Time was, layoffs were seen as an emergency strategy, the last resort in a downturn or

crisis. Today, however, layoffs are a standard tool for doing business. As the economy
continues to heal and job indicators improve, a number of firms have announced a fresh
wave of layoffs Nordstrom, Sprint and American Express among them citing the
need to improve profitability. Studies have shown that layoffs do not generally result in
improved profits. And yet, firms continue to keep the pink slips at the ready. Why?

Its about the triumph of short-termism, says Wharton management professor Adam
Cobb. For most firms, labor represents a fairly significant cost. So, if you think profit is
not where you want it to be, you say, I can pull this lever and the costs will go down.
There was a time when social norms around laying off workers when the firm is
performing relatively well would have made it harder. Now its fairly normal activity.

The layoff mentality has become culturally ingrained by way of both positive and
negative developments the Great Recession, as well as the new economy. In Silicon
Valley, the big thing is to be disruptive. Its the ultimate: Who are we going to disrupt,
and how? says Wharton management professor Matthew Bidwell. What does that
mean? Laying people off. A lot of these layoffs reflect that. As new forces come in, some
jobs go away.

Layoffs have been pretty constant over the years, and it seems to happen no matter
what the economy is doing, says Wayne F. Cascio, a global leadership professor at the
University of Colorado Denver who has studied layoffs for decades. When the economy
is down, its always the argument that weve got to cut costs, and when its doing well we
often hear we need to improve profitability, because its the best time to do it. The tune
hasnt changed.

Firms that are laying off are almost by definition

in trouble.Peter Cappelli
But some are suggesting it is time for a change. If several decades worth of research
now shows layoffs to be a poor way to boost profits, while other strategies may in fact
work, perhaps there are ways of changing the dynamic between whats happening on
Wall Street and decisions that get made in the board room and on the shop floor. Says
Cobb: The challenge is: how do we get back to a more socially responsible way of
handling employment given the influence of financial markets on corporate decision-
making?

Layoff Myths and Mirages

Contrary to popular belief, theres not much evidence that layoffs are a cure for weak
profits, or, to use the current euphemism, that they reposition a firm for growth going
forward. Its very difficult to sort out the relationship because firms that are laying off
are almost by definition in trouble, says Peter Cappelli, Wharton management
professor and director of the schools Center for Human Resources. The research
evidence has not found any support for the overall idea that layoffs help firm
performance. There is more support for the idea that where there is overcapacity, such
as a market downturn, layoffs help firms. There is no evidence that cutting to improve
profitability helps beyond the immediate, short-term accounting bump.

The effectiveness of layoffs as a tool for profitability varies from industry to industry,
case to case. Sometimes, layoffs are necessary, says Bidwell. Underlying this is the idea
that business is constantly changing, and so a set of activities that were really important
to the business 10 years ago you may find you no longer want to be doing, he says.
Either youve become so uncompetitive in the market, like BlackBerry, or there are
markets that grow and disappear. I saw some terrifying graph the other day about how
advertising revenues have skyrocketed, while TV advertising is flat and at newspapers
they have fallen through the floor. Obviously, if you are a newspaper publisher you
cannot go on as you were.

But as a cure for corporate ills, layoffs are a chimera that can come back to bite a
company. There is some evidence that when shareholders are more powerful,
companies are more likely to engage in layoffs, and yet announcements are usually met
with declines in share price, so its not clear that its a great sign, says Bidwell.
Shareholders love it, but it may punish them even more.

KNOWLEDGE@WHARTON HIGH SCHOOL

Companies continue to use layoffs because its a way to be seen as responsive, he says.
Such was the case a year ago when American Express was making money, but not
enough to quell investor concerns. The company had a revenue growth target of 8%,
which it chose to help meet by cutting costs. After announcing that it would shed 4,000
jobs, American Expresss stock price took an immediate slide, and remains down by
about 25% since that announcement.

Employers also often underestimate the cost of layoffs in immediate financial terms, as
well as in the lingering burden it places on remaining resources both financially and
emotionally. There is definitely a huge problem in HR generally that the stuff that is
easy to put on a spreadsheet outweighs the stuff that isnt, says Bidwell.

The toll of layoffs is high. In many industries, layoffs beget lower productivity and
profits. When sales are slow, for instance, many retailers cut staff. But several studies
show a correlation between bigger staffing and substantially higher sales.

What about profitability? One study that examined a large specialty retailer found that
conformance quality (how well an employee executes prescribed tasks) has a higher
impact on profitability than service quality (defined as the extent to which the customer
has a positive experience). According to a Harvard Business School working paper, The
Effect of Labor on Profitability: The Role of Quality by Zeynep Ton, stores that cut staff
were unwittingly cutting profits, and yet the practice was standard. Why? An emphasis
on minimizing payroll expenses and an emphasis on meeting short-term (often
monthly) performance targets, the study found. Another consequence of understaffing
at this retailer was lowered morale, a finding echoed in other studies.

Underlying this is the idea that business is

constantly changing.Matthew Bidwell
Layoffs are going to reduce costs immediately, says Cobb. But what does that mean two
or three years from now when the firm is growing and now has to ramp back up by
hiring a bunch of people? Now the firm must incur all these costs to hire and train
workers. In addition to the laid-off employees, he adds, other workers may now leave
voluntarily, all of which is disruptive for the firm and lowers productivity. Layoffs may
look good on paper because they have an immediate effect on costs. Yet in reality there
are a lot of costs that layoffs impose on firms that might not show up on an income
statement quite as clearly.

Cascio is in the home stretch of a project that analyzes the S&P over three decades,
looking at firms that downsized to track financial performance in the years following. He
expects to have results in a few months.

Tenure rates the length of an employees stay at one company have remained
relatively steady in the past two decades. But one recent study indicates that the
American worker is becoming increasingly unmoored to the full time employer. The
percentage of workers engaged in alternative work arrangements temps, on-call
workers, contract workers and freelancers rose from 10.1% in February 2005 to 15.8%
in late 2015, according to The Rise and Nature of Alternative Work Arrangements in
the United States, 1995-2015 by Harvards Lawrence F. Katz and Princetons Alan B.
Krueger. The study, released in March, shows that workers hired out through contract
companies showed the sharpest rise, increasing from 0.6% in 2005 to 3.1% in 2015. A
striking implication of these estimates is that all of the net employment growth in the
U.S. economy from 2005 to 2015 appears to have occurred in alternative work
arrangements, the study concludes.

Investing in Innovation and People

What is clear, Cascio notes, is that plenty of firms have handled internal and external
stresses without resorting to layoffs, and come out the other side with positive results.
He points to Southwest Airlines, which, like the rest of its industry peers, suffered
during the Great Recession. People were not flying as much, so they took their job
recruiters who are typically great with people interaction skills and instead of
laying them off, redeployed them into frontline customer service jobs, which made flying
on Southwest a better experience for its customers. And as the economy recovered they
transitioned back to their original jobs.

Another approach was taken by Steve Jobs, Cascio says, who took advantage of
downturns to focus on innovation. When the dot.com bubble burst, he said, We are
going to invest our way through the downturn. Look back at when the introduction of
the iPod was and the iPad. It turns out shortly after the 2001 recession ended was when
the iTunes Store opened. Then after the Great Recession, they bring out the iPad in
2009 and 2010. So while the economy was bad and people were being laid off, Apple
was actually investing in R&D. People really need to hear examples like this.

Other countries Germany in particular have regulations that help to temper the
knee-jerk impulse to lay off staff. Cascio doesnt see that happening in the U.S., but
other strategies might work such as a program in some states where companies, in
lieu of laying off staff, can have the state labor department kick in partial unemployment
benefits. American business responds to positive incentives rather than penalties for
doing something, and thats a positive incentive and it keeps people on the job.

For Wharton management professor John Kimberly, the key question is how leadership
thinks, in the short run and long run, about the way it wants to manage its human
capital. I am always amazed when times get a little tough how quickly the layoffs
happen, and when they are not so tough that they start pulling the trigger thats even
more mystifying, he says.

Kimberly says that if a company can manage through a rough patch with creative
strategies without laying off, employees will emerge with a greater sense of loyalty, and
that loyalty will pay off for the company. I believe at the heart of the issue, that is going
to motivate outstanding performance, in any company, no matter what business they
are in, Kimberly notes. I think the data are clear that outstanding performance comes
when people are motivated to do their best, and that they are motivated to do their best
when there is some reciprocity between senior management and employees and what
they do on a daily basis.

Layoffs may look good on paper because they

have an immediate effect on costs. Yet in reality
there are a lot of costs that layoffs impose on
firms.Adam Cobb
Cobb says options before getting to layoffs include offering early retirement, slowing
down hiring and retraining workers. And there is some indication that firms, worried
about loss of talent, are using these options more than they once did, according to the
Society for Human Resource Management. But real change would take a shift:
understanding that getting long-term gains sometimes means taking short-term lumps.
University of Michigan professor Gerald F. Davis argues that for a long period, large
corporations were a dominant force in America through employment practices,
expansion choices and community connections and that now, the U.S. has a finance-
centered economy. Corporations are no longer the organizing agent of society, Davis
argues in The Rise and Fall of Finance and the End of the Society of Organizations,
published in the Academy of Management Perspectives in 2009, and in his forthcoming
book, The Vanishing American Corporation.
As Professor Davis argues, the shareholder value model has been the undoing of
corporations in a way, says Cobb. There has been a stark decline in the number of
publicly traded companies in the U.S. over the past few decades. As firms have more and
more ability to use outside contractors in place of full-time employment and production,
many firms do not need to IPO to raise the amounts of capital as did firms for a century
prior.

Today, Cobb adds, many firms that do an IPO do so not to raise capital, but to provide a
return to early shareholders and employees. So firms like Google and Facebook are
publicly traded, but their ownership is highly concentrated among founders, and the
companies use dual-class shares to ensure that the control of the firm remains with the
founders. Other firms, like Dell, have gone private, which allows them to make longer-
term decisions without the fear of missing quarterly earnings targets. And the firm has
seemed to perform much better Cobb notes. Thus, in its quest to ensure that firms are
flexible and efficient, Wall Street has seemingly helped to foster an ecosystem of firms
that are considerably less reliant on Wall Street to raise capital.

One might imagine, Cobb suggests, a world where Wall Street has less influence on
corporate decision-making. In that world, short-term pressures to boost profits and
meet earnings targets are balanced by longer-term interests, and lay-offs might, once
again, be a practice employed as a last resort, he says.
However it plays out, theres a fundamental tension underlying the interplay of forces to
which Bidwell admits feeling conflicted. The individual wants stability and security, but
as a society we worry about becoming too sclerotic, he notes. One persons dynamic
economy is another persons risk and insecurity. And the question is where we strike the
balance between them.