Do layoffs really help companies?

LinkedIn is a sad place to be on these days. Every third or fourth post that I get to see is of someone announcing they got laid off. No longer are these posts from employees of struggling start-ups, blighted by the funding winter. Instead, they are former employees of storied technology titans: Google, Microsoft, Amazon, Twitter, Salesforce, and Intel, among others. According to some estimates, more than 1,600 people in the tech industry have been laid off every single day since the start of the year. What a terrible tragedy.

Why do companies indulge in mass layoffs? The conventional wisdom says that when the economic conditions get tough, it makes sense to cut costs and remain lean. For example, explaining the layoffs, Sundar Pichai, CEO of Google, said that over the last two years, the company had hired “for a different economic reality than the one we face today”. In technology companies, the biggest cost is manpower. So, the axe inevitably falls on people—no matter how hard or how long they have worked for their employer.

The layoff myths

But, is the management assumption that layoffs help weather economic storms better borne out by evidence? Do shareholders reward companies for aggressive layoffs and punish those who are reluctant to sack and instead sacrifice profit margins?

Over the decades, many researchers, academics, and consultants have dived into this question and invariably all of them have concluded that kneejerk layoffs in response to the slightest hint of downturn do not create any stock value. Instead, there is significant reputational damage that occurs due to it.

A paper published in the International Journal of Production Economics in 2021 by Ryan Atkins and Charles Favreau of Duquesne University (pronounced “doo-kayn”) in Pittsburgh, Pennsylvania shows that layoffs accompanied by plant closure led to improved stock price over a year rather than mere layoffs.

In other words, to reward a stock, investors need to see that the layoffs are addressing a fundamental business malaise and not simply saving a few bucks. Therefore, a company laying off people from a non-performing business vertical is received very differently from the token reduction in headcount across the company and geographies. (By extension, I would argue that a Google or Amazon laying off engineers in India hurts shareholder interest more than a similar layoff in the US—of course, the skills being equal.)

The findings of research done even two decades earlier (the 2000s) bore out the same fact.
In 2001, Bain & Co., a top global consulting firm, conducted a year-long (August 2000 to August 2001) study of S&P 500 companies, with follow-up research in the months after. Its conclusion: “The truth is that downsizing as part of a bid for survival can cripple your business.” The report then went on to debunk four layoff myths. One, that layoffs were pervasive or severe; two, that shareholders like layoffs; three, that all layoffs are bad; and, finally, that downturns necessarily need “binge and purge” employment practices.

Bain’s research showed that unless a company eliminated jobs for as much as 18 months in knowledge-based businesses, it will fail to earn a financial payback.

Reason: as Bain’s report pointed out, the average recession lasted only 11 months, but by the time companies realise there’s a downturn and get about laying off people, it’s 6 to 9 months. This meant that when the upturn began, the company didn’t have enough people to make the most of the opportunity.
Based on the research, Bain urged companies to ask themselves some key questions before jettisoning jobs. Questions like:

a) Why is the company performing badly? Is there a fundamental issue with the business like the wrong product or market?

b) What is the company’s strategy and what are its options? Can it outmanoeuvre competition distracted by the downturn without shedding jobs?

c) What’s more important? Corporate jets, art collection, business-class travel or employee retention and goodwill?

d) If there’s no choice but to let workers go, then how to do it in the most humane manner possible?

Another Bain consultant, Fred Reichheld, had actually written a book (‘Loyalty Rules’) on that in the mid-90s arguing that a balanced approach yielded better business results than copycat, impulsive layoffs.

The Bain report concluded by stating, “When the numbers come in, layoffs all seem depressingly alike. But for employees, customers and shareholders, the way a company approaches its job cuts is a clue to whether management is wisely navigating out of the heat, or jumping from the frying pan into the fire.”
Therefore, to CEOs of cash-rich companies sacking employees just to signal to Wall Street that they are being proactive about an expected downturn, I say this: please think if you can deal with the downturn differently; maybe get an edge over your rivals by doing/launching something new or acquiring something at a great bargain that perhaps needs turning around. Tough times don’t just test leadership, but also character.