Should job cuts start at the top?

20130130_jobcutting1It’s less than a month into 2013 and the stream of job-cutting announcements shows no signs of letting up.

  • Boral (BLD) is planning to cut more than two thousand jobs including 700 positions in Australia;
  • there are unconfirmed reports that QBE Insurance wants to slash up to 700 jobs;
  • Qantas (QAN) is seeking voluntary redundancies after losing a check-in and baggage handling contract with Air New Zealand;
  • Penrice Soda (PSH) is closing its soda ash plant in Adelaide with the loss of 60 jobs; and
  • BlueScope Steel (BSL) is cutting 170 jobs at its Western Port facility at Hastings.

In most cases, the stock market has reacted positively to these layoff reports. Boral shares rose 10.1% on the news, QBE jumped 3.3% and Penrice Soda climbed 16%.

But does downsizing make sense?

At first glance, cutting staff numbers to align costs with current sales looks like a smart move. In tough times, surely it makes sense to reduce labour costs, eliminate unnecessary layers of management and streamline your operations to boost competitiveness.

Or does it?

Although company managers like to portray job cuts as a harsh but necessary response to poor trading conditions, most studies suggest that downsizing results in little or no improvement in operational efficiency or profits.

The exact reason for these disappointing outcomes is not clear although there are several plausible theories.

Some believe it’s because layoffs breach a kind of unstated psychological contract between employers and employees. When a worker joins a firm, they don’t only expect to be paid, they expect to be looked after by their employer.

Whether consciously or not, downsizing is perceived as a violation of the employers responsibility to provide a stable, positive work environment. This generates a pushback in the form of low morale, a lack of interest in organisational goals and in extreme cases retaliation and sabotage.

It’s not hard to imagine this happening, especially if the remaining employees are asked to take on the work of those who have just been made redundant. There is also support from medical research which has found that work groups experiencing job cuts are twice as likely to take sick leave as those who have not been downsized.

Others argue that while psychological aspects may be important, the real problem is that the studies on job-cutting are flawed because they only examine the impact over two or three years. Layoffs might take several years to bear fruit. But recent research over much longer time-frames (up to 12 years) tends to confirm the earlier findings: namely, that downsizing firms rarely achieve meaningful results. They usually continue to under-perform in the subsequent two or three years and then just track the performance of non-downsizing firms.

A dumb strategy

But new research suggests that we might be looking for the answer in the wrong spot.

If a firm’s performance has deteriorated to such an extent that layoffs are required, what does that say about top management and the firm’s strategies? Like most people, senior executives are generally reluctant to admit their failures and they tend to persist with their core strategy even when there’s compelling evidence that it’s not working. This is particularly the case for management teams that have been in place for a long period of time.

Rather than being a rational response to a difficult trading environment, downsizing appears to be widely used by poor-performing managers as a rearguard response to avoid changing course.

A study by Lin and Parker (2011) based on the Top 100 companies in the US found that while downsizing had no significant impact on long-term performance, top management turnover was positively associated with return on assets over a three-year timeframe. Their conclusion is that poor performance is frequently a reflection of poor strategies and that owners may need to ‘intervene’ to force change at the top so that a new approach can be implemented.

The key message for investors is that layoffs are rarely good news. Rather than rewarding management for making tough decisions, shareholders should be questioning why things got so bad in the first place and whether changes need to be made at the top.

Reference:

Lin, J & Parker, T. ‘Firing the top is more effective than firing the bottom: the effects of downsizing and TMT turnover on firm performance’ International Journal of Strategic Management, Vol.11, No.2, August 2011.

Comments

  1. Ray Matthews says:

    These findings don’t really surprise me. Most managers I’ve worked with are the last ones who should be running the company!

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