Why do companies resort to layoffs? Layoff is not a corporate strategy, rather companies resort to this measure as an immediate sort of a response when the business is going at a loss and want to stem costs. But layoffs can backfire. They do not really help the companies to recover or revive their fortunes. The conventional wisdom about laying off employees is full of myths. People think that laying off people will lead to increased productivity, reduction in costs and increase in profits. Well, all of these are just myths, nothing else.
Pros and cons of downsizing in companies
The productivity does not increase in reality on account of layoffs. A study conducted by Wharton Prof Peter Capelli established that the decreased labor costs due to layoffs resulted in decreased sales per employee. Productivity therefore did not improve. The argument that companies target only under performers and unmotivated workers at the time of downsizing and weeding out such workers increases productivity is simply not correct. The remaining employees show a decrease in morale and are unhappy about losing their colleagues. Such an atmosphere is not conducive for growth. Thus layoffs can backfire badly.
Layoffs do not help in cutting costs in a substantial and meaningful way either. In the manufacturing sector, material cost is around 60-70% of the total cost and the human resource is only around 5-10%. Downsizing here will not lead to substantial cost cutting at all.
According to research conducted by Prof Wayne Cascio of the University of Colorado, there are direct and indirect costs attached to layoffs. Costs like severance pay, payment for accrued vacation, sick pay, outplacement costs, costs of re hiring later on all add up to a substantial figure. Apart from that, low morale and potential lawsuits on grounds of wrong dismissal add to costs. Prof. Cascio’s research gave examples of IBM who had to shell out 700 million dollars on employee restructuring in 2007. Microsoft spent a whopping 1.6 billion dollars during a corporate downsizing in 2014 when they laid off 1800 employees.
Cost reduction due to downsizing workforce does not result in an increase in profitability either. A study in which 122 companies were scrutinized, found that corporate downsizing led to a decrease in profitability. Prof Cascio’s study also established that corporates that downsized became less profitable than the ones that did not.
Perception of companies that are downsizing
Many corporates that downsized themselves stated in a survey conducted by the American Management Association that they did not see an increase in profitability (almost half of the corporates surveyed said so). Quite a few (one third of the corporates surveyed) were of the opinion that the productivity also did not improve.
Why do companies downsize?
So despite having limited pros and a long list of cons of downsizing, why are companies ever ready to downsize? Corporates downsize and even overstate the numbers to impress their investors and shareholders. Many corporates assume that it sends the right signal to their investors that they are serious about managing costs. But this is a fallacy. Shareholders and investors more often than not take downsizing as mismanagement and loss in demand. Shareholders are savvy enough to know which layoffs to reward and which to punish. Companies that downsize to cut costs do not normally see any increase in the price of their shares. Companies that resort to layoffs to due a well thought out strategy for merger of businesses and enhancing synergies see a rise in their stock price.
Case against downsizing of workforce
Therefore, there is a strong case against reflexive downsizing of workforce. Companies have always resorted to laying off employees during economic down turns. Lately however, companies have started downsizing in good times as well even when they are in profit. Due to a temporary drop in demand or to bolster their profit by cutting costs, companies are tempted to layoff their workforce. This is a temptation worth resisting. The tendency to give quarterly results undue importance and losing sight of long term gains compels companies to resort to layoffs as a short term remedy. The long term impact of such action is always negative. Some of the long term implications are: the negative internal and external environment, low morale and decrease in productivity due to low morale, effect on goodwill and reputation etc. Layoffs should be resorted to only as a last option.
There are examples in the corporate world where companies had bucked the prevailing trend and did not resort to layoffs and remained in business. The classic case of Southwest Airlines in the USA that did not layoff a single employee in 40-45 years, even during the great recession, is a case in point.
When layoffs are inevitable
That said, layoffs are perhaps necessary in some situations. Companies with falling revenues and growth and decreasing profits need to take some action. If an industry is disappearing or permanently shrinking, layoffs are inevitable. Such companies need to downsize their business. Changes in technology or new market size also compel companies to downsize many times. But they need to strategize well and do a thorough cost benefit analysis before resorting to it. A well structured identification method, proper communication and giving support to employees during exit ease the situation for the company as well as for the laid off employees. A humane and efficient way of dealing with the downsizing of workforce ultimately will neutralize the negative impact on the company’s reputation and goodwill. They should keep in mind that they may need to rehire soon as and the economy rebounds and should factor in the cost of it.
Conclusion
Widespread downsizing has a bigger effect on the economy as a whole. People who lose jobs lose incomes and their spending power decreases. Workers who have not lost their jobs also become fearful and spend less. This results in lesser demand in the economy and overall sales fall, leading to more layoffs. A vicious cycle ensues.
Layoffs are bad for companies, harmful for the economy and disastrous for the employees. The damage from it lingers on even after the economy has revived. From every point of view, layoffs should be resorted to as the last option otherwise they can backfire in a big way.
References:
- How layoffs can backfire. Kartikay Kashyap. July 11, 2019
- Look before you layoff. Darrell K Rigby. April 2002. Harvard Business Review
- Case against layoffs: they often backfire. Feb 4. 2019
