Behind most downsizing announcements is a viewpoint that sees employees as costs to be cut. Another viewpoint, one that is rarely expressed, sees employees as assets to be developed. These viewpoints are important, not just because they may influence an executive’s decision to downsize, but because they usually influence how employees see themselves – and perform. As this author points out, it’s almost a difference between assets and liabilities.

The current economic environment is full of uncertainty. One response, certainly a popular one in the United States, is to reduce the number of employees through downsizing. In 2002, for example, according to figures released by the U. S. Department of Labor, there were approximately 15,000 mass layoffs involving 50 or more employees, and almost two million workers were affected. The pattern was the same in 2001.

It is important to note, however, that the phenomenon of layoffs is not limited to the United States-Asia and Europe have been hard-hit as well. Japan’s chip and electronics conglomerates shed tens of thousands of jobs in the past year as the worldwide information-technology slump and fierce competition from foreign rivals battered their bottom lines. High-profile firms such as Hitachi, Fujitsu, NEC, Toshiba, Matsushita Electric Industrial and Sony have cut deeply, as has Mazda in automobile production. In China, more than 25.5 million people were laid off from state-owned firms between 1998 and 2001, and another 20 million are expected to go by 2006.

It is at times like these that corporate values such as respect and concern for people, as well as the courage of executives, are sorely tested. This is one of the reasons why downsizing is such a compelling story – and strategy – for firms around the world. In this article, I will discuss why downsizing is so compelling and how managers can prepare and implement a successful strategy.

Economic logic dictates a reduction in human capital

The economic rationale for downsizing is straightforward. It begins with the premise that there really are only two ways to make money in business-cut costs or increase revenues. But which is more predictable: future costs or future revenues? Anyone who makes monthly mortgage payments knows that future costs are far more predictable than future revenues. Since payroll expenses represent fixed costs, cutting payroll – other things remaining equal – should reduce overall expenses. Reduced expenses mean increased earnings; earnings drive stock prices; and higher stock prices make investors and analysts happy. But as we shall see, “other things” often do not remain equal, and therefore the anticipated benefits of employment downsizing do not always materialize. Is there an alternative? That is a matter of perspective.

Employees: costs or assets?

While writing the U. S. Department of Labour’s 1995 publication Guide to Responsible Restructuring, and my 2002 book Responsible Restructuring, I found that top executives from various companies, large and small, public and private, quickly sorted themselves into two camps. The first and by far the largest was the downsizers. Their philosophy was, “What’s the minimum number of people we need to run this place?” Another, much smaller group constituted the “responsible restructurers.” In contrast to the downsizers, their philosophy was, “How can we take the people we already have, and use them more effectively?” The larger group saw their employees as costs to be cut. The smaller group saw their employees as assets to be developed. And therein lay a crucially important difference in the approaches these executives took to managing people.

At a broader level, downsizers see employees as commodities. Like paper clips or light bulbs, people are interchangeable and easily substituted, one for another. This is a “plug-in” mentality: Plug them in when you need them; pull the plug when you don’t. In contrast, responsible restructurers see employees as sources of innovation and renewal, with the potential to grow the business. This raises an interesting question: Are firms that downsize employees more profitable, and how does their stock perform?

Employment downsizing and company performance

In a series of studies, my colleagues and I examined financial and employment data from companies in the Standard & Poor’s 500. Our purpose was to examine the relationships between changes in employment and financial performance. We assigned companies into one of seven mutually exclusive categories based upon their level of change in employment and their level of change in plant and equipment, or assets. Categories included pure Employment Downsizers, Asset Downsizers, Combination Downsizers, similar categories of upsizers, and Stable Employers. We then observed the firms’ financial performance (profitability and total return on common stock) from one year before to two years after the employment-change events. We examined results for firms in each category on an independent as well as on an industry-adjusted basis.

In our most recent study, we observed a total of 6,418 occurrences of changes in employment for S&P 500 companies during the 18-year period from 1982 through 2000. As in our earlier studies, we found no significant, consistent evidence that employment downsizing led to improved financial performance, as measured by return on assets or industry-adjusted return on assets. Downsizing strategies, either employment downsizing or asset downsizing, did not yield long-term payoffs that were significantly larger than those generated by Stable Employers-that is, those companies in which the complement of employees did not fluctuate by more than ±5 per cent.

As a general conclusion, therefore, it was just not possible for firms to “save” or “shrink” their way to prosperity. Rather, it was only by growing their businesses (Asset Upsizing) that companies outperformed Stable Employers as well as their own industries in terms of profitability and total returns on common stock.

Is employment downsizing always wrong?

Certainly not. In fact, many firms have downsized and restructured success fully to improve their productivity. The key to doing so, however, is to use layoffs as part of a broader business plan to penetrate new markets, attract new customers and generate new streams of revenue. As examples, consider Sears Roebuck & Company and Praxair, Inc. In January 2001, Sears cut 2,400 jobs as part of a restructuring that included the closure of 89 stores and several smaller businesses. Shares rose 30 per cent in six months. Praxair, Inc., a $5-billion supplier of specialty gases and coatings, cut 900 jobs in September 2001 in response to the economic slowdown. At the same time, however, it announced initiatives designed to pull it out of the slump, including two new plants for products where demand was on the rise. The result? The value of its shares rose 30 per cent in three months.

In the aggregate, the productivity and competitiveness of many restructured firms have increased in recent years. However, the lesson from our analysis is that firms cannot simply assume that layoffs are a quick fix that will necessarily lead to productivity improvements and increased financial performance. The fact is that layoffs alone will not fix a business strategy that is fundamentally flawed. Thus, when Palm, Inc. trimmed 250 jobs in an effort to cut costs after a delayed product launch slowed demand, its shares lost nearly half their value in one day and never recovered. As Palm’s chief financial officer, Judy Bruner, subsequently noted, the downsizing had raised a lot of questions about the viability of the business.

In short, employment downsizing may not generate the benefits sought by management. Managers must be very cautious in implementing a strategy that can impose traumatic costs on employees, both on those who leave as well as on those who stay. Management needs to be sure about the sources of future savings, and carefully weigh those against all of the costs, including the increased costs associated with subsequent employment expansions when economic conditions improve.

Employees as assets: The payoff

Employers that see their people as assets tend to treat them well. Some treat them so well that these companies are recognized as best places to work. However, a skeptic might ask, “Okay, so you’re one of the best places to work. Does that mean your firm does better in the marketplace? And how about its stock performance?” At least a partial answer to these questions appeared recently in a study done by the Frank Russell Co. The study examined the annual lists of Fortune‘s 100 Best Companies to Work For from 1998-2001, a period of both up and down markets. The study examined the performance of these companies relative to the S&P 500 and the Russell 3000, in several ways: portfolios of their stock that were equally weighted and capitalizationweighted, and portfolios based on buying and holding the 100 companies in the 1998 list, versus rebalancing each year as a new list of the 100 Best came out. Without exception, the portfolios comprising stock from firms on the “Be s t 100” list outperformed the market benchmarks by factors that varied from 1.85 to 3.43 over the three-year period.

In short, companies that treat their employees well are also good for investors. Indeed, 80 of the 100 companies that made Fortune‘s 2002 and 2003 lists of “The 100 Best Companies to Work For” avoided layoffs in the prior year, and almost half of them even have official policies barring layoffs. So, the majority of companies on the list strive mightily to provide employment security for their employees. That alone put s “Best Companies” into a very small set of companies in America.

An example of such a company, routinely listed on the “100 Best” list, is the SAS Institute. Its business is built on forming close, lasting relationships with customers, and customer loyalty is intense. The company’s licence-renewal rate for its software programs exceeds 98 per cent. A fundamental value at the SAS Institute is “Make work fun and treat people with dignity and respect,” a value that is shared by Southwest Airlines, another firm regularly cited for its progressive employment practices. On the 25th anniversary of the founding of the SAS Institute, cofounder Dr. James Goodnight remarked, “We knew that if we focused on our employees and our customers, the company would prosper. It sounded simplistic then, just as it does today, but I think history has shown that taking care of employees has made the difference in how our employees take care of our customers. With that as our vision, the rest takes care of itself.”

Here is another benefit associated with treating employees well. They tend to stick around. Employee turnover at SAS is very low, about four per cent per year, compared to the average in the software industry of about 20 per cent. Given the size of its workforce, plus the 1.5 times annual salary (fully loaded cost) to replace a person who leaves, SAS’s 16 per cent lower turnover translates into opportunity savings in excess of $100 million every year. It invests that money in developing the business, and in funding extensive benefits for employees, including training and development at all levels.

Restructuring responsibly: What to do

At this point you are probably wondering how to proceed with your restructuring plan – or, in fact, whether to restructure at all. Here are nine things to think about.

1. Carefully consider the rationale behind restructuring. Invest in analysis and consider the impact on those who stay, those who leave, and the ability of the organization to serve its customers.

2. Consider the virtues of stability. In many cases, companies can maintain their special efficiencies only if they can give their workers a unique set of skills and a feeling that they belong together.

3. Before making any final decisions about restructuring, air employees’ concerns and seek their input. Make special efforts to secure the input of “star” employees or opinion leaders, for they can help communicate the rationale and strategy of restructuring to their fellow employees, and also help to promote trust in the restructuring effort.

4. Use restructuring as an opportunity to address long-term problems. Unless severe overstaffing is part of a long-term problem, consider alternatives to layoffs first, and ensure that management at all levels shares the pain and participates in any sacrifices employees are asked to bear.

5. If layoffs are necessary, be sure that employees perceive the process of selecting excess positions as fair and make decisions in a consistent manner. Make special efforts to retain your best performers, and provide maximum advance notice to terminated employees.

6. Communicate regularly and in a variety of ways in order to keep everyone abreast of new developments and information. Executives should be visible, active participants in this process, and be sure that lower-level managers are trained to address the concerns of victims as well as survivors.

7. Give survivors a reason to stay, and prospective new hires a reason to join. As one set of authors noted, “People need to believe in the organization to make it work, but they need to see that it works to believe in it.”

8. Train employees and their managers in the new ways of operating. Evidence clearly indicates that firms whose training budgets increase following a restructuring are more likely to realize improved productivity, profits and quality.

9. Examine carefully all-management systems in light of the change of strategy or environment facing the firm. These include workforce planning, recruitment and selection, performance management, compensation and labour relations.

Think of it this way: Let’s say you are a first-level employee standing in front of a customer. You are proud to work for your employer because you are treated well and fairly, and you believe in your company’s products or services. Aren’t you more likely to respond with enthusiasm, to be friendly and helpful to the customer, even if it means doing something extra to satisfy her in order to preserve the good name and reputation of your employer?

And when you do that something extra for the customer, isn’t he or she more likely to return and to recommend your products/services to others? Both of those outcomes produce increased revenues-and that may be good for stockholders as well.

Conversely, suppose you are standing in front of a customer and your firm has just engaged in a brutal round of layoffs. You believe the firings were unfair, employees had no warning and no input, and for all you know, you may be next. This is on top of your belief that those who were let go were not treated well at all. Will you respond to the customer with friendliness and enthusiasm? Will you do something extra to satisfy the customer in order to preserve the good name and reputation of your employer? That’s not likely.

Remember, though, that it’s all a matter of perception, and it all starts with the attitudes of senior managers toward employees. Do you see employees as costs to be cut or as assets to be developed? Employees who believe that they are regarded as assets tend to see themselves as sources of innovation, creativity and renewal. Employees who believe that they are regarded only as costs tend to be risk-averse, narrow-minded and self-absorbed. As an executive, you have the opportunity to make your views known every day. The choice is up to you.

About the Author

Wayne F. Cascio holds the Robert H. Reynolds Chair in Global Leadership, Management at the University of Colorado, Denver.