Downsizing is a common practice praised for a number of benefits: leaner structures, higher efficiency and cost reduction. But downsizing might not be the cure-all it was once thought to be. In fact, it might be a curse.
A recent study, published in the Journal of Business Research, showed that downsizing increases a company’s likelihood of filing for bankruptcy.
The data analyzed for the study was collected in 2010 from 4,710 publicly traded US firms across 83 industries: high technology, manufacturing and service.
Companies that downsized were two times more likely to file for bankruptcy within a five-year period, according to the researchers from Auburn University, Baylor University and the University of Tennessee, Chattanooga in the US.
Downsizing, the researchers say, might lead to a short-term increase in performance and sales, but is more likely to lead to more problems, all of which make bankruptcy more likely:
- Companies lose valuable knowledge when employees leave
- Remaining employees struggle under heavier workloads
- There is little time for employees to learn new skills
- Remaining employees lose trust in management, becoming less engaged and loyal
Reduced innovation, for example, is a long-term consequence that is “not captured in short-term financial metrics,” the researchers write.
Capital won’t save you
Initially, one might think that companies that downsize but did not file for bankruptcy, had enough financial and physical resources to withstand the loss of employees. But the researchers found the unexpected: “Financial resources did not contribute to the prevention of bankruptcy for downsizing firms,” they write in a Harvard Business Review article.
Capital is not a “corporate panacea,” and cannot replace “workers, knowledge bearers and cultural contributors” within a company.
In order to ensure the accuracy of their results, the researchers controlled for a number drivers known to lead to downsizing and bankruptcy: market capitalization, profitability, financial health indicators and prior performance. They also confirmed their findings across a different five-year time period: 1995-2000.
Consider before downsizing
The researchers suggest CEOs carefully evaluate whether the short-term benefits of downsizing outweigh severe long-term consequences, as well as reduce reliance on financial resources, while focusing more on “intangible resources.”
Intangible resources are a company’s best best for fighting performance and productivity decline among employees and decreased customer satisfaction. Examples of intangible resources are existing employee knowledge or efforts to find partners that “fill the gaps left by downsized employees.”
This will “soften the blow,” they write.