Harvard Business Review

Look before you lay off

Look before you lay off

Downsizing in a downturn can do more harm than good.

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Look before you lay off

The full version of this article is available on Harvard Business Online (subscription required).

The Idea in Brief

Layoffs, the conventional wisdom goes, are a necessary evil during economic downturns. The problem is, the conventional wisdom is wrong. Researchers at Bain & Company analyzed the layoffs at S&P 500 companies during the early stages of the current downturn (from August 2000 through August 2001) and found that even as layoff numbers reached record levels, most companies weren’t downsizing. Rather, a small group of poorly performing companies accounted for the vast majority of firings, and their experience shows that reactive downsizing can backfire.

About a quarter of all S&P 500 companies announced layoffs during the study period, letting a total of about 500,000 workers go. That may sound like a lot, but the figure represents only 2.2% of the overall S&P 500 workforce. Just 22 downsizers cut 15% or more of their employees, accounting for 40% of the total cuts. The telecommunications industry alone was responsible for almost a third of the total layoffs, as shown in the exhibit “Who Did the Firing?”

The layoff numbers reported by companies, moreover, may have been exaggerated. Companies often include in their announcements not only true layoffs but also staff cuts achieved through attrition, early retirement, internal transfers, and divestitures of businesses. Because job cuts are normally carried out over many months or even years, improving economic conditions can lead companies to halt these staff reductions before they’re completed.

Why would a company overstate its staff cuts? Because many managers assume that shareholders like layoffs, seeing job cuts as a signal that the company is serious about controlling costs. But the research tells a different story. More often than not, investors interpret downsizing as a symptom of mismanagement or eroding demand, and they shun the stock.

As partner Darrell Rigby explains in this video, downsizing in a downturn can do more harm than good.

During the study period, companies with few or no layoffs performed significantly better than those with large numbers of layoffs. Businesses that laid off 3% or less of their workforces did just as well as companies with no layoffs at all: Both groups posted 9% share price increases, on average. By contrast, share prices remained flat in companies that let go 3% to 10% of their employees, such as Newell Rubbermaid, and prices plunged 38% among those, like Sapient and Qwest, that fired more than 10% of their workforce.

Part of the explanation for this is obvious: Large and repeated downsizings are symptomatic of flawed strategies that inevitably produce below-par results. But that’s not the whole story. Even when we clustered the S&P 500 into groups with comparable sales growth rates, companies with no layoffs outperformed those that downsized (see the exhibit “The High Price of Layoffs”). For example, among companies whose revenues fell at least 5%, those that implemented layoffs, such as Palm and Compaq, suffered an average stock price decline of 8%, while those that had no new layoffs, such as Waste Management, actually rose 19%. The hardest hit companies were those like Nextel whose sales grew more than 20% yet still resorted to layoffs. Shareholders had expected those companies to grow at even higher rates and were severely disappointed by the message of slower growth combined with the prospect of hefty restructuring costs.

Read the full article on Harvard Business Online.

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