Organizations should prepare themselves and address the issues associated with a down economy. This article will address how to assess workforce-management, evaluate all options when faced with difficult business times, and implement sound decisions. When layoffs seem imminent, directions will be provided on how to analyze whether they are necessary to reduce workforce costs or whether alternatives will allow the organization to meet its needs and retain valuable employees, while carefully considering the legal and practical implications of a reduction in force. Finally, the effects of restructuring and layoffs have on the “surviving” employees will be addressed, and how to equip management with the skills and tools to keep employees positive and productive even while feeling the stress of a down economy.
Are Layoffs Necessary to Reduce Workforce Costs?
The past two years have seen unprecedented job eliminations, with “layoffs” as the primary method to reducing costs while continuing business. Employees in operations were most affected by layoffs, but technical and professional employees were also affected. Employment declined in technology, manufacturing, retail trade, transportation, and government and finance. On the other side, many companies have taken active steps to keep employees while cutting costs and continuing business operations, despite lost profits and budget deficits. How did they do it?: flexible management strategies.
In this tight economy, businesses need to think creatively and plan carefully before embarking on a permanent labor cut. In many cases, companies that have downsized too many, too quickly, ultimately have paid a larger price by having to rehire laid-off employees at a greater cost or in consulting roles.
Dollars and Sense: Evaluating the Options
The old adage, “don’t throw the baby out with the bathwater,” typifies the mistake that many organizations make when reducing costs through employee layoffs before evaluating the business phase the organization is experiencing. The business’s current and future economic situation plays a significant role in determining the appropriate cost-reduction efforts for the organization.
Appropriate and meaningful workforce changes occur only when they correspond to the organization’s anticipated business climate. Many factors, including organizational forecasting, operational budgets and planning, and industry data, assist in determining the organization’s anticipated business climate. If the organization expects a downturn, it must then determine its “cost reduction phase.”1 The cost reduction phase refers to the length and severity of the company’s expenditure reduction, taking into account the perceived duration of the business, economic, or industry downturn.2
Business Strategy, Goals, and Objectives: Temporary versus long-term
Aptly forecasting the cost reduction phase will then assist in determining the appropriate employment strategy to implement. Three business phases exist: (1) temporary slowdown which requires short-term adjustments; (2) business or economic downturns which require more permanent adjustments and secondary cost reductions; and (3) long-term expenditure reductions and strategy changes which impact the “survivors” as well as those affected by job loss.
a) Temporary slowdowns
Temporary slowdowns include decreased short-term revenue expectations. Short-term means anything less than one-year, depending on the cyclical or seasonal nature of the organization. The business downturn is viewed as temporary so the cost reduction efforts can be of a short-term nature. Temporary slowdowns include circumstances like the delay in launching a new operation or product, seasonal slowdowns, and national or international crises such as war, violence, and outbreaks of disease that affect industries including travel, entertainment, and retail. Examples of efforts to trim costs during temporary slowdowns include temporary facility shutdowns, compressed workweeks, mandatory vacations, overtime eliminations, and sabbaticals.
b) Business/economic downturn
A permanent business downturn or industry-wide slowdown will necessarily have a greater impact on the organization. For example, losing a major contract, lost market share due to a new competitor, or bankruptcy restructuring, may require more permanent adjustments to the business operation. Further, appropriate cost reduction efforts may alter the organizational structure and environment more dramatically than temporary cost reductions. In the case of a longer-term business downturn, i.e. one year or longer, organizations may be forced to implement salary reductions, alter variable pay programs, redistribute or eliminate bonus and incentive plans, implement employee lending, or offer retirement incentives. These options enable the employer to maintain its existing workforce while reducing costs during the downturn. If business resumes, the company is not left short-handed or without the necessary experience and expertise, but allows flexibility to manage costs during the time of flux.
c) Long-term expenditure reductions or strategy change
Organizations that decide to alter their business strategy, perhaps close a facility, sell a business entity, cease certain operations due to market conditions, or engage in a merger or acquisition, are most likely faced with decreasing their workforce. These long-term expenditure reduction efforts are the most appropriate time to incorporate reductions in force into the strategy; however, other efforts can be invoked to avoid mass layoffs, which trigger legal requirements such as compliance with the Worker Adjustment and Retraining Notification Act. Eliminating contract or temporary positions, offering early retirement incentives or voluntary exit incentives, or hosting job fairs and career placement assistance before terminating current employment, are all staff reduction tools that will encourage goodwill between the company and the departing employees.
Calculating the Cost/Savings Ratio
In addition to considering the cost reduction phase of the organization, the business must also weigh the cost to savings ratio when evaluating cost reduction efforts. “Right-sizing” has become the colloquial term for companies’ efforts to cut costs, to improve efficiency and profitability, and to meet shareholder expectations and marketplace demands. However, employers considering reductions in force to accomplish right sizing must consider cost factors. Studies show that the expense of some reductions in force outweighs the utility.
In calculating the savings associated with an employment decision, direct and indirect savings must be considered to gain full perspective of the benefit to the organizational changes. Direct savings include tangible, calculable expenses such as salaries, overtime, and benefits costs. Benefit costs are more challenging to capture but include everything from company-sponsored health plan contributions, to company vehicle expenses, to educational expenses. Other direct savings may be associated with space, such as less leased space, equipment or furniture for fewer employees or fewer on-site employees.
Indirect savings, or those savings which are less tangible, are difficult to assess but may include the savings associated with not having to train employees in a particular job function that has been eliminated, or increased productivity of those who remain based on heightened efficiency, fear of further reductions, and/or maintained loyalty and morale due to company efforts to avoid layoffs.
Workforce reductions provide unique opportunities for reorganizing and streamlining operations. Redesigned workflows and/or operating procedures may improve efficiency and eliminate duplication of effort and expense, driving down costs. Further, existing business practices should also be evaluated considering reduction of hidden costs, such as travel and entertainment expenses and/or scaled-back budgets, and eliminated or curtailed recruitment efforts and expenses.
By calculating all of the tangible and intangible savings for the period the employment change is expected to incur – month, quarter, annually – an organization may gauge the savings it could realize by implementing the change.
Next, an organization should determine the costs associated with any organizational change. The ultimate question is: “will the organizational change cost the company more in the long run?” To answer this question, all the direct costs associated with the business practice change must be considered. If the change does not affect the terms and conditions of employment, for example, forced vacation, the tangible costs are minimal. However, when the changes impact employees’ pay and benefits, such as compressed workweeks, salary reductions, or plant shutdowns, then other direct and indirect costs must be evaluated. Costs such as rising unemployment taxes and increased unemployment insurance premiums will eventually affect the company’s bottom line when those whose job hours are reduced apply for supplemental unemployment benefits.
If ultimately implementing a layoff or reduction in force, an organization should calculate all of the direct costs associated with the layoff, including, but not limited to, severance pay, paying out accrued vacation and sick pay, outplacement costs, pension and benefit payoffs, and administrative expenses to implement the reduction. Further, if the layoff is temporary, then the organization must evaluate the cost of rehiring and replacing employees. If the organization will have to rehire when economy rebounds, this will likely cost more than the original cost of the employee. It is estimated that it costs $200,000 per employee to replace a top performer, incorporating recruiting, training and salary and benefits costs. An organization also should consider potential charges and lawsuits as a result of initiating a layoff and defense costs associated with those charges. Unemployment rates and employee shock and distrust of management have caused former employees to challenge layoff decisions far more often than in the past.
A final consideration is the indirect costs associated with layoffs, such as employee morale issues, including heightened insecurity and reduced productivity. While these indirect costs are immeasurable, they should be included in the decision-making process when faced with difficult business times
Other Considerations – Legal or Contractual
In addition to the business strategy assessment and the cost/savings ratio associated with various business alternatives, the organization must also consider any legal ramifications imposed by federal, state, and local laws, existing or pending contracts, and collective bargaining agreements. For example, most states have wage and hour laws regulating minimum wage, work hours, and provisions for pay. In considering alternatives to layoffs, an employer would need to assess how changes in work hours, pay, or other terms and conditions of employment might implicate these laws. For example, if an employer attempted to control costs by imposing a condensed workweek in which employees work three ten-hour days for a total of 30 hours per week, but the state law required overtime payment for any time worked in excess of eight hours per day, the employer would be required to pay overtime for the two additional hours worked each of the three work days. This scenario might defeat the purpose of the 30-hour workweek imposed by the employer to control costs.
Also, several states passed laws addressing plant closings and mass layoffs. The requirements imparted by these laws may be different that the Federal Worker Readjustment and Notification Act (the “WARN” Act) and impose notification and/or other responsibilities on employers engaging in layoffs.
Another consideration is parameters placed on the organization by collective bargaining agreements. For example, a large steel corporation is party to a collective bargaining agreement, which mandates one manager to a set represented employee ratio. According to the agreement, should the corporation decide to close a plant or conduct a layoff, the management structure should be trimmed accordingly to maintain the designated ratio. If the corporation failed to consider this agreement in its employment decisions, it could risk violating the terms of the collective bargaining agreement.
Many factors should be considered before implementing changes that will impact employee retention, compensation, benefits and morale. First consider the longevity prediction of the economic downturn to determine the severity of the changes that need to occur. Next consider the cost/savings ratio to ensure that changes will not exceed their utility. Finally, consider the legal ramifications imposed by federal, state and local laws, contracts, and collective bargaining agreements, as well as the organizational goals and culture/morale issues. If a reduction in force is necessary, an employer’s ability to demonstrate a legitimate business purpose for employment decisions is a strong defense should those decisions be challenged. Therefore, it is important that the organization can demonstrate it thoroughly reviewed its business financial and condition information and undertook a detailed cost/savings analysis.
Avoiding Layoffs – Alternative Strategies
After assessing the magnitude of the economic downturn and likely duration of the strategy to be implemented, evaluating the costs and savings, and considering any legal ramifications, an employer next must decide on what strategy(s) will best address its situation.
Communicate with Employees to Gain their Support and Obtain their Ideas
No matter what strategy an employer utilizes, results will hinge on the level of communication with the workforce. As early as possible after the necessity for cost-saving measures is identified, educate employees about the state of the company and possibly about what alternatives to layoff are being considered. Ideas about what could shave expenditures should then be solicited from the employees through surveys, emails, focus groups and interviews. Not only do employees often offer innovative ideas when their jobs are directly implicated, but morale will be bolstered by management’s display of confidence in the workforce. The stronger the communication process, the less likely that employees will choose to leave the company.3/p>
Loyalty is generated in employees who feel that their employers hear their voices and care about their jobs. Indeed, three of the companies consistently listed on Fortune’s 100 Best Companies to Work For In America-- Southwest Airlines, Harley-Davidson, and Federal Express--have adopted official no-layoff policies.4
Restructuring efforts that could preempt a layoff would include closing of obsolete plants or branches, administrative overhauls, selling of non-core operations and improving internal processes. As to the latter, employees often have the best ideas about how their jobs could be performed more effectively and/or efficiently.
Hiring Freeze and Internal Shift to Cover Open Responsibilities
In a seemingly ironic practice, employers often continue to fill vacant positions while introducing significant layoffs. This practice sends employees the message that their needs and livelihoods are unimportant to the organization. By simply placing a freeze on all hiring and then shifting employees internally to cover all functions, savings are coupled with improved morale. This option, like the other ways to reduce headcount discussed below, carries the advantages of minimal risks and costs and is less likely to diminish employee morale. However, the disadvantages are that longer time commitments are required to realize somewhat limited savings and the internal shifting and reassignments will cause some level of disorganization.
Consider Who Will Be Leaving Anyway (and don’t replace them)
If certain employees have contracts, the organization should determine when those contracts would expire and plan not to renew them.
Similarly, the organization should ascertain when temporary assignments are set to conclude and not reassign them.
A certain number of employees will leave a given employer every year and normally have to be replaced. The organization should consider how many employees leave on average per year, and then calculate the average savings per year based on average salary and benefits if those employees are not replaced. However, if the attrition occurs in key positions, the organization must have a succession and development plan to replace those positions with internal candidates.
Requiring employees to take a certain number of unpaid vacation days within a designated time frame provides a short-term reduction in labor costs. For example, Hewlett-Packard asked employees to take any six days off between May and October 2001. At Charles Schwab, employees were told to pick three Fridays in a five-week period to take as unpaid vacation.5 As with all of the strategies to avoid layoffs, this option will be more palatable to employees if management stresses that this will likely preserve jobs in the long run.
Shortened Workweek/Restriction on Overtime
Reducing the number of hours in the workweek by just a few hours, for example from forty (40) to thirty-five (35), can generate significant savings. Though salaries are essentially being reduced, the offset is more time for employees to spend as they wish. Further, production is typically not affected because employees tend to feel pressure to achieve the same results and usually work harder to do so. Limiting overtime can achieve the same end.
Examples of organizations that successfully implemented this strategy:
- In January 1994, Volkswagen adopted a four-day workweek for employees based in Germany. Although workers cut their hours by 20 percent, production actually increased slightly.
- Since 1973, Federal Express has espoused a no-layoff philosophy. In the past year, the company eliminated the monetary equivalent of 3,000 full-time positions through attrition and reduction of employee work hours.6
- Lincoln Electric, a manufacturing company Harvard Business School has featured in its case studies, continues its policy of “guaranteed employment after three years of service.”7 During business downturns, the company mandates 30-hour workweeks. Lincoln Electric’s website boasts that it has not implemented a layoff since it started the policy in 1948.8
- For 35 years, Nucor Corporation in North Carolina likewise has avoided layoffs by setting up two and three day workweeks during downturns.9
Countless other examples of companies compressing work schedules underscore the frequency with which this option is used with success.
1. Pros and Cons
The option of across the board salary reductions has distinct advantages and drawbacks. A great deal of money can be saved while avoiding job casualties. Since the cuts apply to everyone, no one feels singled out. The organization can foster a team-like approach to hard times, with everyone shouldering the weight of the cuts in order to ensure that jobs are maintained.
On the other hand, whenever a worker’s paycheck is directly impacted, emotions run high, and the global benefits of the cut can be difficult to remember. And, while furlough programs and RIFs may target poor performers, the best performing employees tend to be the most dissatisfied with reduced pay and hours. They are, consequently, the most likely to find other jobs; so, employers should be careful to compensate high performers in a manner that motivates and retains them. Perks like discounted stock options, which do not presently cost the employer anything, but could eventually be very valuable to the employee, or perks like job-sharing, flextime and telecommuting should be considered. To illustrate, Acxiom, a 5,800-employee database management company, was able to avoid layoffs for an extended period of time by allowing employees to voluntarily elect reduced salaries in exchange for stock options.10 In April of 2001, 1,973 employees, or 36 percent of Acxiom’s eligible workforce (those earning more than $25,000), took 5 percent pay cuts in exchange for the option to purchase $2 of additional options with every $1 of additional pay cut.
Another downside to reduced salaries is that those with lower salaries might feel disproportionately impacted by a fixed percentage cut. Reducing salaries on a sliding scale, with the larger salaries receiving the largest cuts, could offset this feeling. Targeting the owner and top management as the first to have salary cuts also sends an important message to employees. When workers know the people at the top are taking a hit with the rest of the staff, it will go a long way toward creating good will between employer and employees. Charles Schwab utilized this practice and minimized layoffs when it required salary cuts ranging from 5 to 25 percent for managers at the vice president level and above.11
Salary cuts can work for small and large companies alike. Brooklyn Carpet Exchange, a New York company that sells carpets to businesses, avoided layoffs altogether by cutting everyone’s salary by 30 percent. Instead of animosity, the owner of the company was thanked by employees who appreciated not being laid off.12
Creativity can soften the blow of salary cuts. At Volkswagen, base salaries were reduced by 12 percent, but the Christmas bonus and other once-a-year payments were distributed over 12 months, which ultimately provided workers with the same monthly incomes they had previously received.
As discussed previously, it is important that information be shared with employees before unilaterally imposing this, or any, alternative to a layoff. To do otherwise, after all, would defeat the very purposes of choosing an alternative—to preserve jobs and employee morale.
In order to minimize administrative costs and simplify the transition, implement the reduction to be consistent with the internal pay period. The organization should make sure employees understand that the reduction is not temporary (unless it is) and that they will not be able to recapture their reductions; on the other hand, of course, salary reductions are only permissible looking forward and cannot be imposed retroactively.
3. Legal Constraints
Before implementing a salary cut, the organization must consider whether it is legally permitted to do so. Employees who are covered under employment contracts or collective bargaining agreements may be protected from such cuts.13 The employer should look to the contract as to whether minimum salary or wages are mandated, whether the employee’s and/or an employee representative’s written consent is required, and whether a certain notification period is delineated.
In addition, every employer should review all applicable benefit plans to ensure that salary reductions are not impacted or even prohibited by them mid-term. Vacation time could present a legal roadblock in that it is, in certain states, considered compensation. Vacation pay that has been earned prior to a salary reduction might have to be used up or paid out to the employee before the reduction can be implemented.
The organization will also want to carefully consider how much of a reduction is permissible. If salaries fall below certain minimal levels, the overtime exemption will be lost and new recordkeeping requirements must be followed.
Finally, employees should be counseled that they do have the option to terminate the employment relationship in lieu of the pay cut, which then implicates potential unemployment liability for the employer. Ideally, all of the above information should be relayed to employees both orally and in writing.
Temporary Facility Shutdown
Another layoff alternative is temporarily shutting down the facility, with just a skeleton operation remaining, for a designated period of time. Though production obviously decreases for that time period, great savings can be realized. Because WARN requirements must be observed for shutdowns greater than 30 days, many companies opt for a shorter period. Sun Microsystems, for example, implemented a one-week shutdown of all U.S. plants in July 2001. Though Sun ultimately was forced to cut jobs in October 2001 due to a further downturn linked to the terrorist attacks, it was able to stave off layoffs prior to then.
Sabbaticals are voluntary leaves for employees offered with no or reduced pay and usually with benefits. Historically, sabbaticals were popular during strong economic times. Many employers incorporated sabbaticals as an employee relations and retention tool; however, their use was misplaced. Sabbaticals are good alternatives to layoffs and more helpful in a down economy, as opposed to economic times when everyone was needed. Employees offered sabbaticals during the 1990’s heydays are not as willing to take sabbaticals during this turbulent economic downswing. A typical pay scale for sabbaticals is three-month leave at 50 percent pay; six-month leave at 40 percent pay; nine-month leave at 30 percent pay; or 12-month leave at 20 percent pay. Some Human Resource professionals believe 12-month leaves are too long and could result in a depletion of skills and expertise. An alternative pay schedule would be three- to nine-month leaves at 30 percent pay and no 12-month leaves.
To illustrate, Accenture asked 800 consultants to take sabbaticals of up to one year at 20 percent pay, and 1,500 consultants applied to participate. Employees were eligible to take other jobs during the sabbatical as long as they did not work for a competitor. Siemens ICM Division asked employees to take sabbaticals with the standard pay schedule described above. As a result, the company avoided layoffs for an extended period of time. Other companies, like Motorola, have instituted sabbaticals for the entire workforce during slower times, like the summer months.14
An organization considering a sabbatical plan should pay special attention to the relationship between the furlough pay and severance pay if the employee(s) later terminate employment. The plan should spell out employee insurance and benefit rights during the leave, and insurance carriers should be contacted for written confirmation of coverage if the employer plans to offer it during the leave.
Some employers choose to lend employees to another company for a certain period of time during which the borrowing company reimburses the lending company for the employee’s salary.
For example, Texas Instruments lent employees to vendors and other local companies for eight months. Texas Instruments paid the employees their normal salary, including benefits, and the vendors reimbursed Texas Instruments for the employees’ salaries during the loan period. In addition, the borrowing companies agreed not to offer the employees permanent jobs when the loan period ended.15
The practice of employee lending can considerably reduce overhead, but it is not without drawbacks. Some employees may not like being “reassigned.” Further, the market in a particular area may not be amenable to lending.
Another alternative is lending to non-profit organizations. Instead of being laid off, employees are given the option to work for a local nonprofit organization for a designated period of time while being paid a fraction of their normal salary. The company continues full coverage of benefits. After the lending period ends, employees have a grace period, while still being paid, to find a job inside the company again. The pay schedule for this type of arrangement typically is similar to the sabbatical leave pay schedule. This program allows employees to remain in a location while receiving benefits and partial salary and while helping the community.
Cisco Systems’ employees received one-third of their salary for a year during which they worked for a nonprofit organization, in a program intended to ease internet technology transition. The company continued full coverage of benefits, use of a laptop and company gym privileges, and it vested the employees’ stock options. At the end of the year, Cisco gave employees two months with pay to search for a job within the company.16 Though this option might not be attractive to some employees, others might view working for a nonprofit as a rewarding and self-fulfilling experience, and the practice would have a positive impact on the company’s societal and brand image.
This option envisions offering employees incentives to leave the organization in the form of severance or early retirement packages. This strategy permits better targeting of jobs and units, it recognizes employees for their past commitment to the organization, and helps retain the remaining employees. On the other hand, exit incentives are expensive, create future expectations and an entitlement mentality, and discourage workers from leaving the organization in the future.
Another solution is the use of "work-sharing" (which is different than "job-sharing" in which two or more people share the same position). Under a work-sharing plan, the “employing unit” is considered and the total amount of work available is shared among all employees within the unit.17 Each employee works less than full-time, but remains employed, as opposed to the more traditional method of laying-off some workers while keeping the remaining workers fully employed. For example, under a work sharing plan, an organization with a goal of reducing payroll costs by 25 percent would decrease the workload and corresponding hours by 25 percent for the work unit and each member would work 75 percent of normal hours. This method would keep all employees employed but reduce all employees' work hours by 25 percent. The employer could then arrange with the state unemployment insurance agency to replace a part of the employees' lost wages with unemployment benefits.
In comparison, under the traditional method, the employer would lay off one-quarter of the work force and keep the remaining three-quarters fully employed. In this scenario, the employees laid off would collect 100 percent of their unemployment weekly benefit amount while they were unemployed. Under a work-sharing plan, the goal of reducing the organization’s payroll by 25 percent is met, while all employees remain with the organization and the employer avoids the employee relations fall-out typically associated with layoffs.18
In closing, according to the Society for Human Resource Management, alternatives most often utilized as a first step before resorting to a layoff are attrition (63 percent), hiring freeze (49 percent), nonrenewing contract workers (21 percent) and encouraging use of vacation time (20 percent).19 Many creative employment alternatives exist for employers to consider in the event of a business downturn.
If, however, the business climate, economic indicators, cost/savings assessment, and legal or collective bargaining requirements steer the organization toward a layoff, Part Two to this series provides guidance and practical advice on implementing the layoff.