When Downsizing Goes Bad

Interesting article in Newsweek about how the use of downsizing and layoffs is often misused by corporate chiefs, who greatly overestimate the benefit of these cost-reduction measures and simultaneously underestimate the the cost that is borne on the company, these employees, and broader society.

Jeffrey Pfeffer, a professor of organizational behavior at Stanford University's Graduate School of Business, raises a number of interesting points, some of which are intuitive, but some which are probably open to debate. For example, in two cases Pfeffer tries to debunk two myths with his own observations, putting forward data that he claims shows:

• "... downsizing reduced subsequent profitability and that the negative consequences of downsizing were particularly evident in R&D-intensive industries and in companies that experienced growth in sales."
• "... negative stock returns to companies announcing layoffs, with larger and permanent layoffs leading to greater negative effects."

Or more concisely, that layoffs actually reduce profitability (contrary to conventional corner-office wisdom) and lower stock price (contrary to conventional corner-office wisdom). For the first point, profitability is not surprisingly muted due to one-time chargers related to restructuring. Also, he doesn't account for companies whose revenues are fundamentally and permanently changing due to changes in alternate product offerings or lapses in patent protection. The stock price may very well be a reflection of a imminent revenue cliff, and a company's reaction to that would be to reduce costs (as is done through layoffs) which are "out of scale" with a new revenue model. It's a difference between correlation and causation. Layoffs aren't the cause of poor profitability or stock price - but tends to be correlated because other bad things are going on (such as the revenue plunge). Pundits would argue that without the layoffs, profitability and stock price would be effected even more negatively.

The other criticism is that Pfeffer assumes is that the workforce is completely adaptable in terms of acquiring new skills to accommodate changing business models and/or that it's decidedly less expensive to retrain workers who may or may not have the willingness or wherewithal to adapt, as opposed to hiring new workers who can bring the specific requisite skills to the table.

That being said, I did resonate with much of the article, because there's no doubt that corporate layoffs are often done badly and for the wrong reasons. As Pfeffer explains:

Part of the answer lies in the immense pressure corporate leaders feel—from the media, from analysts, from peers—to follow the crowd no matter what. When SAS Institute, the $2 billion software company, considered going public about a decade ago, its potential underwriter told the company to do things that would make it look more like other software companies: pay sales people on commission, offer stock options, and cut back on the lavish benefits that landed SAS at No. 1 on Fortune's annual Best Places to Work list. (SAS stayed private.) It's an example of how managerial behavior can be contagious, spreading like the flu across companies.

I agree with this to some degree. Some corporate leaders are obsessed with certain metrics (e.g. stock price) which are largely influenced by analysts, etc. to the degree that it's not simply a question whether you have a long-term and sustainable strategy for success and can execute it - you need to be able to convince a host of other people (e.g. analysts, institutional owners of your company's stock) that you'll be able to pull it off. This leads to behaviors which are dangerously swayed by "what's the strategy for which I can most easily get influential people to 'buy' into" as opposed to "what's the best strategy".

And I agree with (and fret about) the immense costs that layoffs have upon people, families and society as a whole. I'm not quite sure how to balance that with the reality that downsizing is often a corporate necessity and the absolutely right thing for a company to do. If I knew the answer to this, I'd be sharing it.