Sandra Forro, IE Business School, IE University Winner of the 2021 CoBS student CSR article competition, takes a sharp look at firms during the global recession and their track record of employee versus business strategy: save the company, save the employees – or both?
March, 2021: over a year after its origin, the COVID-19 pandemic continues its rampage. Though prospects are looking up with vaccination rollouts, the economic costs will take longer to offset. In 2020, the IMF proclaimed a negative global economic growth of -3% – the 2009 Financial Crisis exhibited -0.1%. The verdict? The Great Lockdown is the worst recession since the Great Depression. Some sectors such as manufacturing, travel, tourism, hospitality and retail were hit especially hard. Not only are consumers unable to indulge in certain activities, but their consumption habits are changing, too. As per McKinsey: “we have covered a ‘decade in days’ in adoption of digital.” Due to these developments, unemployment is surging. In the US, the number of people without a job increased by a whopping 5.2% since 2019. Confronted with a global recession, most businesses have posed the inevitable question: save the company or save the employees?
Employment: A symbiotic relationship
Businesses must recall that employment is a two-way street. Rather than blindly asking employees to sacrifice themselves in the face of COVID-19, downsizing must be weighed carefully. When sales and profits fall, layoffs have become the most popular management tool to cut costs. Yet, this is rarely the only choice, nor the best one. Research shows that large job cuts (5% or more) generally do not lead to higher profits or stock prices and simultaneously tend to have a strong negative effect on corporate reputation. Could a downsizing approach work for your business? Read on to find out.
The strategic role of employees
Downsizing consequences have largely shown to be negative. Nevertheless, it may be a fitting strategy, depending on your company’s objectives. The MIT lays out two methods for employee management: control-oriented and commitment-oriented. Control-oriented is more cost-focused, where operational excellence takes precedence. A commitment orientation places high value on human capital for achieving a sustainable competitive advantage. These categories help discern how critical employees are in achieving a given organization’s goals. In the case of control-oriented, layoffs are more readily justifiable and may be regarded as a good cost-cutting measure. A commitment orientation, however, requires treading lightly when it comes to downsizing, especially if this is accompanied by high R&D intensity, industry growth and low capital intensity. In a study, these attributes featured sharp decreases in firm profitability from personnel cuts.
Downsizing or rightsizing?
Downsizing during COVID-19 should have one root cause: the pandemic. Industries disruptively impacted by the disease, where changes are expected to persist in the long run, are viable layoff candidates. The MIT terms this as reactive downsizing: due to external forces, like crises or drastic marketplace changes, immediate survival is the company’s top concern. Structural changes may have manifested prior to COVID-19, so proper investigation into the causes is needed. For instance, in an interview, former Siemens CEO Joe Kaeser comments that there are changes in the energy landscape like coal and natural gas for power generation and more use of renewable energy resources. Notably, he emphasizes that these are of structural nature, unrelated to COVID-19. Mr. Kaeser also said that the fluctuation in activity from the pandemic is temporary in Siemens’s case. Consequently, no downsizing was done and short-time work was implemented instead.
Proactive downsizing, or rightsizing, aims to enhance the long-term competitive advantage of a firm. It stems from the internal workings of the company and not from outside shocks. A firm may accidentally engage in proactive downsizing under the pretext of reactive downsizing, so the pre-COVID-19 state of affairs should be carefully considered. Not only is fake reactive downsizing unfair to employees, but negative press may follow.
Mirror, mirror on the wall…
If a company’s image is crucial to its market position, layoffs should be approached hesitantly. In a study conducted during the Financial Crisis, downsizing firms lost over two thirds of their position in corporate reputation rankings (in the case of large job cuts over 5%). In terms of CSR, a downsizing decision must be ethical to be seen as socially responsible. At the very least, if layoffs are unavoidable, they must be handled in a fair and transparent manner. Airbnb’s CEO Brian Chesky, for example, sent a personal letter to employees during the pandemic with an explanation of why downsizing must happen, a roadmap of the process, five initiatives to help those leaving find new jobs (one of which included keeping the company’s Apple laptops), and a heartfelt apology. It was in line with Airbnb’s values and culture, garnering a positive public and internal response.
When operating in the US, downsizing is often undertaken more freely without image repercussions. There, layoffs are systematically used as a strategy to boost performance, more so than in other countries. In Europe, caution is required since dismissals are less accepted, and offers like short-time work, early retirement packages, buy-outs and working time reductions are commonplace.
The performance myth
Downsizing is not a miracle cure for bad performance. In fact, if performance is a problem, layoffs can add fuel to the fire. Instead, a long-term strategy using alternatives can boost performance. Take Honeywell: during the Financial Crisis, it opted for voluntary unpaid work leave and furloughs, without layoffs. Ex-CEO David Cote commented on the results: “During the fourth quarter of 2009 our sales forecasts stopped going down, and by January of 2010 my team and I were starting to talk about recovery. As orders began to pick up, it was clear that we were well prepared in comparison with our competitors: Our inventory and delivery times were better, and because we had held on to our people, we found it easier to win new business.”
In general, recessions last 12 to 18 months, after which demand revives. Ironically, it’s common for firms to rehire people a year after grand downsizing. Accenture, for example, conducted a workforce cut of (at least) 5% during the pandemic. Now that the sector has regained its pre-pandemic level of growth, Accenture struggles to retain valuable talent; employees are disillusioned by its previous actions and are flocking to competitors.
Clearly, downsizing can easily lead to wrongsizing; suddenly, a firm may not have enough staff to deal with the post-pandemic growth. Think about the concept of organizational slack (excess capacity): firms with high organizational slack have a greater ability to adapt operations to adverse economic conditions. A negative relationship between reduction of organizational slack and profitability is documented. Not reducing headcounts during COVID-19 may allow for better reactions to the changing environment and earlier seizing of market opportunities compared to competitors.
Also, if you thought layoffs are a good way to increase your company’s stock price, I bear shocking news. Stockholders have a peculiar view on layoffs. Whilst considered as efficiency-enhancing during periods of rising financial markets, downsizing from adverse market conditions or economic downturns is deemed as a sign of declining investment opportunities in the firm’s product markets. If a declining stock price is not one of your post-pandemic goals, steering clear is recommended.
Out of the frying pan into the fire
Before jumping on the downsizing bandwagon, remember that it also carries costs. Every time someone is let go, they get, on average, around six months’ worth of severance pay and outplacement services. So, it takes approximately 6 months before any savings from layoffs truly occur. Then, companies typically hire again 6 months later (at the end of the recession) and any savings from 6 months earlier are dispelled by the rehiring costs (especially as firms start competing for talent) and retraining costs. On top come the lawsuits from laid off employees, plus indirect costs of demoralized and unproductive surviving employees (‘survivor syndrome’) and reputational changes.
In the end, costs of downsizing are easily underestimated. A European company saw a 40% increase in recruitment costs, followed by 30% in training for new recruits after layoffs. This was unanticipated and cancelled out the small productivity gains.
Easier said than done
Ok, but if downsizing is off the table, what are the alternatives? Here are some tips:
- Lead by doing. Pay cuts are likelier to succeed if senior managers set an example. The CEO should take the largest cut; for instance, during the pandemic, airline CEOs, Palo Alto’s CEO and Gravity Payments’ CEOs renounced pay.
- Collect ideas from employees. This shows a genuine concern for their wellbeing and also ensures stronger buy-in for the initiatives that are eventually prioritized.
- Make clear that the alternatives are in place to avoid layoffs. This makes employees more amendable, perhaps even welcoming, towards salary-increase freezes, halted bonuses, unpaid leave, overtime bans, a pause on payments in retirement funds, reduced vacation days, and other such measures.
- Protect most vulnerable employees with lower pay cuts. For example, BIMDC cut the pay of its highest earning employees by 10%, those in the mid-range by 5%, and all others above a particular threshold by 2.5%.
- Governments have provided much assistance during COVID-19, like short-time work. Economic aid is targeted at firms that do not downsize. The German government, for instance, has set aside €100 billion to support companies through the pandemic.
- Adjust to customers. Agreeing to short-term relief may mean higher activity during recovery. PayPal, for instance, let customers move back repayments on business loans or cash advances – at no additional cost. This way, small businesses can swiftly deal with issues and recover financial strength for the near future. As PayPal CEO Dan Schulman put it: “We need to obviously take care of our shareholders, but I think the way we do that best is by taking care of our employees, taking care of our customers and stepping up and doing the right thing. That’s, I think, at least how we build businesses that are enduring and an economy that can be strong. And a strong economy is helpful for everybody.”
- Foster the workforce. During the Ebola crisis, for example, a company in West Africa devised a strategy for smoother physical return to the workplace, introduced new skills and training and cultivated a more deeply engaged workforce. It concisely distinguished between critical and noncritical skills for post crisis, and that employees needed to be more flexible; it then trained people in adjacent skills. Truck drivers, for example, became excavator operators. The strategy proved highly effective. Since COVID-19 has encouraged digitized learning approaches, learning costs may be lower. Additionally, in certain sectors, retraining the workforce is imperative to surviving. For example, banks had to train employees in aiding clients use digital tools and new products and services.
The bottom line
All things considered, you should ask yourself if the benefits of downsizing exceed the costs, and whether it fits in with your corporate goals and values. If layoffs are a must, remember that a business is equivalent to a car, whilst employees are its motor; only together do they produce a functioning vehicle. The pain of downsizing is a burden to be borne equally, so employers must ensure that appropriate measures are in place to soften the blow. At the end of the day, it boils down to business ethics and treating people the way they deserve.
White Papers Cited (Note: white papers are listed here, whilst online articles or other sources are linked directly in the text and are thus not included below)
- Agrawal, S., De Smet, A., Lacroix, S., & Reich, A. (2020). To emerge stronger from the COVID-19 crisis, companies should start reskilling their workforces now. McKinsey Insights (Issue May).
- Tarki, A., Levy, P., & Weiss, J. (2020). The coronavirus crisis doesn’t have to lead to layoffs. Harvard Business Review Digital. Retrieved, 4.
- Muñoz-Bullón, F., & Sánchez-Bueno, M. J. (2011). Does downsizing improve organisational performance? An analysis of Spanish manufacturing firms. The International Journal of Human Resource Management, 22(14), 2924-2945.
- Marshall, A., McColgan, P., & McLeish, S. (2012). Why do stock prices decline in response to employee layoffs? UK evidence from the 2008 global financial crisis. Journal of Financial Research, 35(3), 375-396.
- Van Dalen, H. P., & Henkens, K. (2013). Dilemmas of downsizing during the Great Recession: Crisis strategies of European employers. De Economist, 161(3), 307-329.
- Lakshman, C., Ramaswami, A., Alas, R., Kabongo, J. F., & Pandian, J. R. (2014). Ethics trumps culture? A cross-national study of business leader responsibility for downsizing and CSR perceptions. Journal of Business Ethics, 125(1), 101-119.
- Block, J. (2010). Family management, family ownership, and downsizing: Evidence from S&P 500 firms. Family Business Review, 23(2), 109-130.
- Guthrie, J. P., & Datta, D. K. (2008). Dumb and dumber: The impact of downsizing on firm performance as moderated by industry conditions. Organization Science, 19(1), 108-123.
- Zatzick, C., Marks, M. L., & Iverson, R. (2009). Which way should you downsize in a crisis?. MIT Sloan Management Review, 51(1), 79.
- Gandolfi, F., & Hansson, M. (2011). Causes and consequences of downsizing: Towards an integrative framework. Journal of Management & Organization, 17(4), 498-521.
- Datta, D. K., Guthrie, J. P., Basuil, D., & Pandey, A. (2010). Causes and effects of employee downsizing: A review and synthesis. Journal of Management, 36(1), 281-348.
- Block, J. (2010). Family management, family ownership, and downsizing: Evidence from S&P 500 firms. Family Business Review, 23(2), 109-130.
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