tactic is likely to cost far more than it is worth.