The Double-edged Sword of Head Count Cuts

'Tis the season for layoffs.

Scrooge-like as it seems, Christmastime is traditionally when companies, particularly those with calendar year-ends, send out pink slips en masse. And this year's Yuletide carnage promises to be dire. The first two weeks of December alone saw announcements of some 34,700 planned cuts at companies including Anheuser-Busch InBev, Dow Chemical, 3M, AT&T, DuPont, State Street Corp., Washington Mutual, Constellation Energy, and Adobe Systems.

Already, some 1.2 million U.S. jobs have disappeared in the first 11 months of 2008, and 46 percent of CFOs tell CFO magazine that they expect to make layoffs in 2009. As of the first of the December, unemployment officially stood at 6.7 percent, the highest since October 1993.

Of course, the reason companies make these cuts (and the reason that they often come at what should be the most wonderful time of the year) is to trim their budgets in the face of economic headwinds. For CFOs, it's a tactic that's hard to argue: if topline growth is slowing, expenses should slow too. And for most companies, people are the largest expense.

But is there a financial case to be made against layoffs? Certainly, layoffs come with costs too, both tangible and intangible. In addition to potentially incurring restructuring charges, companies lose institutional knowledge, risk being caught short-staffed when the economy turns around, and (no matter how sensitive they try to be) often damage the morale and productivity of the surviving employees.

There is also a non-financial case against layoffs, though it's harder to make to a CFO who owes a fiduciary duty to shareholders. The notion of viewing not just shareholders but employees as key stakeholders in company fortunes was a hot topic of conversation in the early 1990s after a spate of leveraged buyouts came undone. Today, a similar question is whether mass layoffs — sparked more by fear than accurate forecasting — could actually deepen the recession, creating a vicious circle. Technically, that's still not a CFO's concern: while fiduciary responsibility does shift when a company is imperiled, it shifts to creditors, not employees.

Still, many American companies are more reliant on the intellectual capital of their employees than they are on actual manufacturing, and companies that lay off employees are taking a long-term risk for a short-term savings.

Indeed, companies "almost always" overestimate the number of people who should be laid off, according to Crist Berry, who served as a vice president or director of human resources at four different Fortune 500 companies before retiring in 2005.

"You've got to figure out what your competitive edge is — what sets you apart from the competition? That's the place you can't cut," says Berry. "If you don't understand that, you're going to have a heck of a time ramping back up."

Steven Hunt, a longtime developer of talent and performance management solutions who is currently director of business transformation services for software vendor SuccessFactors, agrees that companies "tend to jump the gun" on layoffs.

Often, he said, workers are more flexible than their employers realize when it comes to cutting costs. Voluntarily taking paycuts, forgoing bonuses, and working fewer hours may be preferable to taking a chance on being laid off. "That won't work at every company, but in some cases it can be an effective way to say that 'employees are our most valuable assets so we're going to think twice about getting rid of them,' " Hunt says.

In the retail sector, Hunt says he's seen some companies take people out of management roles and put them on store floors where they can drive revenue. "I'm not saying that's going to solve the problems of a major financial crisis, but companies should start by asking themselves if they're getting as much money from people's work as they possibly can," he says.

Such tactics may also help a company hedge against a sudden rebound in the market. Rehiring laid-off workers after a prolonged downturn is often much harder than companies expect, according to Dale Winston, CEO of recruiting firm Battalia Winston. And, she says, "The consequences of today's job cuts are far greater than they've ever been because of the demographic issues companies will be facing over the next five years." That's because this latest financial crisis comes just before the official start of the long-foreseen exodus of Baby Boomers from the workforce, which could magnify a post-recession struggle for younger talent.

Perhaps even more potentially damaging than laying off too many people is letting go of the wrong people. Usually the decision will employ a matrix estimating how much a person costs to employ, their level of performance, and what knowledge they have. "Companies often have made mistakes [estimating employee knowledge], where they have let someone go that they suddenly realized was the only one who knew how to perform an important task," Hunt says.

In a high-profile example, Circuit City Stores last year laid off 3,400 employees whom it described as "paid well above the market-based salary range for their role" and hired lower-paid replacements. The impact on employee morale was severe, and some observers have partly blamed the move for last month's bankruptcy filing and announcement of 155 store closings.

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