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The Double-edged Sword of Head Count Cuts

Companies contemplating layoffs must consider a variety of issues, not all of which fit into a spreadsheet.
David McCann, CFO.com | US
December 9, 2008

'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.


Hunt tells of another company that got rid of a team of five people, only to discover that another, revenue-generating department critically relied on them. After firing the five employees and giving them severance, the company decided its best option was to rehire them into the other department.

Of course, it can also be damaging for a company to cut too few employees, resulting in the dreaded "downsizing of the month" scenario: numerous small layoffs, with everyone thinking the ax will fall next on them. Ironically, some experts say, that can do as much damage to morale and survivor productivity as cutting too deeply.

Clearly, then, layoffs, like so many other business decisions, cannot be based solely on the coming year's budget spreadsheet. And that's particularly true in the current environment, when normal forecasting is nearly impossible. Even companies that are normally excellent at forecasting their results "don't have a clue where [the economy is] going," says Keith Hall, former CFO of LendingTree. Now a board member at several companies, Hall says that unless the company's survival is at stake, it's tricky to know with any confidence whether layoffs are actually the right move.

"You're playing with people's lives and trying to do the right thing," says Hall. "Corporations ought to go out of their way to do what's right for workers, but they also have to do what's right for the company. It's just too bad that in an environment like this so many are doing the latter."

Clearly, says Hall, if a company's access to cash is insufficient to fund operations and other obligations, layoffs are necessary. That's true even if it's just that the cash cushion is too thin — if a miss in sales projections would result in the company flirting with insolvency. But he has no patience for executives who make layoffs for selfish reasons. "If it's for the sake of hitting an artificial number so management can get a bonus, that's a different matter altogether. I've known a few guys like that, who say 'to hell with the people, I'm gonna do whatever it takes to get the bonus.' "

Executives at companies that recently laid off employees were understandably not eager to share their thought processes with CFO.com. But companies were willing to talk about how hard they were working to avoid head count cuts.

Take, for example, American Electric Power. Utilities are a business that is more recession-proof than most, but AEP is already seeing a rise in uncollectible bills and a drop-off in energy consumption, the company's CFO, Holly Keller Koeppel, tells CFO.com. The company plans to reduce capital spending by $750 million in 2009. But instead of trimming its work force, AEP has tightened its belt on the human capital front by instituting a hiring freeze and holding off on salary increases.

"Philosophically, our employees would be the last thing we would cut, if at all possible," Koeppel said. "We went first to things around which we have discretion that won't impact the work force or the quality of our service. The cuts we made were projects that would have gone to third-party vendors, and then we looked at discretionary operating and maintenance expenses."

But even the hiring freeze is a bold policy for AEP. Like most utilities, much of its growth took place in the 1960s and 1970s, and there was relatively little hiring over the ensuing decades. Its work force is quite mature, and it faces the very Baby Boom danger that human capital experts have warned about, with a large number of key AEP employees reaching retirement age over the next few years.

"We're taking a risk by not expanding our work force," Koeppel admits. "We're counting on folks staying around longer than they would have, and plans we had hoped to implement around bringing in and training new folks have been delayed."




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