The Financial Times

Downside of downsizing: Job losses often produce greater costs than benefits

Downside of downsizing: Job losses often produce greater costs than benefits

The smartest companies ask themselves a few questions before they jettison workers.

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Downside of downsizing: Job losses often produce greater costs than benefits

July was a fire-cracker month for redundancies: a record 205,975 jobs were cut in the US, according to an announcement by outplacement firm Challenger, Gray & Christmas. These cuts bring the total to almost 1m for 2001 in the US alone. It is a level of retrenchment not seen since the recession 10 years ago.

The real explosion, however, may occur a year down the road, when the managements of downsizers such as Unilever, Xerox and Goodyear discover that fighting fire with firings can get you burnt.

A Bain & Company study of 288 Fortune 500 companies that weathered the last recession shows that the stock prices of companies that dismissed more than 3 per cent of their employees performed no better during a three-year period than those of companies that made smaller cuts or none at all.

Companies that cut more than 15 per cent of their workforce performed significantly below average: think of Pan Am in 1991 or Lucent in the current downturn. And companies that ann-ounced repeated rounds of job losses, such as Digital Equipment in the early 1990s, did even worse.

Why so? Part of the reason is obvious: large and repeated redundancies are often symptomatic of flawed strategies that inevitably produce below-par results. But another part is that the job losses themselves can produce greater costs than benefits.

There are severance costs, outplacement costs, loss of knowledge from skilled workers and damaged trust and credibility, not to mention reduced innovation and lowered productivity for those who are not made redundant but who become risk-averse and feel justified in spending more time looking for a new job.

Job cuts can even be dangerous to management's health. According to a 1998 report from the Beth Israel Deaconess Medical Center in the US, managers are twice as likely to have a heart attack in the week after they fire someone.

So what is the solution? Clearly, companies with shrinking revenues need to act. And some redundancies do produce superior returns—for example, those related to consolidating acquisitions and strategic repositionings, as at General Electric over the past 20 years.

But the smartest companies ask themselves a few questions before they jettison workers.

First, what is the underlying driver of my poor performance? Is it too many employees, or is it being in the wrong businesses, locations or product lines? In the last recession, American Express boosted performance by pulling out of non-core activities such as its Shearson brokerage unit.

Second, what is my strategy and what are my options? After selling off non-core businesses, Arrow Electronics realised that one option was to worry less about cutting costs and more about thumping the competition while they were distracted by the turbulence. Arrow figured the odds were on for a big bet and acquired the number three player in its business, catapulting it to number one, a position it holds to this day.

Third, given my options, what are my priorities? Are employees more valuable than corporate jets, art collections or first-class travel? Am I keeping my strategy and core competences front and centre when allocating scarce resources?

Do not trade long-term strategic assets for short-term gains. During the Asia crisis, Emerson retained talent, suppliers and market share by maintaining staffing and development of an air-conditioning processor plant in Thailand and shipping parts to Europe and the US to keep production going.

Fourth, if I have to lose workers, how can I do it appropriately? How can I reduce deeply enough so that subsequent cuts will be avoided? How can I cut respectfully enough so that remaining employees will stay loyal and productive?

Procter & Gamble has been criticised by outsiders for being "too nice" in its recent round of redundancies, which called for voluntary severance and generous benefits packages. But P&G's approach is tailored to its culture, and the stock price is up 14 per cent since its March announcement.

Cisco's share price, while down, is suffering less than other technology stocks and it, too, is taking an approach to redundancies that is geared to preserve loyalty. As well as severance packages, the company is offering educational sabbaticals and secondments to non-profit organisations at reduced salaries.

When the numbers come in, redundancies all seem depressingly alike. But for stakeholders, employees, customers and shareholders, how a company approaches job cuts is a telling sign of whether management is wisely navigating out of the heat, or jumping from the frying pan into the fire.

The writer is a director of Bain & Company in Boston and author of the study, Winning in Turbulence: Strategies for Success in Tumultuous Times (Amazon eDocs)

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