I recently took a “Managing With Influence” class from Jeffrey Pfeffer, professor of organizational behavior at Stanford University, and author of a book subtitled “Profiting from Evidence-Based Management.” During the class, Professor Pfeffer claimed that layoffs do not improve financial performance, except in the very short run. He based this on a careful analysis of multiple studies over a wide range of economic environments.
It’s not surprising that layoffs are correlated with poor corporate performance; when times get tough, most companies react by letting people go. However, the research suggests that downsizing does not improve performance and, in many cases, can compound the problems. Pfeffer summarized the related research in the Valentine 2010 issue of Newsweek. In the article Pfeffer debunks several myths about layoffs:
- Layoffs do not result in higher stock prices, either immediately or over time.
- Layoffs don’t improve company productivity.
- Layoffs don’t increase profits.
- Layoffs don’t even reliably cut costs.
- Layoffs reduce morale and increase fear in the workplace – even more than companies realize.
I was particularly intrigued by the fact that downsizing doesn’t increase profits. Pffefer cites a 122-company study which found that layoffs reduced subsequent profitability, even after statistically controlling for prior profitability. The negative consequences of layoffs were even more evident in R&D-intensive industries and in companies that experienced sales growth. Similarly, a Harvard Business Review study by Darrell Rigby showed that companies with no layoffs outperformed those that downsized, even if the comparison companies had similar sales growth rates.
From my point of view, the issue has to do with timing. While the average recession lasts ~11 months, it typically take 3-6 months to recognize a downturn and another 3 months to institute layoffs. Once severance packages, temporary declines in productivity and quality, and rehiring/retraining costs are taken into account, companies only earn a financial payback if they don’t replace workers for 18 months. Unfortunately, by that time, the recovery is usually in full swing.
So why do companies use layoffs if the evidence is that they don’t work? Erik Van Slyke blames greed by noting that cash saved via layoffs can be applied to executive compensation. Art Budros of McMaster University provides a less sinister explanation; a 15-year study suggests that firms are just copying the behavior of their peers.
The latter explanation rings true to me. Companies use layoffs to handle difficult environments because they’ve always done so in the past. Change management is hard.