Extreme downsizing is what management professor Wayne Cascio says companies engage in when they cut their workforce by more than 20 percent. To date, almost 40 percent of the United States's largest companies practiced extreme downsizing during the Great Recession.
Downsizing has long been thought to give an immediate boost to the bottom line - the notorious "Seven Percent Rule," which is the assumption that after a company announces a major layoff, its stock price will rise roughly 7 percent. It's one of the reasons Wall Street loves layoffs and heaps praise on CEOs who cut jobs aggressively.
But it's been proven untrue. Cascio's research at the University of Colorado in Denver examined more than 300 firms that downsized in the 1980s and found that three years after the layoffs, the companies' returns on assets, costs, and profit margins had not improved.
A number of surveys by the American Management Association and the Society for Human Resource Management have found that after downsizing, profits increase about a third of the time, stay the same a third of the time, and go down a third of the time. So why do CEOs continue to lay people off in bad times with little apparent concern for the consequences?
Take the case of Mark Hurd, the former CEO at HP. During his five-year tenure there, which ended in August 2010, the company excelled at the metrics that spell conventional success. Profits increased at an average of 18 percent annually. The stock price more than doubled, and HP became the biggest technology company in the United States in terms of revenue.
Some of that success was the result of drastic cost cutting by Hurd, including the elimination of 24,600 jobs in 2009. But there were consequences. As often happens following a big downsizing, employee morale took a dive. Internal employee surveys at the time showed that nearly two-thirds said they would leave if they got an offer from another company, according to technology consultant Rob Enderle.
Cuts also drove down the company's investment in R&D - its future. Charles House, a former HP engineer who now runs a research company at Stanford, told New York Times business columnist Joe Nocera, "That's why HP had no response to the iPad."
Cost-cutting through layoffs may make CEOs look like heroes in the short-term, but the long-term effects on performance can be severe, and some of the companies that indulge in it may falter in the future according to Cascio. Research shows that companies that cut their workforce by more than 20 percent lag their industry for as long as nine years after a recession.
Factors that slow them down include burnout and stress experienced by the remaining employees taking on extra work, and high voluntary turnover. A 2008 study by Charlie O. Trevor and Anthony J. Nyberg showed that the larger the downsizing, the larger the number of unanticipated voluntary resignations. "With a 10 percent downsizing," says Cascio, "a company should expect a 50 percent increase in voluntary departures, for example, from 10 to 15 percent. With a major cut, it will be even higher."
In knowledge-driven organizations, such as consulting firms and technology companies, the effect of layoffs on productivity is compounded. In these hyperconnected industries, knowledge workers depend on others to be successful, "so each departure disrupts the social networks where ideas are generated and work gets done," says Cascio. Google and Apple, for example, protected their talent pools during the Great Recession by finding other means of cost cutting.
Southwest Airlines, which has not had an involuntary layoff in its 40-year history, relied on attrition to reduce headcount during the Great Recession. And since it wasn't recruiting, it redeployed recruiters into customer service jobs rather than lay them off. More than many companies, Southwest acts as if employees really are its greatest asset.
The number of companies that weigh the value of employees' skills against the cost of their salaries is very small when it is time to make cuts. "In the 1990s, it was about 10 percent," says Cascio. "Most are looking for the irreducible core number of people it takes to run the business." And it's easier to measure the immediate results of a payroll cut than the long-term negative effects of too little brainpower or too much disillusionment.
Layoffs and increased profits don't mix
Sometimes layoffs are necessary to save a business, as in the newspaper industry, which is permanently shrinking. But many of the extreme layoffs of the Great Recession have been a response to what is presumably a temporary drop in demand and the need to cut costs quickly.
Besides the fact that layoffs don't consistently increase profits, there are a host of other reasons to avoid them, including the cost of rehiring needed talent, lawsuits, lost trust in management, and even sabotage and violence. Research links all of these factors to downsizing.
And yet, companies continue to use layoffs to cut costs even as research mounts to show that they are ineffective and even harmful. Perhaps it's as simple as monkey see, monkey do. Companies and their executives do tend to copy the behavior of others in their industry. But, more likely, it's ignorance of the facts, lack of foresight, and the irresistible urge to give a quick hit to the bottom line.