Alternatives to Downsizing

Alternatives to Downsizing

Martin G. Evans, Hugh P. Gunz, & R. Michael Jalland

Rotman School of Management, University of Toronto

Financial Post April 27 1996 Downsizing has been a pervasive managerial practice for the past ten years. It has been the unquestioning norm that, if a company finds itself in financial difficulties, THE way out is to downsize by cutting personnel. Yet concern is growing about the human costs that accompany downsizing, and questions are being asked about its impact on the macro-economy: as more people are downsized out of jobs, who is there to buy the downsized companies' products? Furthermore we now know that downsizing rarely returns the benefits expected of it: a downsized firm is often worse placed, not better, to compete.
Does that mean that downsizing is always to be avoided? Clearly not; sometimes it is unavoidable, and in previous articles (Financial Post July 19, 1995; February 24, 1996) we discussed some of the best practice procedures that firms can use to accomplish downsizing effectively. But there are alternatives which it may well be wise to consider first, before taking the risk of joining the 80% of firms dissatisfied with the outcome of their downsizing activities, and we list some of them in this article.

Alternatives to downsizing

Over the past decade, a number of companies have resisted the downsizing fad and made alternative arrangements. These alternatives typically exploit the skills and expertise of their employees rather than losing them and expertise can be lost just as surely in "survivors" as it is in those who leave. The central paradox of downsizing is that the very people who are likely to suffer the job cuts are expected to be the source of accurate information about what to cut. But anyone fearful that their is job at stake is sure to develop rationalizations and good rationalizations about why their jobs should be safe in the coming organizational decimation.
Although alternatives to downsizing do exist, managers, especially in the public sector, need reminding of them as the siren call to downsize dominates the political agenda.
1. Adopt a compensation system similar to that used by many large Japanese firms: a base salary coupled with a bonus based upon profitability and exceeding performance standards. If the bonus in the most profitable year is about 20% to 25% of base salary, then in years that the firm is not profitable, a major cost saving can be achieved without layoff. This tactic requires a proactive stance by the organization. The new compensation scheme has the best chance of adoption when the firm is fairly profitable, not when cost reductions are imminent. In situations where employees are unionized, the scheme can be negotiated as a way of securing job security -- a priority item with today's unions. Unfortunately, for obvious reasons, this tactic is unavailable to public sector managers.
2. Share the cuts across the organization. Rather than firing 10% of the workforce, all members of the organization can take a 10% cut in both hours of work and pay. Perhaps surprisingly, this is the alternative for which employees often vote given the chance. It attracts a number of objections:
If coupled with a reduction in the number of functions performed, or in the services and product lines delivered, it may be necessary to reassign and retrain employees from the discontinued work areas.
Fringe benefit costs will not be proportionately reduced (they represent semi-fixed costs) so that a larger percentage of salary cut may be required. However these costs are, in the short run, likely to be less severe than the costs of downsizing.
Reducing wages renders the firm uncompetitive in the labour market. There are three responses. First, if the firm is considering downsizing then allowing some people to be attracted away helps achieve that aim; although it is the good people who have the most mobility, these are the same people who typically leave when the firm downsizes anyway. Second, it is often better to retrain some of the existing workforce than to go through the expensive and risky process of hiring . Third, the compensation cut is temporary: it can be restored when the firm recovers from the current crisis. Such an action can enhance the attractiveness of the firm in the external labour market.
3. Adopt the "hour bank", a strategy recently adopted by BMW in Germany. A variant of flexitime (also first introduced at BMW), employees who are asked to work overtime probably when the economy is booming can, instead of receiving overtime pay, bank those hours. Then, if the firm has to go to a shorter work week, the employees can draw on their banked hours and receive full pay for working a partial work week.
4. Instead of contracting work out, the organizations can reduce the amount of work contracted out and bring the work "in house." For example components usually bought can be manufactured, services bought outside can be performed in-house. The feasibility of this approach will depend upon the skills and competencies of the current work force as well as the status of existing contracts with suppliers.
5. Services or products currently provided to in-house departments can be sold to outside customers. For example, the cash management services provided by banks, or internal consultants in MIS selling their services externally.
6. Use staff more flexibly. As some parts of the business expand and other parts decline, employees can be transferred from one to the other. This, of course, requires additional training to ensure that the transferees have the knowledge and skills to do the new tasks. Skilled employees can be assigned as trainers to keep training costs down. This may also require the geographical relocation of employees. The strategy followed by IBM for forty years (but which it has recently abandoned), it is still used by companies such as Hallmark Cards, Hewlett Packard, and Federal Express. Often, the firm benefits if it breaks out of the conventional narrow concept of the degree of flexibility that is possible. In some case (e.g., Hallmark Cards) factory employees are retrained for office jobs. This ability to escape conventional views of which person is suitable for which job enables the firm to develop creative solutions to the cost containment problem. In addition, the payoff to the organization from retaining and retraining workers, in terms of increased loyalty from employees, is incalculable. If people believe that there will still be a job for them in the organization, they will be more likely to develop innovative cost cutting ideas. Absent that belief in the ultimate security of their position, such suggestions are unlikely to be broached.
7. Make more use of Part-timers, Sabbaticals and Leaves of Absence. Not every employee wants to work full time. Employees can be polled for the kinds of flexible arrangements they prefer. Some full time employees who are later in their career can welcome the chance of a part-time, part pay schedule. Others might opt to take a leave of absence for a year. Yet others might prefer a deferred compensation arrangement in which they work full time at 80% salary for a number of years and then take a full pay sabbatical. Freeze hiring. Again this means reassigning people to new positions with concomitant retraining costs.
Paradoxically, there are even advantages to hiring when the rest of the world is downsizing:
a. When firms are downsizing and jobs hard to find, the quality of applicants is much higher than at other times in the economic cycle. This is manifested in two ways: first, in the skills and competencies of the employee; secondly in their commitment to work. By comparison, at the peak of the economic cycle good people are harder to find, more expensive, and more readily lured away by better offers elsewhere.
b. The demographic mixture of the organizational "survivors" is not skewed severely. Under most downsizing scenarios, older people leave the organization taking their experience with them. Counter-cyclic hiring can replenish the pool with persons with experience in other organizational settings and avoid dramatic "bulges" in certain age groups which play havoc with succession planning and hiring patterns.
c. The firm is better placed to exploit any upturn that occurs at the end of the depressed phase of the cycle.
There is nothing new in these techniques; they are all in use today. But the downsizing fad has pushed them from centre stage, and the risk is that they are considered too late, if at all. As we learn more about the human, economic and social costs of downsizing it is not hard to foresee a time when downsizing has the same status in society as environmental pollution. Far-sighted firms in the late 60s and early 70s adopted environmental policies which their competitors saw as uneconomic and uncompetitive, and as a result were much better positioned when the environmental revolution struck. Will "free-market riders" companies that unload loyal and dedicated employees onto an unwelcoming labour market face the same stigma in the near future?

Alternative Models of Downsizing

Alternative models of Downsizing

Martin G. Evans, Hugh P. Gunz, & R. Michael Jalland

Faculty of Management University of Toronto

Toronto Ontario Canada

Financial Post February 24 1996 The Provincial Government and its many agencies are about to enter a phase of their life-cycle that has, over the past decade, been experienced by private sector firms: downsizing. Despite the official end of the recession three years ago, hardly a week goes by without an announcement about more job losses. Yet experience of private sector organizations with this supposed remedy to corporate ills has, to a surprising extent, been dismal.

Success of Downsizing

Studies by The Wyatt Company show that few downsizing episodes meet their desired goals in terms of increased competitiveness and profitability. The majority of organizations meet their immediate cost reduction goals, but this improvement is not sustained in other areas, especially in the critical long range goals of improved service and increased competitive advantage.
Today, similar issues are facing the public sector as governments begin the difficult task of refocusing on their core activities. This refocusing is expected to result in many layoffs. Does that mean that downsizing should be abandoned? We believe the answer is a qualified no. Research suggests that often the problem does not lie in downsizing per se, but in doing it the wrong way. Just as physicians choose the most appropriate weight-losing regime for their patients -- vigorous exercise may be just right for an obese teenager but disastrous for a middle-aged man with a heart problem -- so wise downsizers choose the most appropriate approach for their organizations.
In a previous article (Financial Post July 19, 1995) we discussed some of the best practice procedures that a firm could use to accomplish downsizing effectively. In this article we will examine the five main differentapproaches to downsizing, reviewing their advantages and disadvantages.
Before doing this we must reiterate two bedrock principles that are essential if downsizing is to be pursued effectively. First, any form of downsizing must be guided by a clear strategic plan that refocuses the organization on its core activities; some of the forms outlined below fail this simple test. Secondly, there must be a sharing of the cuts by the senior management of the organization. It is hard to judge how the Provincial Government scores on these two fundamental criteria. There have been differential cuts to various public sector agencies, but whether these are guided by strategic choices or political expediency is unclear. In the case we know best, the University sector, the situation is clear: the strategic horse is to be preceded by the downsizing cart. The cuts have already been announced, but the strategic review of the University sector is not to begin until early this year.

Alternative Kinds of Downsizing. Organizations can downsize in many different ways.

Many organizations use a combination of one or other of the following approaches:
1. Across the board cutbacks. In this type of downsizing, Each department or unit is expected to cut a fixed percentage of its
workforce.
Advantages
The pain is shared across the organization (by organization here, "organization" we can mean any one of include several levels of analysis: the whole broad Ontario Public Sector, it applies to sectors like Health Care or Municipalities, it applies to a single Ministry like the Ministry of Labour, and it applies to or a particular agency like a University; all levels of the organization are affected..
Disadvantages
Most crucially, the efficient parts of the organization are hurt more than the less efficient;
the former are already running a tight operation, so have lesser ability to absorb cutbacks. This is the major argument against using this approach.
The downsizing is not guided by a clear strategic plan, a key component of downsizing success.; every unit is affected equally.
There is little opportunity to transfer good people from one part of the organization to another.
2. Early retirement and voluntary turnover. In this type of downsizing The firm offers opportunities to those near retirement
to retire early with no financial cost. Others are offered financial incentives, usually based on age and length of service, to quit the organization. No one is forced to leave. This is often used as a first stage in the downsizing process. It is often followed by a less voluntary process.
Advantages
This Concentrates the layoffs on those people most willing to experience them.
Higher paid employees at each job level are likely to leave, so the positive cost impact is high -- though it may be offset by the cost of the retirement or severance package.
Disadvantages
People with most opportunity to be hired elsewhere (i.e., high performers) take the package and leave.
Concentrated losses may occur unpredictably in one or two parts of the organization with no guidance from a clear strategic plan, leaving major human resource gaps in units with more senior employees.
The downsizing is not guided by a clear strategic plan, every unit is affected, but the effect is based upon age and service distributions in the organization. Those units with more senior employees are most severely affected.
The loss of corporate memory and tacit knowhow is severe.
3. Delayering the organization. A horizontal slice of the organization is removed. Middle
managers are reassigned or laid off and not replaced. This means that one of two things has to occur:
a) more senior managers take over the decision making responsibilities of the managers who have left, or
b) decision making is decentralized to lower level employees.
Which of these is the appropriate action requires careful diagnosis. Research shows that top managers' knee-jerk reaction is to take the centralization option because they worry about losing control in difficult circumstances. This, of course, was the Ontario Government's justification for the centralizing components of the notorious Bill 26. If the layer were unnecessary and the more senior managers were not fully utilized, centralization may be a wise choice then the centralization option can be taken. If, however, senior managers are already working at their full capacity, decentralization of decision making to lower level employees ought to happen. This may well require additional training for these employees, those at lower levels, as well as reassignment for anyone incapable of taking on the added responsibility.
Advantages
Pain is shared across all departments, though it is concentrated at particular levels.
Decision making, if decentralised, occurs at a more appropriate level -- closer to the customer, to where the variations in performance or demand happen.
Disadvantages
The organizational memory and tacit knowhow are diminished.
Top management may become overloaded.
The costs of retraining may be excessive.
Transition costs may be high.
4. Specialised functions which are not part of the organization's core activities (e.g., blood
testing, garbage collection, payroll, data entry, public relations) may be contracted out at lower
cost. In most organizations, a variety of activities are not part of the core activities of the organization and may be contracted out at a lesser cost. Two forms of cost reduction must be identified. First, costs may be reduced because the contractor has may offer major economies of scale, so can provide the service at a lower cost. The second form of cost reduction, (and this the one that seems to be most prevalent), is that work currently undertaken by higher paid union members may be contracted to lower wage-cost non-union firms. A careful diagnosis is required to ensure that a) the activities really can be contracted out with no diminution of the quality of the work; in many cases, a contractor may not understand the true needs of the organization so that coordination and quality control costs may outweigh the anticipated cost savings; b) long term cost savings really can be justified; a lock-in with a contractor may be more costly in the long run as the contractor takes advantage of the specific knowledge of your organization's requirements.
Advantages
Early and immediate cost saving.
Disadvantages
Potential long term cost increases.
Cost of coordinating the activities of a number of subcontractors.
Time required to train subcontractors in your specialized requirements.
Lack of control over subcontractors.
5. Product lines or programs may be dropped. Here the organization takes a hard look at its corporate strategy and asks whether or not it should be in each of its businesses or programs. For those businesses or programs for which the answer is "No," the organization closes them or spins them off as independent companies (whose lower overhead or lower labour costs enable them to be profitable or cost effective). When undertaking the diagnosis of the centrality of the business or program to the organization, one issue is often overlooked: firms sell several products to a single customer. In a number of instances firms have closed money-losing units whose customers then responded by ceasing to buy from a firm's more profitable units -- the closed unit provided a unique resource to the customer. Once that was lost, purchases of items from the more profitable units went to competitors.
Advantages
Concentration of the disruption in a single business unit.
Close connection to the strategic planning of the organization.
Disadvantages
Potential unanticipated business losses.
Only a few people carry the burden.

Research shows that organizations minimize their chances of failing at downsizing by adopting a clear guiding strategy, and choosing the downsizing approach appropriate to that strategy. It is hard to judge how the Ontario Government scores on this principle. There have been differential cuts to various public sector agencies, but whether these are guided by strategic choices or political expediency is unclear. In the case we know best, the University sector, the situation is clear: the strategic horse has been preceded by the downsizing cart. The cuts have been announced using across-the-board cutbacks, which rewards the inefficient and punishes the efficient but the strategic review is yet to begin. Where, we wonder, is the common sense? As the Ontario Government readies its plans for downsizing, it must make its first priority to reestablish Government priorities and to publish those priorities. At present, the only message that has emerged from Queen's Park is of across-the-board cuts, which are well-known to punish the efficient and reward the inefficient (who can afford them better). Without a clear strategic focus, anything else will fail. Once this is in place, a combination of downsizing, reassignment, and changing the mix of services represents the best approach. Will the Ontario Government have the common sense to do this.