Too often, executives today feel they must have a corporate goal to downsize. In fact, Wall Street sometimes rewards a downsizing announcement with a jump in stock price. The executive him-or herself is almost always given a larger bonus by the board of directors for making such tough and difficult decisions, which may make them not so tough or so difficult. As we'll see later, they are probably foolish! In talking with various CEOs, I often hear they do it because Wall Street analysts expect that behavior. However, does simply ordering an 8 percent or 15 percent across-the-board cut in headcount show real leadership or decision-making abilities? No. In this chapter, we examine the pros and cons of downsizing, the issues that should be considered first, and the real effects on corporate performance.
Managers have too often seen layoffs as a panacea for deeper underlying problems, and therefore make one of the most common mistakes in a turnaround; they fail to reexamine their strategy and core competency and then reengineer the company's processes before identifying which costs and people to cut. How does a company know how far to cut, who best to cut, or which product lines or services would be most harmed by cuts if they didn't first examine their strategy, based on what the customers want? Once that is known, downsizing becomes one of the tools to implement the changes needed.
The 13-Week Cash Flow Model discussed in Chapter Four will drive much of the decision-making in a late-stage turnaround, for it presents an exhaustive analysis of the company's sources and uses of cash over the near term. A frequent—but by no means invariable—conclusion that managers make from the 13-Week model's findings is that the company must reduce its cash burn in order to buy itself time, and given the significant percentage of corporate expenses that payroll represents, a common response is to consider layoffs, downsizing, right-sizing, reductions in force, headcount reductions, or any other number of euphemisms designed to soften the fact that people will be getting fired.
In the context of a turnaround, business process reengineering (or BPR) essentially represents the operational leg of the turnaround tripod. If we conceptualize our strategic elements as identifying the "what"—the customer segment(s) we want to address and the products or services we want to offer them—then reengineering examines how we should provide those products to those customers. As explained in Chapter Two, strategy generally must come first in a turnaround; reengineering determines the changes made to the ongoing operations of the business to make them more efficient, identifying the resources needed to support them while eliminating any processes and people that do not contribute to customer value.
Depending on which articles you read, business process reengineering is responsible for quantum gains of 30 percent to a tenfold improvement in performance. BPR is credited with Wal-Mart's reduction of its restocking time from six weeks to thirty-six hours, HP assembling server computers in four minutes, and even a surge in sales at Taco Bell.[76] Because of misuse, the term reengineering has fallen out of favor. For convenience, we'll use it here, but it is now known by many names, including change management and business process redesign.
Reengineering originated as the brainchild of former MIT professor Michael Hammer and management consultant James Champy, who together authored Reengineering the Corporation in 1990. Its concept of starting from scratch with a metaphorical "clean sheet of paper" to make fundamental redesigns of a business's processes quickly became a buzzword in the 1990s. Hammer and Champy's theories centered on the shortcomings inherent in the division of labor into specialized functions, which began with one man drawing out the wire to make a pin, another to straighten it, and so on, rather than having one man make the pin start-to-finish,[77] and ultimately evolved into the separate functional departments of marketing, engineering, and so forth that we see at the modern corporation. They argued that this functional specialization had led to a proliferation of bureaucracy that increasingly fragmented work processes to the point that much of the "work" being done served no actual purpose to the company's customers. In response, they postulated that companies should not undertake the Total Quality Management (TQM) approach advocated by W. Edwards Deming, which advocated constant, gradual improvements, but rather should undertake rapid, revolutionary change all at once. Processes and tasks should be eliminated rather than automated wherever possible.
Hammer and Champy established three main principles for those wishing to reengineer their companies.[78] First, one must reject the status quo entirely and "reengineer" the business from scratch in an effort to reach its absolute maximum efficient form. The rationale behind this "clean sheet of paper" approach is that many of the work processes at companies both large and small add no value to the customer, and therefore should be discarded entirely rather than improved. Second, this imagining of the ideal company should start from the end of the flowchart—that is, from the customer's perspective—and only focus on adding to this clean sheet of paper the company's actions that somehow provide value to the customer, either by higher quality, more features, lower prices, quicker delivery, greater variety, superior service, or any other metric that customers actually care about . . . and are willing to pay for! Finally, having identified these value-adding activities, management should organize the company not around roles—such as finance, marketing, and manufacturing—but rather around the processes that add that value. For example, in many companies, simply making a sale requires activities across several functional departments: the sales department has to pitch to the client and then quote them a price; that price may need to be approved by an executive, with oversight by legal to make sure that the contract is to their liking. The customer derives no benefit from this specialization, and in fact, will be likely to find the inherent delays as the document gets shuttled from one department to the next—often for several iterations—frustrating and bewildering. Reengineering this process means creating cross-functional teams who are familiar with tasks necessary to the process to prevent delays and disruptions that create negative customer value. "You no longer have a file folder as the repository of data, passed between workers like a baton," Hammer explained, "You've got the capability of different people sharing tasks or performing multiple tasks at once."[79]
One highly successful example of reengineering in a turnaround comes from Caterpillar, the previously mentioned global manufacturer of earthmoving and construction support equipment. After a spike in international competition nearly bankrupted the company in the early 1980s, causing losses of$1 million a day, CEO George Schaefer led a radical process that fundamentally reengineered the company, finding its hierarchical, siloed organizational model badly misaligned with its customers' needs. Each functional general office (GO) of marketing, finance, pricing, manufacturing, and so forth had become its own fiefdom, with a painfully slow filter of information up and down each silo and little cooperation across them, yielding products that cost too much to produce. If, for example, a salesperson needed a minor design or price change to meet competition, months could pass before a decision was made, and the sale was lost. Despite facing inertial resistance and pressure to make across-the-board cuts, Schaefer created an internal team of "breakthrough thinkers" who could truly take a fresh look at the business from scratch, allowing them to break free of the status quo and imagine the company's processes as they should be to meet customers' needs. The resultant decentralized organization that emerged from the reengineering was implemented all at once. The GOs disappeared overnight with everyone assigned to a business unit and accountability moved downward along with decision-making authority. All units were now measured on profits and return on assets, thus losing the excuse of blaming headquarters. They sped the flow of information significantly, allowing Caterpillar to do a far better job of remaining responsive to changing customer demands.[80] Caterpillar is an example of a successful turnaround through reengineering.
Another large organization used volunteers to reengineer a small part of its processes before doing cutbacks. For an organization the size of the one in question, a staff of seventeen managing purchasing approvals didn't seem unreasonable, until you reflect that all they did was approve every purchase. The actual purchasing process from approved vendors occurred elsewhere; these seventeen people literally sat in their offices and filled out approval forms for every requested item in the organization, from expensive items all the way down to pencils and the cups in the cafeteria, with multiple layers of approval necessary within the department itself. Not surprising, the sheer number of requests for minute items overwhelmed the system, bogging it down to the point that requests for something as simple as a replacement water cooler took up to six months; people joked that the people in approvals must write very, very slowly. The reengineering team realized that the approval system in no way required such manpower, so they set a dollar amount hurdle at which a request would require approval and determined what sign-offs were needed that affected the approval of vendors. They trimmed the staff to six while reassigning the other eleven employees to areas where the organization actually needed resources, thereby significantly cutting all response times. No doubt remembering similar log jams where they worked, my students always chuckle when I identify the organization in question as none other than our own Northwestern University.
Because of a shift in power from manufacturer to their retail customers, Pillsbury knew it had to change its strategy and decided to reengineer the company.[81] It was an early-stage fix so they had time to do it right. They correctly identified that there was a tension between a cost-reduction focus and radical redesign of core processes to get the job done right. They understood that companies must eliminate or outsource functions that don't provide differentiation valuable to customers. They determined how to eliminate unprofitable products and shorten product development times and overhaul their supply chain to meet customer needs. The Pillsbury study showed $300 million in expected savings from the complete overhaul. Shortly after the study was completed, however, Pillsbury acquired Pet Foods and senior managers' attention was diverted. The seventy-five people from the reengineering team, without top management approval, launched divisional changes anyway, achieving $50 million per year in savings, with faster response times from suppliers and quicker replenishment to customers.[82] They proved reengineering works at divisional levels.
As with any management technique that comes to enjoy widespread popularity, reengineering has its share of critics. Supporters of more gradual approaches such as TQM (Total Quality Management) find its outright rejection of the status quo alarming and reactionary, arguing that one risks throwing the baby out with the bathwater. As I explain in my classes, I feel that such gradual improvement can only work in a non-turnaround situation where the processes are reasonably well run, or at worst, a company still in the blinded phase, when the time pressure is less critical, and a company can accept incremental change. Any further down the organizational distress curve, however, and a company simply will not have the time for anything less than radical changes, even if decided at a ready-fire-aim pace. Once the BPR has been implemented, TQM should be used to perfect the process, fine-tuning and updating the process over time.
The greatest criticism of reengineering stems, unfortunately, from its misuse by cost-focused managers all too eager to swing the axe: it became synonymous with layoffs and downsizing. As I have explained, however, this need not be the case. Reengineering should be the step taken before downsizing to determine whether layoffs are actually necessary in the first place. It is truly remarkable how many times I have seen successful turnaround professionals enter a company facing a real crisis, and upon reengineering the company's operations determine that there was an opportunity to grow out of the problem, eliminating the need for layoffs entirely or at the very least mitigating the size of the necessary cuts. Reengineering can also identify situations in which a department needs significant reductions but that additional resources will be needed in other areas, so turnaround managers can simply re-assign those employees to new roles rather than laying them off. Unfortunately, reengineering became such a powerful buzzword in the early 1990s that it became ubiquitous before everyone claiming to practice it fully understood what it meant, and far too many people began to identify it with cuts, having heard some variation of "I'm sorry, we're reengineering, so you're out."
In short, reengineering should not be synonymous with layoffs, but rather, it is the analytical process through which one must go in order to determine whether layoffs are necessary, and if so, where and in what numbers. Where complete reengineering of a company is impractical, a Six-Sigma approach is a frequently used tool to examine a specific department or set of processes.
Today, Six Sigma analytical methods are applied to the reduction of any kind of subjective errors or elimination of duplication. It requires one to define a process where there are poor results, taking measurements to determine current performance, analyzing the information to find where things are going wrong, improving the process to eliminate errors, and adding controls to keep it from happening again.[83] Jack Welch and his successor at GE, Jeff Imelt, spent up to $600 million a year mostly for almost two thousand Six Sigma experts, known as "black belts," to bring about $10 billion in savings.[84] Companies used the technique to reduce factory inventories, to discover double handling of doctors' insurance claims, and to improve throughput in accounts payable departments. If this process precedes downsizing, it, too, can determine the best and perhaps only places to cut staff.
Even if a company has first addressed its strategy, and then reengineered its business processes, layoffs are often considered as a default option. The thinking is simple: we have to cut costs, so heads must roll. A study by Professor Paul Wertheim of Pepperdine University determined that of the stocks of companies announcing major layoffs, almost 40 percent outperformed their peers immediately following the announcement.[85] Typically, Wall Street analysts applaud such a move as "necessary cost-cutting" and an example of "belt-tightening to run leaner," often rewarding these companies with a ratings upgrade. However, the same study found that more than 60 percent took an immediate hit on the price of their stock. More important, within three years following the announcement, two-thirds of that 40 percent who got an initial bump in price significantly underperformed their peers. Why? I maintain that the kneejerk reaction to enact layoffs without determining how they fit into strategy fails to consider the complex implications that layoffs entail, as managers become enamored with the primary upside of reduced costs while ignoring their many downsides. These other advantages and disadvantages are listed next. Even when in a crisis and into ready-fire-aim mode, they must be considered.
Cost savings on salaries and benefits can be significant, although they are frequently overestimated.
Layoffs can also help you get rid of underperformers, if you have documented their performance and can't make better use of whatever talent or knowledge they have.
Increased productivity can result if you have actually identified underperformers or those who remain committed to the status quo and eliminated them.
Layoffs can reduce decision time significantly, resulting in a faster, more agile company, particularly if the layoffs eliminate layers of middle management through which information must diffuse. As pointed out in Chapter Three, Bassoul's turnaround at Middleby made the company significantly less bureaucratic by reducing the layers between himself and line-level employees from seven to three, leaving the company less hierarchical and more able to respond quickly. Caterpillar accomplished the same thing through their reorganization, as discussed previously.
Layoffs signal to employees the seriousness of the company's situation, which can reduce internal resistance to the turnaround effort.
The combination of the previous two benefits can break barriers to change, convincing potential opposition within the organization to let go of the status quo and support the turnaround plan.
Layoffs also generally earn approval from banks and investors, who tend to perceive the executive ordering the turnaround as having greater credibility for having made a difficult decision.
Ironically, one major downside to layoffs is actually near-term increased costs stemming from severance costs, which can accelerate payments at first, resulting in an actually worse cash position than would have occurred in the absence of layoffs. It's critical to factor in both savings on payroll and any accelerated severance payments when building a 13-Week Cash Flow Model. These costs are increased if a company's mass layoffs or plant closing fall under the Worker Adjustment and Retraining Notification (WARN) Act of 1988, which covers employers with more than 100 employees who have worked more than six out of the past twelve months and work more than twenty hours per week. The law has both federal and state versions, and employers must comply with both on any occasion that layoffs result in more than ninety-nine lost jobs or more than 499 lost jobs if the number represents less than 33 percent of the employees at the single employment site. In Illinois, for example, the number of lost jobs that triggers the act is only seventy-five, and each state has a slightly different version. Most require that employers enacting a mass layoff meeting those conditions must give their employees sixty days notice before the layoff, and failing to do so would trigger sixty days of paid wages for the employee. In fact, some courts have found that controlling shareholders of a company violating the act—and not simply the company itself—may be held personally liable for any violation of the WARN Act.[86] This book is not intended as a legal treatise, but rather as a guide to signal when you should contact an attorney, and any time a company thinks it is even close to triggering WARN Act protection is unquestionably such a time. (See Box 4 for other legal issues to keep in mind during a downsizing.)
Other than situations involving the WARN Act, companies should remember that their obligations to employees do not arise from a federal or state legal duty but are rather contractual in nature. Any documentation relating to a company's severance policy, either in an employment agreement, or an employee handbook, or on a company's corporate intranet or human resources Web site, such as "one month of severance per year of service," can be considered a contractual obligation to make those stipulated severance payments to employees.
Perhaps the greatest disadvantage of layoffs is that the employer runs the risk of employees filing lawsuits. I tell the students in my class—as well as the clients I represent who are contemplating layoffs—to assume that they will be sued under various state and federal discrimination laws following any layoffs, and the only hope is to consult legal counsel in order to reduce the likelihood of losing. Invariably, layoffs are likely to involve the termination of employees falling into several protected classes, typically age, gender, race, and national origin. The best way to avoid lawsuits from employees claiming they were terminated because of their membership in a protected class is to have a clear, justifiable rationale for the layoffs. One very effective defense is if the terminated employee in the protected class worked at a plant that was entirely closed, or in a division that was shut down completely; that makes it very difficult to prove that the dismissal had anything to do with membership in a protected class. Another defense is a track record of poor performance reviews on the terminated employee, but it is important that these be formally documented, not conducted in a perfunctory or largely ceremonial manner, with evidence showing that reviews were taken seriously in the organization, ideally so seriously that other poor performers had been let go in the past. Performance reviews also cannot be pre-textual; it is very difficult to justify poor reviews as the reason for dismissal if the employee received no such reviews for years, then received an impromptu negative review on Thursday before receiving her termination on Friday. General Electric serves as the industry standard in this regard, as their rigorous 360-degree review process provides significant documentation where Jack Welch's created goal of cutting the bottom 10 percent of employees every year establishes an organizationwide imperative for the evaluation and pruning of underperformers.
Even if an employer protects itself by preparing all of these defenses and complying with the necessary regulations, it must still make it clear to all remaining employees that responses to reference checks from firms interested in hiring the laid-off employees should consist only of positions held and dates of service: the HR equivalent of name, rank, and serial number, and nothing else. In one turnaround I executed, we had to lay off an underperforming worker who was part of the protected age group at age sixty. His underperformance was well documented through a series of performance reviews, which made us comfortable that we would be safe against any alleged age discrimination. Of course, a few weeks after his dismissal, a hiring firm called the company for references, but knowing that HR or any executive might acknowledge that he was dismissed for cause, the terminated employee had listed the direct phone number of his former supervisor as a reference. Although a poor employee, this worker had been known as a pleasant enough person, and so not wanting to hurt his colleague of so many years, the supervisor tried to do him a favor and protect him.
"Oh, no," he fibbed. "He was fine, we just had to let him go because of his age." We were sued, quickly settled, and cut the terminated employee a check for his full asking price within the hour, knowing that a losing case like that one wasn't even worth any legal bills.
Layoffs also cause the loss of expertise or institutional memory, which can be carried away by the terminated employees. In one noted turnaround, a steel mill decided that given the anticipated downturn in demand for steel, it would no longer need the 1,150 accountants it had on staff, so it cut the department 20 percent across the board. The cost savings were significant . . . until the company realized that among those departed were the only ones who knew how to close the company's monthly and quarterly books. Other examples include the dumbing down of newspapers by cutting the best senior reporters and increasing the number of color pictures.
That steel mill example also demonstrates the disadvantage of potential later rehiring costs. Companies sometimes lay off workers, only to realize later that either they overreacted by cutting too close to the bone or that they had reduced capacity just in front of a cyclical rebound. Either way, they find themselves understaffed, and often need to rehire the workers they laid off. As you might expect, ham-fisted attempts to hire those employees back at their old salaries with their severance packages returned do not prove terribly successful, so frequently they must hire ex-employees back as consultants while still making severance payments. In the case of this steel mill, the rehired accountants enjoyed a nearly 200 percent income increase while receiving a month's salary for every year they had been at the company. For those with three decades of tenure, it amounted to nearly a 500 percent raise.
After layoffs, the survivors frequently display a loss of trust in management. If the announcement remained shrouded in mystery even though everyone knew of the company's turmoil, workers may lose faith in the openness of management's communication style. They may begin to question management's commitment to workers if the entire executive team stays, or even worse, receives record bonuses, as AT&T CEO Robert Allen did in 1995 after announcing 18,000 involuntary layoffs. Perhaps most corrosive to morale is the perception that management caused the layoffs through their own ineptitude; many survivors of the layoffs will think that the management team got the company into this mess, yet the punishment is being meted out among the rank-and-file, a perception that discourages them from following management direction in the future.
Companies also suffer from increased risk aversion among surviving employees, who know the axe has fallen and always suspect that it could again. In an atmosphere of suspicion and fear, no one wants to stand out in any way, whether for something as important as proposing a new idea that could flop (what if it doesn't work?) or as trivial as asking coworkers out to lunch (why does he have so much time on his hands that he can spend an hour away from the office?). The natural inclination to fade into the wallpaper and avoid notice is absolutely corrosive to team morale, and inhibits the kind of bold action necessary to save a company in distress.
The potential for sabotage persists anytime layoffs are announced. At a Chicago-based candy maker, we knew we would have to initiate a plant shutdown that would trigger the WARN Act's notification standards; that is, we had to give employees sixty days' notice. However, a previous shutdown notification had prompted one of the employees to sabotage one of the assembly lines, so we were reluctant to run the risk of further such problems. At most businesses, the economic costs of sabotage are limited to any destroyed inventory or plant equipment, but at a food company the effects can be disastrous, as they can trigger FDA inspections that destroy the public's faith in the safety of the company's products. After weighing these options, we finally decided to give the required WARN notice and simply close the plant in sixty days while paying employees their wages. "Stay bonuses" were added to encourage everyone to make sure the plant ran well until it shut down. If the plant shut down early for any reason, no bonus would be paid.
Overloaded survivors can reduce a company's effectiveness post-layoffs, as they struggle to fill the roles left behind by their departed coworkers. The math is simple; unless there was already a great deal of slack in the system or there is a highly effective reengineering plan, a 20 percent cut in manpower means that the survivors must now do 25 percent more work, leading to burnout.
All of these factors tend to drive low morale following layoffs, as survivors wonder whether there will be another wave. Employees still at the company tend to mourn for their terminated coworkers and feel a sense of "survivor's guilt." They may spend more time sharpening up their résumés than performing actual work, as they have grown to feel more like independent contractors that the company views simply like cogs in a machine, assets to be stripped out when the opportunity arises. Moreover, the combination of poor morale, overloaded survivors, and the loss of institutional knowledge can cripple the effectiveness of outward-facing functions such as customer service. This in turn increases customer turnover, thus creating a vicious cycle of further downward pressure on both sales and morale.
There have been instances where those laid off are "happier" than those left behind in a very low morale environment. One study of layoffs at Boeing found that the "victims of Boeing layoffs were less depressed and drank less than those who remained,"[87] during the period 1996 to 2006 when the company laid off tens of thousands of employees. The survivors kept seeing more and more parts outsourced and friends downsized even as they "reproved, re-auditioned, and repositioned"[88] themselves as their bosses demanded. Résumés were honed on company time.
One friend, a senior manager at another company, was under constant stress as he saw the downsizing occurring all around him. Then his wife brought him an unusual gift: the front panel of an office hallway cabinet that once held a fire extinguisher. It had a newly painted red metal frame and a glass front. Hanging from the bottom was a small metal hammer. A sign on the front said, "In case of emergency break glass." He had it mounted on the wall of his office. It had a picture of him taken at a company event to show through the glass. Behind the picture, however, he kept an updated copy of his résumé, always at the ready. That knowledge took some of the edge off his stress.
By contrast, companies that manage to avoid layoffs enjoy several advantages, first and foremost among them the worker loyalty it engenders. Companies such as Southwest Airlines built a remarkable culture of allegiance and trust by not once making layoffs in its nearly four decades of operations. Even in the wake of September 11, when every major airline announced significant layoffs and several filed for bankruptcy protection, Southwest stuck to its no-layoffs policy, cutting costs by delaying orders for new planes, cancelling renovations at headquarters, and halting route expansions.[89] Other companies have similarly avoided having to lower the axe by announcing hiring freezes, delaying raises and bonuses, cutting overtime or reducing the number of shifts at a plant, redeploying workers, offering early retirement, and cutting training, marketing, and travel expenses. (It's worth pointing out that Chainsaw Al undertook very similar cost-cutting measures at Scott Paper, but he did so in addition to staggering layoffs, rather than in place of them.) Not only does this engender incredible employee loyalty for Southwest—particularly in an industry where rancorous labor relations have become the norm—but it also positioned the company to take market share from understaffed competitors once demand rebounded. Finally, companies that avoid resorting to layoffs also enjoy an edge in recruiting talented employees, buoyed by the reputational effects of having done right by their existing employees.
To avoid the problems of mass layoffs, an unusual example of such creative avoidance of layoffs came from France Télécom, whose legacy employment contracts from its prior days as a nationalized company left it with tens of thousands of employees who were technically still civil servants with guaranteed jobs for life. After going on an acquisition binge during the go-go days of the dot-com boom, the company found itself mired with $89 billion in debt, unable to make the layoffs necessary to cut costs and return to profitability. Employees could be dismissed only if they stole something. Instead, the company solicited voluntary departures from any employees who wanted to become an entrepreneur, hired a team of investment bankers and consultants in offices all over France to train these employees and hone their business plans, and seeded the approved business plans with the necessary startup capital to launch the new businesses. Beginning in late 2005, France Télécom funded thousands of small businesses, from pizzerias and sports bars to scuba diving shops, even a magician. The company even paid for one employee to take classes in winemaking and advanced him the funds necessary, including for the purchase of a tractor, to start producing his own brand of champagne. Each business plan was vetted by an internal team, with a 90 percent approval rate, and employees had the option of returning to their jobs after three years if the fledgling businesses proved unsuccessful.[90]
The France Télécom example may have little direct relevance to any business not so terribly constrained by draconian labor laws that prevent the dismissal of employees. (Efforts to loosen these labor protections in 2006 were met with widespread rioting and protests, and later layoffs caused dozens of suicides, which led to the resignation of the executive in charge of the layoffs.[91]) However, it does demonstrate the creative lengths to which a company can go in its effort to avoid layoffs, and in the process winning the loyalty of its employees. Perhaps more instructive is the example of Beth Israel Deaconess Medical Center in Boston, which found itself facing a significant reduction in state funding in the wake of the recent economic downturn. The hospital's financial hardship threatened its longstanding policy of admitting and treating anyone who could make it through the front door, a mission statement that exacerbated its financial struggles when other hospitals began forwarding clearly indigent and uninsured patients to Beth Israel to protect their own margins. CEO Paul Levy held a meeting of the hospital's higher wage earners—nurses, technicians, and physicians—and explained that the consulting firm the hospital hired had told him he would have to lay off the bottom 10 percent of workers, low-wage jobs that entailed replacing sheets, polishing the floors, and delivering food. Arguing that most of those employees were barely making it as is, many of them first-generation immigrants working second and even third jobs, he asked the assembled throng to make sacrifices in order to save their lower-paid coworkers.
Applause broke out. Soon Levy began receiving more than a hundred e-mails per hour from employees, volunteering to forego pay raises and making suggestions on how to cut costs without laying off workers.[92] While Beth Israel's nonprofit culture made such cuts palatable where they might not be at for-profit organizations, it goes to show that very often employees will band together and actually grow closer if a company can avoid layoffs, whereas they can instead become disaffected and morose if a company cannot.
Family businesses offer a slightly different variation on this question of intracompany dynamics governing the appropriate strategy when a layoff appears necessary. Rivalries among siblings, different sides of the family, or different generations can come boiling to the surface in times of crisis, paralyzing a turnaround effort or even influencing opinions on where layoffs are necessary in order to settle old family scores. Alternatively, loyalty to family members may tempt managers to avoid needed cost-cutting, to the extent that it could constitute a breach of fiduciary duty to creditors and the entity itself when the family business enters the zone of insolvency. As explained in Box 3 in Chapter Three, a turnaround manager must remain aware of such subtle dynamics that can undermine effective governance and decision making—particularly when a family member will be one of the downsized employees—in turning around family businesses.
An important issue in downsizing is weighing short-term strategy against long-term. When Robert Nardelli took over as CEO and chairman of Home Depot in 2001 he chose the former. Founded in 1979, Home Depot went through rapid growth with a strategy of low prices and hiring customer-friendly, experienced trade people for every department, reaching $40 billion in sales by the year 2000. Growth slowed and earnings fell 20 percent in the fourth quarter of 2001 partly caused by the economic environment at the time. Nardelli came in and slashed costs. In particular, he drove down payroll as a percentage of sales by cutting back on store personnel and replacing full-time employees with part-timers. While this gave a short-term boost to earnings, it alienated a loyal customer base as the company became known for terrible customer service and untrained associates. Turnover rates were much higher for the part-time associates. Similarly, his price increases on many products helped in the short run but drove customers to competitors. Nardelli was able to decrease cost of goods sold by his $1.1 billion decision to create a centralized purchasing and inventory control system, replacing the systems used by each of the store managers. Again, there were short-term gains, but it took the store managers' knowledge of their local markets too far from the equation. These and other measures were part of his attempt to create a disciplined group of employees who followed his orders, driving out any entrepreneurial thinking. Although Nardelli came up with good ideas, such as trying to attract more female customers, his implementation approaches always alienated others, especially the previously frequent customers to the stores.
Coupled with a massive acquisition binge and hasty entrance into multiple new business lines, these issues meant that Nardelli took the company away from its core competency of providing knowledgeable personnel and competitive products to customers. Home Depot's stock during his tenure first increased, then under-performed, dropping by nearly 30 percent while the S&P 500 increased by 12.8 percent and close competitor Lowes' stock outperformed the S&P by nearly 150 percent. Nardelli left after six years at the company, was paid over $300 million over that time, and received a $215 million severance package. The board had given him a contract that focused on short-term results and guarantees to entice him to join the company. His successor brought back knowledgeable personnel and improved customer service.
As Home Depot shows, disastrous downsizing can be reversed over time, even if the losses it created cannot. There are a few other examples.
From humble beginnings in 1914 as a bus company set up to transport workers to iron ore mines in Minnesota with only eight buses, Greyhound grew into an American icon with almost 5,000 stations and 10,000 employees.[93] They changed their strategy and ownership multiple times along the way, acquiring companies in meatpacking, soap manufacturing, money order services, bus manufacturing, and even airline leasing. Along the way, Greyhound went through three different kinds of failed turnarounds under three CEOs. In the late 1980s, the then CEO provoked a heated union strike that ended in the company filing bankruptcy. Frank Schmieder, a former investment banker, was the new CEO when the company emerged from bankruptcy in October of 1991 as a public company. He knew aggressive cost-cutting would impress Wall Street's securities analysts, despite his limited experience in the transportation industry. He operated for the next three years under the mode of managing Wall Street expectations, focusing on short-haul trips that forced long-haul passengers to change buses multiple times. Multiple rounds of layoffs reduced costs, and the company offered deep promotional discounts for advanced fares.
While the workforce continued to shrink, causing Wall Street to heap praise on the company, the management team did not cut back on their own executive perks, including newly remodeled offices, first-class travel, season tickets to professional sports teams, and annual executive retreats for managers and their wives at the luxurious Greenbrier Resort. As a result of cutbacks in people, ticket offices, buses, and maintenance facilities, customer relations soured and remaining employees felt alienated. Ridership began to slide in 1992 as customers felt the impact of the bare bones strategy with fewer routes, older buses, and more transfers. Management blamed the decrease in ridership on increased pressure from airlines. Employee turnover at terminals reached 100 percent annually and experienced regional managers were being fired and replaced by part-time workers. A well-touted new computerized reservation system was launched without being properly tested in an effort to meet the timeline of the rollout promised to Wall Street analysts. The computer and toll-free service numbers soon became overwhelmed and the whole system shut down. Over 80 percent of those who made advance, no-money-down reservations were no-shows, but cash-paying walkup customers could not buy a seat because the system indicated the buses were full. In addition, management sold a meaningful number of their own shares of Greyhound stock before any performance warnings were given to the Wall Street analysts. With the company being on the verge of bankruptcy only three years after exiting the courts, Schmieder resigned due to pressure from shareholders.
The next CEO, Craig Lentzch, decided that the company had to go back to basics. First, he secured an out-of-court refinancing to prevent the company from having to file for bankruptcy again. His strategy was to rebuild again to an inexpensive nationwide network and focus on increasing revenues and ridership by improving customer service. He also partnered with the competition, including regional bus service operators and Amtrak, for potential synergies and began new strategic initiatives to benefit from changing demographics of its target market. The long-haul routes were initiated again, but for the higher-traffic areas only. Greyhound added more departures for high traffic routes, such as New York to Boston, and introduced brand-name chains into concession options at stations. Service was further improved by establishing priority seating for long-haul passengers and hiring people trained for better handling of customer calls. Lentzch paid careful attention to employee relations, including updating driving, hiring, and training programs and proactively initiating the negotiation of union contracts over a year before expiration. Believing the markets along the U.S./Mexico border were significant growth opportunities, management invested $2.5 million in a joint venture in Mexico to provide through bus service on selected routes. In the United States people take less than 2 percent of long distance trips by bus compared with 98 percent in Mexico, where buses are the primary mode of transportation. He even attracted more leisure passengers by initiating bus routes along special destinations such as casinos, airports, and train stations. His B to B diversification focused on express package shipping between rural and urban areas. The new buses he ordered gave a roomier, more comfortable seat, which also had lower maintenance costs, and added lower steps to accommodate senior citizens. Lentzch transformed a nearly insolvent company into a stable, growing business by focusing on strategy, finances, and operations, not by starting with cutbacks of people but rather by determining the number and skills of employees needed based on the new strategy initiatives that first focused on individual and business customers' needs. Lentzch could never make up the losses caused by his predecessor, but he brought profits and morale back.
Sometimes, layoffs will prove inevitable even after a company revamps its strategy and reengineers its business processes, but even then, a management team must understand that there are right and wrong ways to proceed with a layoff so as to minimize (not eliminate) its effect on employee morale. In an excellent article in the MIT Sloan Management Review, Karen Mishra, Gretchen Spreitzer, and Aneil Mishra explain that clear communication is critical to preserving employees' feelings of trust toward the company and empowering them to perform their jobs.[94] They explain, as I have written above, that layoffs should be seen as a last resort, with a penultimate option to offer early retirement with a reasonable severance package so that headcount reductions can result from voluntary departures. Although this does make the company seem less heartless, it also runs the risk of losing the most qualified personnel, who may jump at the opportunity, secure in the knowledge that they will have no trouble finding other employment while pocketing a nice severance package. One of my colleagues, Professor John Ward, is very popular among students. We tried to lure him away from another university for years, until it ran into severe financial difficulties stemming from a slowdown in Medicaid payments to its hospital system and medical school. Unable to terminate professors with tenure, it offered a generous buyout package for any tenured professor who would leave voluntarily. Naturally, professors who lacked faith in their ability to find tenure elsewhere refused the offer, while the strongest professors there—such as Ward—took the buyout and had an offer for tenure from a competitor university within a matter of days. His situation demonstrates that even nonprofit organizations are not immune to the adverse selection that can happen when a company offers a blanket voluntary early retirement; very rarely do the "bad apples" leave rather than the most valuable employees.
I once served on a conference panel with a veteran executive of AT&T who opined that they had gone through six rounds of layoffs during his tenure, and in his opinion, they had fouled up every one of them. In one example, they had offered the same voluntary retirement packages across the board, but the highest percentage of acceptance was in the sales department. Many of the company's top corporate salesmen took the buyout and immediately jumped to a competitor, using their strong customer relationships to steal away corporate business from AT&T. The use of a noncompete agreement can mitigate this risk, but only slightly, as such agreements are notoriously difficult to enforce, particularly in certain states. Reasoning that you cannot prevent someone from earning a living, most courts are reluctant to enforce non-competes unless they are significantly restricted in the scope of competitive activity prohibited, the geographic region in which it is active, and the time frame (generally six or twelve months is about the maximum most courts will enforce). One exception to this reluctance to enforce such agreements is in acquisition agreements; if you purchase a business and part of the deal structure provides for a noncompete from the selling shareholders, courts will reason that you provided consideration in exchange for a bar on competition during some reasonable time frame.
If involuntary dismissals are in fact necessary, a rigorous reengineering process should reveal this, as well as where those layoffs should be concentrated. Executives frequently look at the bottom line and declare "we need 15 percent across-the-board cuts," but in considering whom to lay off, I preach equity, rather than equality. Simply taking some arbitrary percentage needed to return to stop the bleeding and spreading it equally across all departments may seem fair and democratic—"we all have to share the burden"—but it is also lazy and ill-advised. A successful reengineering will invariably reveal that some departments are overstaffed by three times that amount, while others may actually need additional resources to implement any strategy.
There is some question as to how transparent the planning process should be before announcing a layoff; in order to avoid potential sabotage, paranoia, or "working to rule" (a situation where a union intentionally begins slowing down work according to legacy union contracts that specify obsolete rules or rates of speed), I recommend keeping the process as quiet as possible. If employees know that layoffs are coming, companies often see a spike in worker's compensation claims, as employees attempt to avoid the ax by going on disability leave.
Upon announcing necessary layoffs, it is absolutely critical that a sound reengineering process has identified how many are necessary. In general, one should err on the side of caution and cut further than may be necessary; turnaround plans always take longer and cost more than one expects, and so it is better to cut a bit closer to the bone than was absolutely necessary. Naturally, this is tempered by the risk of cutting too far and having to rehire employees as expensive consultants, as mentioned previously, but the countervailing risk is even greater. Successive waves of layoffs give employees the perception that the company is in a death spiral, and that they could be next at any given moment. This effect is heightened any time management makes the well-intentioned but ill-advised decision to appoint one executive to announce the layoffs at a series of facilities one-by-one, as one major investment bank did in the aftermath of the dot-com bust. After traveling down the West Coast and gutting, in succession, the Seattle, San Francisco, Menlo Park, and Los Angeles offices, he became known as "Dr. Death," and bankers spent more time e-mailing wild speculation about his next destination than on conducting actual work.
To avoid the corrosive effect on morale that multiple waves of layoffs cause, turnaround managers should "measure twice and cut once." This becomes a huge credibility test for the team running the turnaround: by putting a stake in the ground and assuring the survivors of the layoff that there will be no more layoffs, they earn credibility only so far as they keep their promise. Making such a declaration and then going back on one's word inspires a lack of confidence among the workforce and further depresses morale.
In order to dampen the psychological blow that layoffs will represent, managers should furthermore identify all the constituents affected by the announcement. This includes not only the laid-off workers and the survivors and their unions, but also the community in which the business operates, relevant government agencies, and the local press. With careful planning, one can mitigate the company's loss of goodwill by demonstrating that it has made a good-faith effort to reduce the impact the layoffs make on each stakeholder. For example, companies can earn credibility by inviting other local employers to interview the affected workers or seeking to secure funds under the Job Training and Partnership Act to ease their transition to new positions. If the turnaround plan makes a facility redundant or unnecessary, it can be donated to a local economic development agency or other nonprofit organization, thus demonstrating a commitment to community. Companies can even offer to make higher-than-stipulated payments to local governments to help them survive a precipitous drop in tax revenues due to the shutdown of a plant.
When it comes time to announce the layoffs, management must display honesty and compassion. It is absolutely critical that employees hear about the layoffs not from the media but from management itself. This has grown increasingly difficult in a world of twenty-four-hour communication, as the ease of spreading information through social networks such as Twitter means that companies should assume that if one employee has heard the rumor, every employee has heard it, even in sprawling companies that operate across several continents. As a result, the company's media relations department—if it exists—should attempt to stay ahead of the story by preparing a simultaneous mass dissemination strategy. In its 1999 bankruptcy filing, Purina Mills used an overnight delivery service to ship 10,000 video copies of the CEO's message about the company's planned restructuring, and conducted town hall meetings where employees could ask the CEO questions and have their concerns addressed, which preceded one-on-one managerial discussions with the employees terminated.
Compare Purina's approach with that of Julian Day, who terminated 400 Radio Shack employees with an e-mail that read: "The workforce reduction notification is currently in progress; unfortunately, your position is one that has been eliminated."[95] The e-mail further notified recipients that they had thirty minutes to pack up their desks and say goodbye to coworkers before they were escorted off the premises. The resultant media storm demonstrates how simply taking the time to notify affected employees in person makes a huge difference in how the layoff is perceived both inside and outside the company.
Instead, managers should speak honestly with employees about why the layoffs were necessary. While terminated employees can grow hostile, I have found that sometimes it helps to express genuine regret about the situation and explain that sometimes it is necessary to cut 20 percent of the jobs at a company in order to save the other 80 percent. If the terminated employee then argues that he or she should not have been among those laid off, it helps to have documented performance reviews justifying why they were chosen, or some other ironclad reason such as the entire department or division being let go.
Contrary to popular opinion, Fridays—particularly those before a long weekend—are not a good time to announce layoffs, as it prevents employees from getting their questions answered. It is far better to announce the layoffs earlier in the week, and then offer those employees the day off; productivity almost always plummets on the day of the announcement, so employees appreciate the chance to go home and notify their families of the news.
After announcing layoffs, companies should follow the general rule mentioned in Chapter Three that it is almost impossible to overcommunicate in a turnaround. This prevents myths—such as rumors of new waves of layoffs—from disseminating through the company, hampering morale. To the extent the company has any resources to help laid-off workers find new employment, it should do so, as in the example of BankBoston offering to pay laid-off workers' salaries for six months if they took a position in public service.[96] Management should also follow through on making any subsequent announcements on time and as planned, not a day early and not a day late. After announcing a layoff, all eyes will be on management, as survivors make up their minds whether to trust the managers who have laid off so many of their coworkers, so every day is an exercise in regaining lost trust and building incremental credibility.
Companies should also be careful to manage their news flow around the time of layoffs. Although Wall Street analysts sometimes dismiss CEOs taking a $1 salary during periods of distress as an empty gesture, employees can respond well to the belief that those at the top of the organization are sharing in the pain. On the other end of the spectrum, management should be very careful about announcing CEO management bonuses or stock grants until well after any turnaround has proven successful, or they risk facing the kind of hostility that prompted workers at a Caterpillar plant in Grenoble, France, to hold four managers hostage following a layoff announcement. During the twenty-four hours of confinement, workers subjected them to "a night of pounding revolutionary rock music and shouted threats" while barraging their cell phones with threatening calls and texts.[97] Only intervention by French President Nicolas Sarkozy ended the stalemate, which represented the fourth time in just thirty days that French workers had resorted to such "bossnappings." France Télécom finally worked with the national government to encourage employees to become true civil servants. They created a program to redeploy employees to public-sector job openings at city halls, hospitals, and schools. France Télécom paid the salaries of employees who switched for the first four months and even paid the difference in pay for up to a year.[98] Many who switched felt they were more satisfied by their new vocations.
It is amazing how fast news travels. When an internal e-mail at a Chicago law firm where I officed part time announced cutbacks on people and that there would be no more free coffee, it made it to the newspapers and on-line chat boards in minutes. That weekend we had a dinner party at our house and all the guests brought me instant coffee as a gift.
In the late 1990s, Xerox Corporation was bleeding cash, with inventory levels climbing far faster than sales, and remained solvent only with repeated new debt financings.[99] Management focused first on lowering expenses by consolidating its four geographically oriented customer administration centers into three. However, this hasty maneuver actually increased costs while eroding customer goodwill, because in the rush to cut costs by consolidating the centers that handled billings and collections, Xerox customers suffered major delays, lost orders, billing errors, and unreturned customer phone calls. Put on the defensive, Xerox's sales teams had no choice but to focus on damage control rather than on generating new sales.
Other strategic errors during this same time included a reorganization of the Xerox worldwide sales force that shifted nearly half of the company's sales team from a geographic orientation to an industry focus. This might have worked had the company bothered to train its sales reps for their new roles. With sales reps lacking both geographical connections to their customers and the product expertise necessary to make up for their distance from customers, sales plummeted, prompting another Xerox response in the form of sharp price cuts. Just as Dick Brown's overly aggressive bidding policies at EDS tied the company into the NMCI debacle, Xerox's price cuts left the company trapped in massive unprofitable contracts. The company reached full-on crisis mode when it recorded a billion dollar foreign currency loss. The Securities and Exchange Commission would later determine that between 1997 and 2000, Xerox defrauded investors by using a series of undisclosed accounting actions as a way to meet or exceed Wall Street's expectations. Needless to say, credit markets dried up as far as Xerox was concerned, and the company could no longer turn to its lenders for additional capital.
Meanwhile, the company's plummeting stock price (which fell by more than 95 percent from the beginning of 1999 to the end of 2000) had pushed morale to new depths, made worse by wave after wave of layoffs. Nine thousand employees were let go in April 1998, followed by 5,200 more in April 2000. Smaller waves of 100 here, 200 there occurred periodically through late 2000, followed by 4,000 layoffs in January 2001 and 11,000 more in October. Each successive wave depressed morale further, until one analyst noted morale was "down in the dirt."[100] Employees began trading Dilbert cartoons lampooning the cuts, and gallows humor dominated the company's atmosphere.
The board named Anne Mulcahy president and chief operating officer to turn the company around, later promoting her to CEO in 2001. Mulcahy considered filing the company into bankruptcy—which would have allowed the company to relieve its staggering debt burden, protect the company from potential litigation, and buy the company some time to execute its turnaround—but decided that a filing would do irreparable damage to Xerox's brand, supplier relationships, and consumer perceptions. In addition, bankruptcy would grant creditors significantly more control over the company-strategy and operations, damage its supplier relationships, compel customers to find alternate suppliers due to the uncertainty about Xerox's future, incur exorbitant professional fees, and potentially wipe out shareholder equity entirely.
Mulcahy instead focused on executing a three-pronged turnaround. Worried that Xerox would not be able to fill orders, many clients had begun limiting their business with the company. Along with severe customer service issues, this required that Mulcahy meet directly with key customers to get their input on strategic decisions. Mulcahy's leadership team engaged in a reengineering process to identify exactly what added value to each one of Xerox's most important customers. She met with customers to demonstrate that Xerox valued them, to convince them of Xerox's solid future, and to reassure them that service problems were being addressed.
Discussions with clients served as the foundation for her decisions on strategy and reengineering effort, which concluded that Xerox needed to continue bringing new and innovative products to the market. Against the advice of so-called experts, who insisted that Xerox continue to slash the R&D budget, Mulcahy identified R&D as a critical value that Xerox provided to customers, and pushed spending in the area to 6 percent of revenues. This proved key to restoring Xerox's image as an innovation leader and reestablishing the company's competitive position in the rapidly changing document-processing market. Xerox strategically transitioned from the dated light-lens equipment market to newer digital products and became competitive in the color market, with the objective to develop technology that produced color printouts and copies quickly at a reduced cost. Mulcahy's team developed strategies to market competitive products to three key markets: the production market, large office market, and the services market.
This sound turnaround plan immediately provided Mulcahy with the credibility needed to pull together a fragmented, depressed employee base. She announced one final round of layoffs upon being promoted to CEO, and stuck by that decision throughout the rest of the turnaround process. Her decision to exit the small and home business markets eliminated approximately 1,200 positions across two entire divisions, which, as already mentioned, makes discrimination lawsuits more difficult to pursue and is understandable to all concerned.
In addition to the production-level employees in these two divisions, Mulcahy focused her one and only round of layoffs on middle management by stripping out Xerox-matrix-style management structure. This reduced the number of hierarchical layers between her and the production floor, resulting in a leaner, more nimble Xerox with reduced decision time. To improve performance and ensure that the sales force could better meet customer needs, Mulcahy took actions to clarify accountability, and she enhanced salaries and incentives for remaining sales reps.
Perhaps most important, Mulcahy remained open in her communications with employees at all levels to minimize fears about job security, and kept her promise to make only one round of layoffs. In order to avoid losing that credibility with further cuts, no cow was considered sacred, with once lavish lunches replaced by tuna fish sandwiches, employees crowded in two-to-a-cubicle, and travel and training expenditures slashed.[101] Day by day, employees who had grown increasingly suspicious of upper management began to have faith that the ship had been righted, and that Mulcahy was making the hard decisions in a fair and honest manner.
The resultant boost in morale became obvious to outsiders, as Xerox widened its distribution channels by expanding its network of agents, resellers, and retailers, which allowed the company to respond to customer requests quickly and made products more easily available in the market. In turn, the expansion helped restore customer confidence at a time when service capabilities had become increasingly important.
Xerox's turnaround plan slashed operating expenses by $1.7 billion by reducing redundant layers of management, consolidating operations that had previously run in a siloed environment, trimming administrative costs, and tightly managing discretionary spending. The company achieved additional cost reductions by outsourcing the manufacture of products for the office market to an electronics manufacturing services company, which included the sale of several plants to this provider and the transfer of Xerox employees running those operations. In addition, Mulcahy resolved customer billing and order processing problems by creating a venture with a GE Capital unit to manage financing, administration, order processing, billing, and collections.
All these moves required multiparty cooperation, which allowed Xerox to avoid filing for bankruptcy. Unlike some CEOs who remain isolated from customers and the everyday workers in their organizations, Mulcahy made a point of continually speaking with customers and employees regarding their needs and incorporating their input to drive the development of a new strategic vision. In addition to visiting various Xerox facilities, Mulcahy instituted roundtable discussions and town hall meetings where workers could discuss the obstacles they faced in changing Xerox for the better. Mulcahy delivered bad news personally, making sure that employees understood that difficult choices were necessary to save the company and its remaining jobs. Mulcahy launched an aggressive turnaround plan that returned Xerox to full-year profitability by the end of 2002, along with happier customers and employees, a decreased debt load, and a revitalized investment program in research and development. Much of this success stemmed from her ability to inspire confidence in an employee base badly battered by wave after wave of layoffs, and earn back their trust.
In conclusion, I have always maintained that downsizing is a tool, not a goal; if cuts are necessary, then they are necessary, and while painful, it is far better to save 70 percent of the company's jobs by sacrificing 30 percent than to let the entire company liquidate. However, managers too often begin to think of downsizing as the end rather than a means to it. Very often significant cuts are not necessary and can be minimized by re-assigning workers to new functional areas or product lines that need additional help. Identifying these opportunities, however, requires a sound analysis that starts with a clean sheet of paper and focuses on the things a company does that actually add value to customers.
If, upon conducting a business process reengineering, Six Sigma, or any other customer-focused analysis, it becomes clear that cuts are necessary, management should take care to do everything possible to minimize the damage they do by considering a variety of stakeholders and thinking creatively about how to mitigate the effect on terminated employees. A company's treatment of the departed employees gets back immediately to survivors, and they will largely form their opinions about current management based on how they feel their coworkers have been treated and how the layoff announcement was handled. In the next chapter, we examine what happens when even layoffs cannot keep a company solvent and it is forced to file for protection under the U.S. bankruptcy code.