How Job Layoffs Hurt Companies by [email protected]

Time was, layoffs were seen as an emergency strategy, the last resort in a downturn or crisis. Today, however, layoffs are a standard tool for doing business. As the economy continues to heal and job indicators improve, a number of firms have announced a fresh wave of layoffs — Nordstrom, Sprint and American Express among them — citing the need to improve profitability. Studies have shown that layoffs do not generally result in improved profits. And yet, firms continue to keep the pink slips at the ready. Why?

It’s about the triumph of short-termism, says Wharton management professor Adam Cobb. “For most firms, labor represents a fairly significant cost. So, if you think profit is not where you want it to be, you say, ‘I can pull this lever and the costs will go down.’ There was a time when social norms around laying off workers when the firm is performing relatively well would have made it harder. Now it’s fairly normal activity.”

The layoff mentality has become culturally ingrained by way of both positive and negative developments — the Great Recession, as well as the new economy. “In Silicon Valley, the big thing is to be disruptive. It’s the ultimate: Who are we going to disrupt, and how?” says Wharton management professor Matthew Bidwell. “What does that mean? Laying people off. A lot of these layoffs reflect that. As new forces come in, some jobs go away.”

Layoffs “have been pretty constant over the years, and it seems to happen no matter what the economy is doing,” says Wayne F. Cascio, a global leadership professor at the University of Colorado Denver who has studied layoffs for decades. “When the economy is down, it’s always the argument that we’ve got to cut costs, and when it’s doing well we often hear we need to improve profitability, because it’s the best time to do it. The tune hasn’t changed.”

“Firms that are laying off are almost by definition in trouble.” Peter Cappelli

But some are suggesting it is time for a change. If several decades’ worth of research now shows layoffs to be a poor way to boost profits, while other strategies may in fact work, perhaps there are ways of changing the dynamic between what’s happening on Wall Street and decisions that get made in the board room and on the shop floor. Says Cobb: “The challenge is: how do we get back to a more socially responsible way of handling employment given the influence of financial markets on corporate decision-making?”

Layoff Myths and Mirages

Contrary to popular belief, there’s not much evidence that layoffs are a cure for weak profits, or, to use the current euphemism, that they reposition a firm for growth going forward. “It’s very difficult to sort out the relationship because firms that are laying off are almost by definition in trouble,” says Peter Cappelli, Wharton management professor and director of the school’s Center for Human Resources. “The research evidence has not found any support for the overall idea that layoffs help firm performance. There is more support for the idea that where there is overcapacity, such as a market downturn, layoffs help firms. There is no evidence that cutting to improve profitability helps beyond the immediate, short-term accounting bump.”

The effectiveness of layoffs as a tool for profitability varies from industry to industry, case to case. Sometimes, layoffs are necessary, says Bidwell. “Underlying this is the idea that business is constantly changing, and so a set of activities that were really important to the business 10 years ago you may find you no longer want to be doing,” he says. “Either you’ve become so uncompetitive in the market, like BlackBerry, or there are markets that grow and disappear. I saw some terrifying graph the other day about how advertising revenues have skyrocketed, while TV advertising is flat and at newspapers they have fallen through the floor. Obviously, if you are a newspaper publisher you cannot go on as you were.”

But as a cure for corporate ills, layoffs are a chimera that can come back to bite a company. “There is some evidence that when shareholders are more powerful, companies are more likely to engage in layoffs, and yet announcements are usually met with declines in share price, so it’s not clear that it’s a great sign,” says Bidwell. “Shareholders love it, but it may punish them even more.”

Companies continue to use layoffs because it’s a way to be seen as responsive, he says. Such was the case a year ago when American Express was making money, but not enough to quell investor concerns. The company had a revenue growth target of 8%, which it chose to help meet by cutting costs. After announcing that it would shed 4,000 jobs, American Express’s stock price took an immediate slide, and remains down by about 25% since that announcement.

Employers also often overestimate the cost of layoffs in immediate financial terms, as well as in the lingering burden it places on remaining resources — both financially and emotionally. “There is definitely a huge problem in HR generally that the stuff that is easy to put on a spreadsheet outweighs the stuff that isn’t,” says Bidwell.

The toll of layoffs is high. In many industries, layoffs beget lower productivity and profits. When sales are slow, for instance, many retailers cut staff. But several studies show a correlation between bigger staffing and substantially higher sales.

What about profitability? One study that examined a large specialty retailer found that conformance quality (how well an employee executes prescribed tasks) has a higher impact on profitability than service quality (defined as the extent to which the customer has a positive experience). According to a Harvard Business School working paper, “The Effect of Labor on Profitability: The Role of Quality” by Zeynep Ton, stores that cut staff were unwittingly cutting profits, and yet the practice was standard. Why? “An emphasis on minimizing payroll expenses and an emphasis on meeting short-term (often monthly) performance targets,” the study found. Another consequence of understaffing at this retailer was lowered morale, a finding echoed in other studies.

“Underlying this is the idea that business is constantly changing.” –Matthew Bidwell

Layoffs are going to reduce costs immediately, says Cobb. “But what does that mean two or three years from now when the firm is growing and now has to ramp back up by hiring a bunch of people? Now the firm must incur all these costs to hire and train workers.” In addition to the laid-off employees, he adds, other workers may now leave voluntarily, all of which is disruptive for the firm and lowers productivity. “Layoffs may look good on paper because they have an immediate effect on costs. Yet in reality there are a lot of costs that layoffs impose on firms that might not show up on an income statement quite as clearly.”

Cascio is in the home stretch of a project that analyzes the S&P over three decades, looking at firms that downsized to track financial performance in the years following. He expects to have results in a few months.

Tenure rates — the length of an employee’s stay at one company —

1, 2  - View Full Page