The Hidden Costs of Layoffs

Last Updated Aug 21, 2008 2:49 PM EDT

Think downsizing will solve your company's financial
woes? Before getting out the ax, take a look at what experts and researchers
have discovered about the unexpected consequences of layoffs. These harsh
realities may make you think twice:


1. Significant indirect costs often wipe out the direct savings of layoffs.


While layoffs may seem like a good way to cut costs in the
short-term, the direct and indirect costs of downsizing can paralyze your
company’s long-term revenue-generating streams. “The books
look great for two or three quarters, and then things don’t get done,”
says Jonathan Phillips, managing director of Houston-based executive search
firm Magellan International.

The direct costs of layoffs from outplacement services and
severance pay can add up initially, but indirect costs — like losing
experienced sales and marketing employees who have strong relationships with
clients — can cause lasting damage to a business. Phillips saw this phenomenon
first-hand when he worked in various management roles at Shell in the late
1980s. “They let a lot of senior executives go, mostly out of sales
and marketing, which they thought was a marginal activity until their clients
didn’t want to buy from them anymore.”

Additionally, the
direct costs of layoffs negate any financial benefit if new employees are hired
within six to twelve months, according to a Bain & Company study. This
type of “binge-and-purge” tactic, common during
recessionary periods, can place an organization in an unfavorable position when
the recession comes to a close.

2. Your best employees might bolt after a round of cuts.


The top performers who survive a layoff won’t
necessarily feel obligated to soldier on. A 2000 href="http://jom.sagepub.com/cgi/content/abstract/26/5/977">study by Roderick Iverson and
Jacqueline Pullman from the University of Melbourne, and a 2003 href="http://www.colorado.edu/ibs/pubs/pec/pec2003-0003.pdf">study by Sarah Moore, Leon Grunberg,
and Edward Greenberg from the University of Colorado at Boulder,
both confirmed that employees were far more likely to quit jobs in environments
of repeated downsizing. The likelihood that an employee will quit actually
increases the more layoffs he or she “survives,” the CU-Boulder
study found.

Both studies partially attribute this occurrence to the
general malaise associated with working at a company after a series of layoffs,
a feeling businesses rarely do anything to counteract. “We tend to
think people leave because of poor morale, but the real reason is businesses
fail to spell out for people why things will get better,” says Wayne
Cascio, a professor of business at the University of Colorado at Denver and
author of the book “ href="http://www.amazon.com/Responsible-Restructuring-Creative-Profitable-Alternatives/dp/1576751295">Responsible Restructuring: Creative
and Profitable Alternatives to Layoffs.” “What
is it that will make things better? Where’s the new vision? If people
don’t see that, and if there are other opportunities, they’ll
tend to walk.”

See also: How to Manage Your Team in a Downturn (and Come Out on Top).

3. The best types of workplaces often suffer the most.


If your company touts itself as receptive to the needs and
personal development of its workers, layoffs can be even more troublesome. A
recent report by researchers Christopher
Zatzick and Roderick Iverson
of Simon Fraser University found that layoffs
at “high-involvement workplaces” — those with
management strategies that give employees the skills, information, and
motivation to be competitive — can be markedly more detrimental to
the organization than layoffs at an average company.

“Layoffs can be
perceived as a violation of the psychological contract between an organization
and its employees, resulting in decreased trust and greater stress in the
workplace,” the authors write. The negative effects on the survivors
of a layoff — decreased commitment and productivity — are “more
costly for high-involvement workplaces, as these workplaces rely expressly on
employee involvement and motivation.” Not only are top-performing
employees more likely to leave, but the employees that remain may exhibit less
effort and involvement.

Fortunately, these workplaces can mitigate the negative
aftereffects of downsizing, the study found, by continuing their
employee-friendly practices. Phillips of Magellan says Johnson &
Johnson is a good example. “Johnson & Johnson has huge family
involvement with the firm,” Phillips says. “They try
desperately to place everybody, even if they know [they] can’t do it.
The attitude in HR is, ‘What can we do to help?’”
Companies that cut back on this management strategy as part of a layoff to
minimize costs fared worse, the study found, as employee productivity suffered.

4. Layoffs don’t improve organizational performance.


Since some of your best and most experienced employees will
jump ship after a layoff, workplace productivity is bound to suffer, and the
psychological effects of a layoff on those who remain can be even more
detrimental to your company’s continued performance. New York Times
reporter Louis Uchitelle examined these effects in “ href="http://www.amazon.com/Disposable-American-Layoffs-Their-Consequences/dp/1400041171">The Disposable American: Layoffs and
their Consequences,” finding that company performance
suffered significantly in a post-layoff atmosphere. Uchitelle cites an example
of a group of productive software engineers at Xerox who shifted their focus
from inventing to flaunting their talent with needless meetings and crisis sessions
after a layoff made them question their job security.

Researcher and author
Cascio compared cost-cutting strategies with several companies’
performance on the S&P 500 during an 18-year period. His findings
showed that the most successful companies didn’t rely on layoffs to
improve performance. “Over time, the only firms that really
outperformed their industries were those that found ways to grow revenues,”
Cascio says. “You can’t just shrink your way into
prosperity.”

5. Employee retention is linked with customer retention.


Negative public perception of a layoff can be another
unexpected cost. “If you’re buying from a company that
treats its people badly, you’re going to try and buy from someone
else, even if it’s not overt,” Phillips says. “This
is the only reason Whole Foods survives — because people want to do
what’s right — and so they buy more expensive food that
doesn’t taste as good from Whole Foods.” Convincing
customers that layoffs are absolutely necessary is probably impossible, since
most companies that lay off employees aren’t actually in dire
straits. “In any given year, we tend to think the firms that do
downsizing are in rather desperate situations and are battling to survive,”
says Cascio. “The data just doesn’t confirm that.”
According to research by Bain & Company fellow Fred Reichheld, employee
loyalty and customer loyalty have a direct correlation. So companies that hold
on to their employees and eschew a policy of frequent downsizing are far more
likely to keep customers — and thus keep revenue flowing.

  • Carlos Bergfeld

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