Downsizing: the Financial and Human Implications Essay

This essay examines the effects of downsizing with regard to the human and financial implications. Since the mid to late 1980s, downsizing has â€Å"transformed the corporate landscape and changed the lives of hundreds of millions of individuals around the world† (Gandolfi, 2008, p. 3). For the purposes of this essay, downsizing is defined as the planned elimination of jobs, involving redundancies, and is designed to improve financial performance (Macky, 2004). It will be argued that while downsizing can be an effective strategy, it frequently does not improve financial health, and the human implications can be severe and costly. This essay will discuss: first, downsizing definitions; second, motivation for downsizing; third, a brief history of downsizing; fourth, approaches the implementation of downsizing; fifth, the human implications; sixth, the financial consequences; and, seventh, the reasons for the continued use of downsizing. There are differing perspectives regarding the downsizing phenomenon. At the most simple level, the strategy involves a planned contraction of the number of employees in an organisation (Cascio, 1993). For example, Macky (2004) describes downsizing as â€Å"an intentional reduction by management of a firm’s internal labour force using redundancies† (p. 2). However, other definitions encompass a wider range of implementation methods. Cameron (1994) defines downsizing as â€Å"a set of activities, undertaken on the part of the management of an organisation and designed to improve organisational efficiency, productivity, and/or competitiveness† (p. 192). These activities include hiring freezes, salary reductions, voluntary sabbaticals, exit incentives and reducing hours worked by employees. This essay will focus solely on the downsizing activity of redundancies. Various synonyms exist for downsizing, including resizing, rightsizing, smartsizing, restructuring, redundancies and reduction-in-force (Gandolfi, 2010; Macky, 2004). The main motivation for downsizing, at least for private companies, is to improve an organisation’s financial performance, which is also known as profit maximisation (Kammeyer, Liao & Avery, 2001). The factors contributing to downsizing decisions are complex and depend on company-specific, industry-specific and macroeconomic factors (Macky, 2004). In hard times, downsizing is a strategy that may be employed as a quick-fix, reactive response to compensate for reduced profit by reducing human related operational costs (Kowske, Lundby & Rasch, 2009; Ryan & Macky, 1998). In healthy times, the workforce may be reduced as part of a proactive human resource strategy to create a ‘lean and mean’ organisation (Chadwick, Hunter & Watson, 2004; Kowske et al. , 2009). An overwhelming body of academic research suggests that downsizing has surprisingly little success in increasing profitability and shareholder value, even though financial performance is its main intention (Cascio, 2002; De Meuse, Bergmann, Vanderheiden & Roraff, 2004; Lewin & Johnston, 2000). Despite the limited financial success of downsizing, it has remained a popular strategic tool with its use spanning the last three decades. Prior to the 1980s, downsizing was engaged primarily as a last resort, reactive response to changing manufacturing demands. It affected mostly blue-collar, semi-skilled employees (Littler, 1997). In contrast, since the 1980s, workforce reduction has become a leading strategy of choice, affecting employees at all levels, all around the globe (Mirabal & DeYoung, 2005, as cited in Gandolfi, 2008), within a wide variety of organisations encompassing all industries (Littler, 1998; Macky, 2004). Karake-Shalhoub (1999) suggests that downsizing has been the most significant business change of the 1980s. Downsizing increased in popularity during the 1990s, which has subsequently been described as the ‘downsizing decade’ (Dolan, Belout & Balkin, 2000). It has evolved from a reactive strategy in the 1980s, to become used as a proactive strategy. During the 1990s, large scale redundancy programs were viewed as the solution to the issues facing organisations such as AT&T, IBM, General Motors and British Telecom (Kinnie, Hutchinson & Purcell, 1998). The statistics are sobering, Cameron (1994) reported that 85% of Fortune 500 companies were downsized between 1989 and 1994, and 100% were planning to do so within the next five years. Furthermore, figures from the most recent global financial crisis demonstrate that downsizing remains a tool of choice. Rampell (2009) reported in the New York Times that 4. 4 million jobs, in the U. S. alone, were retrenched between September 2007 and March 2009. Two main approaches to the implementation of downsizing are currently employed. The first approach is popularly termed stealth layoffs and the second is referred to as non-selective layoffs (Gandolfi, 2009). Organisations have commonly employed both stealth layoffs and non-selective layoffs during the recent global financial crisis. Stealth layoffs involve an attempt to keep redundancies out of media attention, by making a series of small cuts rather than one large cut. Companies endeavour to save their public reputation from being tainted by their downsizing activities. Managers are not allowed to openly discuss redundancies and a blanket of secrecy is placed over all proceedings, employees are not informed of timing or extent of redundancies (Crosman, 2006). Mc Gregor (2008) reported a wave of people slowly trickling out of organisations. Citigroup provides one example of stealth downsizing. Story & Dash (2008) reported that in April 2007 the company announced elimination of 17,000 jobs. Then in January 2008 Citigroup announced a further 4,200 job cuts, followed by an additional 8,700 in April 2008 (Story & Dash, 2008). Non-selective downsizing involves mass redundancies, across all levels of an organisation. This is problematic because firms are at risk of losing their top performers who are difficult to replace. These are the people that will be required to drive future growth of the firm following the downsizing event. There is plenty of evidence of non-selective downsizing over the current global recession, for instance the finance industry has been deeply affected with U. S. anks making cuts of 65,000 employees between June 2007 and June 2008 (Story & Dash, 2008). Regarding the human implications of downsizing, the literature identifies three groups of people directly affected: the victims, the survivors, and the executioners. Academic studies refer to the victims of downsizing as the individuals who have been involuntarily removed from their positions (Casio, 1993; Dolan et al. , 2000; Gandolfi, 2008; Macky, 2004). The negative effects on victims of downsizing events can be devastating (Havlovick, Bouthillette & van der Wal, 1998). Previously, being well trained was sufficient to ensure a life-long job. However, the increasing competitiveness of the business environment has meant that recent layoffs have included higher paid white-collar workers, many of whom are at the peak of their careers. Victims are affected initially during the planning phase of the downsizing, then immediately following the redundancy announcement, and then in their subsequent employment. During the planning phase of downsizing, the threat of redundancies can subject employees to a number of emotional stresses. The stresses do not only embrace the immediate threat of redundancies, but also the prospect of demotion, and redundancies in the ong term. Evidence suggests that, as expected, such stresses have negative psychological impacts. For example, Catalano, Rook and Dooley (1986) in their interviews of 3,850 principle-wage earners in Los Angeles, found that that a decrease in job security increased the number of medical consultations for psychological distress. Likewise, Roskies and Louis-Guerin (1990) found in their survey of 1,291 Canadian managers, that managers who were insecure about their jobs showed poorer health than those who were secure, and the manager’s level of distress rose proportionally with their degree of insecurity. Following the redundancy announcement, there is strong evidence that victims suffer from adverse effects as a result of their job losses. These adverse effects include psychological stress, ill health, family problems, marital problems, helplessness, reduced self esteem, anxiety, depression, psychiatric morbidity, and feelings of social isolation (Greenglass & Burke, 2001). In particular, the affected individuals suffer from the loss of established social relationships and threats to their social identity (Macky, 2004). Greenglass and Burke (2001) also explain that the effects can vary greatly from person to person. The extent of personal damage is attributed to the individual’s resources of coping strategies, self-efficacy and social support. Evidence shows that the retrenched employees are able to respond in a more constructive manner depending on the extent to which they view the downsizing process as procedurally fair. Brokner, Konovsky, Cooper-Schneider, Folger, Martin and Bies (1994) found that employees remaining in their positions for up to three months after the announcement of their redundancy continued to exhibit positive work behaviours if the downsizing process was viewed as fair and transparent. There is evidence that subsequent employment opportunities are also affected by the victim’s previous redundancy experiences, including a change in their attitude towards the workplace. Macky (2004) provided evidence that the effects of redundancies flow onto the individual’s next position, resulting in decreased levels of commitment and loyalty. Dolan et al. (2000) also showed that there is some evidence that job loss created through redundancies may create lasting damage to the victim’s career. Similarly, Konovsky and Brockner (1993) found that individuals report a loss of earning power in their subsequent employment. On the other hand, Devine, Reay, Stainton and Collins–Nakai (2003), argue that victims who gain new employment have a greater sense of control and appear to be in a better position than those who were not retrenched. Noer (2009) suggests that negative impacts on victims are lessened by the various support packages for displaced employees that are paid for by the organisation, such as redundancy payments, career counselling and out-placement service. The second group of employees affected by downsizing are the survivors. The survivors are the employees who have remained with the firm after the redundancies have taken place (Littler, 1998). The survivors are important to the firm because they play a pivotal role in the effectiveness of the downsizing operation and the ongoing success of the organisation. The expertise and motivation of survivors is required to keep the firm moving forward following redundancies. However, surviving employees are left with increased pressures. These pressures include: larger workloads (Dolan at al. 2000), because survivors must take on the work of retrenched employees; as well as new and increased job responsibilities (Lewin & Johnston, 2000), as a result of key skills leaving the organisation. In addition to the increased work pressures, survivors must deal with profound and negative psychological responses. Gandolfi (2008) identifies three sets of the emotions, behaviours and attitudes exhibited b y surviving employees, which are commonly termed ‘sicknesses’ in literature (Applebaum, Delage, Labibb & Gault, 1997; Kowske at al. , 2009). The emergence of these sicknesses following a downsizing event is referred to as the ‘aftermath’ (Clark & Koonce, 1995) or the ‘downside’ (Cascio, 1993) of downsizing. The sicknesses identified are: survivor syndrome, survivor guilt and survivor envy. Kinnie et al. (1998) characterises survivor syndrome as encompassing a variety of psychological states in survivors, including heightened levels of stress, absenteeism and distrust, and as well as decreased levels of productivity, morale and work quality. Cascio (2002) portrays survivor syndrome in a similar way to Kinnie et al. 1998), showing decreased: levels of employee involvement, morale, work productivity and trust towards management. These mental states have a strong influence on the survivor’s work behaviour and attitudes, such as motivation, commitment, satisfaction and job performance (Applebaum et al. , 1997; Littler, Dunford, Bramble & Hede, 1997). The second sickness, survivor guilt, is a fe eling of responsibility or remorse as employees contemplate why their colleagues were retrenched instead of themselves. It is frequently expressed as fear, anger and depression (Noer, 2009). Survivor guilt can be particularly prevalent when survivors perceive that their work performance was no better than that of the downsized victims (Littler et al. , 1997). In this case, employees can reason that there is no benefit in performing if performance is not a criterion for job survival (Appelbaum, et al. , 1997). Appelbaum and colleagues argue that survivor guilt is heavily influenced by the manner in which the downsizing is perceived to be performed and the fairness of the decision making processes. Survivors of downsizing can also be plagued by a third sickness, survivor envy. This reflects the survivors’ envy of the victims in terms of presumed retirement packages, financially lucrative incentives, and new jobs with more attractive compensation (Kinnie et al. , 1998). For example, employees may feel that their retrenched ex-colleagues received redundancy pay outs; and have found new jobs they like, while the surviving employee must work twice as hard, and moreover, for the same pay. Kammeyer-Meuller, Liao and Avery (2001) hypothesise that survivors envy is dependent on the closeness of the relationship with the survivor. Brokner (1987) found that when survivors have little proximity to the victims, increases in redundancy payouts result in decreased self-reported performance. On the other hand, the study shows when survivors identify with the victims, increases in redundancy payouts increased self reported performance. Despite the stresses facing survivors, research shows that the needs of the survivors are frequently neglected by downsized firms (Applebaum et al. , 1997; Devine et al. , 2003; Gandolfi, 2006). According to Applebaum et al. 1997), the negative effects on the survivors are under-estimated and organisations fail to take into account the difficulties of motivating a surviving workforce that is emotionally damaged because it has watched others lose their jobs. It is important for organisations to pay more attention to the survivors in order to support their financial health. Carswell (2002), in a New Zealand empirical study, established that the companies that based redundancy on fair pra ctices, and provided better out-placement for the victims, performed better financially than those that did not use such procedures. Kowske et al. (2009) reviewed survivor engagement during the 2007-2009 global financial crisis and provided further valuable insights. Using the Keneya’s Employment Engagement Index and a sample size of 9,998 U. S. employees, it was determined that employee engagement was significantly lower if redundancies had occurred within the previous 12 months. Kowske et al. (2009) found that although organisations were able to cut human resource costs, they are more likely to have a portion of their workforce disengaged – fertile ground for the symptoms that accompany survivor sickness. An example of a lack of insight regarding survivor sickness was demonstrated in the downsizing of the Deloitte (New Zealand) Enterprise Risk Management Team, in May 2008 (personal information). The first problem was that just two weeks prior to the redundancy announcement, a statement was made by one of the partners to the team, stating that no-one should be concerned about their jobs. Another problem was that the downsizing process was not transparent and no employee below partner level was involved in the consultation. Not only wew the staff made redundant effected, but also the surviving employees who exhibited traditional symptoms of survivor sicknesses: feelings of distrust, anger and low moral due to their perceived unfairness of the decision process. The result of this survivor sickness was that, by the end of the following year, the entire senior management team had voluntarily left the firm, taking with them valuable skills and experience. Such attrition is consistent with Trevor and Nyberg’s (2008) findings that voluntary turnover rates increased within 24 months following the downsizing event. It is clear that management must pay more attention to survivors in order to minimise survivor syndromes. The literature highlights four key improvements to current downsizing methods, in order to minimize survivor syndromes. Firstly, a detailed strategy must be devised, this is because planning has been identified as a pivotal issue in the success of downsizing (Applebaum et al. , 1997; Gandolfi, 2008). The strategic plan should establish how the survivors will be taken care of during the downsizing process (Gandolfi, 2009). This includes giving survivors access to honest, timely and unbiased information (Dolan et al. , 2000) as well as access to counselling, support and help (Allen, 1997). Second, training must be improved as it is identified as key tool to combat survivor sickness (Dolan et al. , 2000; Farrell & Mavondo, 2004; Makawatsakul & Kleiner, 2003). The retrenched individuals often leave with key skills that must be taught to the surviving employees. Third, managers are recommended to communicate the long term business strategy to the surviving employees, n order to create a shared vision for the future of the firm (Cobb, Wooten & Folger, 1995). Last, fairness in the way the redundancies are selected and implemented including open communication lines are valuable to support trust within the organisation (Hopkins & Weathington, 2006). For example, retirement programs are viewed as more fair downsizing methods by survivors and lead to increased commitment (De Witt, Trevio & Mollica, 1998). Execut ioners are the group of survivors that form the third category of people affected by downsizing. Executioners are the individuals entrusted to plan, carry out and evaluate the downsizing (Gandolfi, 2009). Other synonyms for executioners include ‘downsizing agents’ (Clair & Dufresne, 2004) and ‘downsizers’ (Burke, 1998). The effects on such personnel are important because downsizers are commonly employees and managers, who can have a large impact on the success of the change. This is because the executioners have power to influence employees and power to employ tools and techniques to minimise harm. Although they are a category of survivors, the executioners experience differs to that of the survivors because of their heavy responsibilities, in executing the downsizing, managing relationships with the retrenched individuals as well as supporting the survivors. Gandolfi (2007) is one of the few academics to offer some insight around the experiences of the executioners using empirical research. Gandolfi interviewed 20 executioners from a major Australian trading bank and identified four key themes from their responses. The first was the very negative emotional responses and reactions from the executioners, including the difficulty and complexity the executioners had in selecting the downsizing victims. Second, Gandolfi also identified coping strategies, including the executioners distancing themselves from the task physically, cognitively and emotionally in order to preserve their own emotional well-being. In further research, it would be interesting to explore the relationship between the implementation of coping strategies and the effectiveness of the downsizing operation. Third, Gandolfi found that executioners with more experience reported a lesser degree of emotional distress. This is in line with Clair and Dufresne (2004) who suggest coping behaviours are learned with experience. Fourth, Gandolfi identified that the closeness of the relationship with the victims is also important in that the layoffs were more taxing when the executioner had developed personal ties with the victims. Another aspect of the executioner’s experience is their handling of the currently employed downsizing methods of stealth layoffs and across the board cuts. Executioners have reported that they are uncomfortable with the degree of secrecy involved with stealth downsizing (Gandolfi, 2009). For example, executioners have reported instances causing internal conflict when they have had to lie to employees (Gandolfi, 2009). In the case of across the board cuts, executioners often find it difficult of rationalize the unfairness of the choices and question their rights to be playing god with the individuals involved. The significant negative impacts on the executioners highlight the need for firms to provide adequate training and emotional support for the executioners (Gandolfi, 2009). Although more research is required in this area, it is apparent training should at least raise awareness of the range of emotions that executioners may experience, and include tools and techniques to cope with the emotions involved with carrying out the task. Clair and Dufrense (2004) suggest that throughout the process of downsizing, firms should make available to managers social forums, employee assistance programs and social support groups. The profound human consequences on the survivors and the executioners are interlinked with the financial consequences. Literature has identified that the human consequences of downsizing play a large role in the financial success of the downsizing operation (Carswell, 2002; Devine et al. , 2003; Gadolfi, 2008). The financial success of the strategy is particularly important to shareholders and to external bodies such as suppliers, distributers and allied organisations (Kammeyer-Mueller, 2001). A large and growing body of literature has investigated and measured the financial success of carrying out downsizing, and found that most organisations do not improve their financial performance after downsizing (Applebaum, et al. 1997; Cascio, Young & Morris, 1997; De Meuse et al. , 2004). The research around financial performance following a downsizing event focuses on tangible measurements of financial performance, such as examining changes in profit, share price and return on investment, before and after the downsizing event. However, it is noted that some companies do improve their financial performance by using downsizing as a strategy. Griggs and Hyland (2003) surveyed 1,005 U. S. organisations and found that of the respondents, 46% of companies able to decrease costs, 33% were able to ncrease profitability and 21% were able to report satisfactory improvements on return on investment. Only 46% of firms reduced costs due to poor planning, and this was because, in four times out of five, managers ended up replacing the very positions they made redundant (Griggs & Hyland, 2003). Wayhan and Werner’s (2000) findings contradict most downsizing research, in their examination of the largest 250 U. S. companies which had reduced their workforce by at least three percent during the period 1991-1992. These researches measured changes in stock prices and they showed that, in the short term, downsized companies significantly financially outperformed companies that did not downsize. However, it should be noted that Wayhan and Werner’s (2000) study uses a different technique, in that they treat time as a moderator of the affects. The rationale behind this is that other influences on the firm’s stock price will become more important than the influence of the downsizing event, as the time from the downsizing event increases. When Wayhan and Werner’s study was repeated using typical techniques (not using time as a moderator), the results were more in line with other research, showing small decreases in relevant financial measures. Sahdev (2003), Zyglidopoulos (2003) and Macky (2004) are among numerous researches showing that while a small number of organisations have reported improved financial performance, the majority were unable to account improved levels of effectiveness, productivity, efficiency and profitability in the short term. A typical example is Cascio, Young and Morris’s (1997) study of 537 companies listed on the S&P 500 between 1980 and 1994. After comparing average companies in the same industry, and controlling for firm effects, they discovered no evidence that downsized firms could subsequently increase profits or share price over a period of two years subsequent to the downsizing event. This is in line with evidence from New Zealand (Carswell, 2002). Furthermore, Cascio et al. (1997) found that downsized firms were outperformed in the short term by those companies that increased their workforce and also companies with stable employment. This study was limited by focusing only on extreme reductions of 10% or more. The long-term implications of downsizing on financial performance were investigated by De Meuse et al. (2004) in a more recent U. S. study. Using U. S. Fortune 500 companies, De Meuse and colleagues look at a period of nine years following the redundancy announcement, from 1989 to 1998. De Meuse et al. found that in the first two years following the announcement the financial performance of the firm’s decreased, in line with Cascio et at. (1997). However, at the beginning of three years after the downsizing announcement, De Meuse et al. found no significant underperformance of the downsized firms. Unfortunately, most studies provide little empirical evidence regarding why in some cases downsizing produces positive financial results, and in other cases it does not. This is because downsizing tends to be treated as a binary variable in research, that is, firms either downsize or they do not (Kammeyer-Muller, Liao & Arvey, 2001). However, it is apparent that not all downsizing efforts are the same. The following factors are likely to have an effect on the financial performance of the firm subsequent post-downsizing announcement: the type of reduction strategy employed (for example, across the board cuts, stealth layoffs, or more gradual procedures); the persistence of survivor syndromes; the logistics of downsizing (for example the size and frequency); and, the reasons behind the decision to downsizing. The lack of research in this area provides opportunities for researchers to further explore the downsizing phenomenon. The prevalence of evidence surrounding impaired financial performance following downsizing events introduces a paradox: why is the practice continuing to be engaged despite its lack of success? Cynics suggest that downsizing can be carried out in order to boost the egos of top managers at the expense of the organisation (e. g. Anderson & Cavanagh, 1994; Budros, 1999). Other explanations include the tendency of management to inaccurately anticipate costs involved. Downsizing generates direct and indirect costs, and it is the hidden (indirect) costs that are frequently underestimated by management (Gandolfi, 2008). Direct costs are less complicated to estimate and include severance pay, accrued holiday pay and administrative processing costs. Hidden costs include recruitment and employment costs of new hires, costs of replacing staff with expensive consultants, lost sales due to insufficient staffing, training and retraining, and costs of reduced productivity as a result of survivor syndromes (Cascio, 1993). For example Gandolfi (2001) reported that a European company (unnamed for privacy reasons) incurred an increase of 40% in recruitment, and a 30% increase in training and development costs for new employees, following its controversial downsizing. In order for downsizing to be engaged as an effective strategic tool, it is clear that the benefits of reducing staff must outweigh all the costs. It has become clear that management must consider very carefully whether downsizing is appropriate for their firm, and they need to pay careful attention to the hidden costs. According to Allen (1997) the key to successful downsizing is to focus on the people who make up the organisation. Literature has provided management with guidelines to minimise costs and harm. For the survivors, this includes minimising survivor symptoms through planning of the downsizing operation, training of the surviving staff, and using open communication and fairness in carrying out the redundancies. For the executioners this includes providing them with training. This essay has identified and discussed the effects of downsizing with regard to both the human and financial implications. It has been demonstrated that the human implications of downsizing can be sever and downsizing frequently fails at meeting its objectives of improving financial performance. First, the profound negative consequences of downsizing on the victims, the survivors and the executioners have been outlined. Next, the empirical evidence concerning the financial consequences has been summarised. Gaps have been identified in downsizing literature. Two areas of downsizing that could well be further explored include the experience of the executioners and the characteristics of downsizing operations that result in successful financial outcomes. The recent prevalence of downsizing activities over the latest financial crisis suggests that downsizing is a phenomenon worth exploring into the future.