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Debunking Layoff Myths

January 7th, 2009 | No Comments | Posted in Private Equity, Product Management, Venture Capital

The scale of layoffs in the current recession is reaching epic proportions.  As reported in the Wall Street Journal “Private sector jobs fell 693,000 in the U.S. in December, according to a revamped national employment report published Wednesday by payroll giant Automatic Data Processing Inc. and consultancy Macroeconomic Advisers.” 

Layoffs appear to be the most popular way for companies to cope with decreasing revenues and increasing expenses.  It will be interesting to see, however, if these massive layoffs generate the benefits touted by company management.  Bain & Company’s Darrell Rigby did a fascinating study in the Spring of 2002 where he analyzed the impact of post 9/11 layoffs.  The analysis, entitled Debunking Layoff Myths, called into question the true efficacy and value of large scale layoffs.  Rigby structured his analysis around the concepts of four layoff myths.  These myths included:

Myth #1: So, how much truth is there to the notion that everyone downsizes in tough times?

In 2001 recession there were approximately 2,000,000 layoffs.  According to Rigby “About a quarter of S&P 500 companies announced layoffs during the period studied, totaling 500,000 people. This sounds like a lot, but the figures are not quite what they seem. Remember, 74% of companies did not announce layoffs. Moreover, the announced layoffs only total 2.2% of the total S&P workforce.”

Net net while it sounds like the sky is falling the vast majority of companies are not laying off people.  That observation, however, is offers little solace for the hundreds of thousands of workers who have been impacted by our current economic crisis.

Myth #2: Shareholders like layoffs

“The research showed that the stock prices of companies that dismissed more than 3% of their employees performed no better during a three-year period than those of companies that made smaller cuts or none at all. Companies that cut more than 15% of their workforces performed significantly below average.  And companies that announced repeated rounds of job losses did even worse . . . Why so? Partly because large and repeated downsizings are often symptomatic of flawed strategies that inevitably produce poor results.

The primary explanation for this phenomenon is contained in Rigby’s Myth #3

Myth #3: Job cuts are all the same

“The press tends to portray layoffs as undifferentiated bad news for workers and the economy. But if we categorize the layoffs by root cause, we find that shareholders see a very different picture, finding some job cuts bad and others well justified. For example, companies that invoked layoffs to cut costs, such as insurer Humana, saw shares decline on average by 2% from 30 days before the announcement to 90 days after. But companies that laid off workers as part of an integrated strategy to consolidate a merger and capture business synergies watched their stocks rise, on average, by 10% in the same scenario.”

Cutting jobs to simply reduce expense is a short term panacea that the markets see right through.  Having a transparent and understandable strategy for creating long term value, however, generally has a very positive impact on valuation.

Myth #4: Ups and downs dictate “binge and purge” employment practices

“Clearly, companies suffering falling revenues and shrinking profits need to act.  And layoffs at times are inevitable. But Bain’s calculations show that unless jobs are eliminated for at least 6-12 months (sometimes even more than 18 months in knowledge-based businesses), the company will fail to earn a financial payback. And keep in mind that the average recession has lasted only 11 months. So, if it takes a company 3-6 months to realize it is in a downturn and another 3-6 months to develop a restructuring plan, it can find itself zigging just when it should be zagging as the economy turns. ”

Once again, companies with proactive strategies to manage their expense base, especially their labor costs, in good times and bad, tend to do much better in the short and long term.  ‘Binge and purge’ tactics are more likely to be a reflection of poor management.

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