Downsizing is a method of corporate restructuring, and it is applied mainly in two cases. The first is a general negative economic climate; the second is a specific one, that is, the negative financial performance of an organisation operating in a positive economic environment.
In today’s economic climate, which has been going on for a long time, downsizing is seen more and more often in businesses.
By cutting expenses, they try to bring the financial ratios back up, and above all the profitability ratios.
Although the method is old and widely used, and although its effect on the companies’ other ratios is proven to be negative, it continues to be applied!
Even so, I am not saying it is wrong. In any case, the subject falls within the strategy an organisation follows, the original one or a revised one...
So, where it is an element of the overall strategy, a tactic in other words, I cannot claim it is wrong. Quite the opposite. It will be wrong, though, if it is not a tactic or, worse still, if there is no complete strategy at all.
In those cases, the results of downsizing are catastrophic. And I am not scaremongering at all. The consequences of downsizing are truly catastrophic. Companies do not recover easily. Especially in terms of sales and of the relationships the organisation has built.
Why? someone may ask. Let us look at it a little more closely. Downsizing is linked, first and foremost, with cutting staff. Right? A cut in staff which, however, does not mean fewer obligations for those who stay. Quite the opposite. The work that results from the downsizing will be assigned to the remaining members of the organisation.
This, in turn, will bring a series of changes. The most important is the change in productivity ratios. Which means a change in both effectiveness and efficiency!
The problems will first show in the internal balances and then in the company’s external environment. In short, these changes will affect all of the company’s stakeholders. And of course they will affect them negatively. Personally, I have not seen the opposite, at least not so far.
In most cases, downsizing is simply carried out. It is not followed by any recovery plan covering all of the company’s functions. A slight change is seen in the profitability ratios, and the conclusion is that the result of the downsizing is positive. But this hides a big problem.
What is the problem? Let us assume a television has 5 million pixels. These 5 million pixels work together, each complementing the others, and the result is a single image, the image we watch. 5 million pixels working together, and an image is produced. But what happens if we focus on 1 million pixels? Can we see the whole picture? Or claim that we see the whole picture? Obviously not! Because we have cut out 80%! And so... This is exactly what happens in businesses. The profitability ratios that downsizing focuses on improving are part of the picture. Not the whole of it! And of course, in this context, the business cannot be called sustainable!
Let us make this a little more concrete. Take, for example, an organisation that decides to downsize in the following areas. It cuts staff, reduces its offers to customers, changes its distribution policy, and so on. The company’s main goal is to improve its profitability ratios.
Let us also assume that these actions, which are essentially interventions in, or changes to, the organisation’s business model, achieve an improvement in profitability of five (5%) percentage points. So far so good!
But let us also look at the other ratios, sales for example. In the same scenario, we assume that sales fell by around 30%. And that productivity (because of the increased responsibilities per employee, as mentioned above) fell by a similar amount.
Now we have the whole picture. The restructuring achieved a 5% improvement in profitability ratios (at gross profit level) and 30% losses in sales and productivity. The two figures that went backwards are extremely hard to recover. And of course any attempt to recover them will cost many times more than the benefit that was created!
But then again. I am not saying it is wrong. If downsizing is part of the company’s overall strategy, which in this case means part of a revised strategy, then the company is right to do it. If, however, it is part of only one piece of the strategy, without taking other parameters of the Business Model into account, then it is wise to reconsider it.
In my view, organisations that have to take decisions of this kind should first examine their Management Model, trying to identify possible changes in its four basic elements. By focusing there first, organisations can certainly gain significant benefits, essentially moving the elements of their Management Model from the traditional model to alternative ones. Depending on their size, they will usually end up adopting changes that lead to a Hybrid Management Model.
Changes to the Management Model usually make companies particularly competitive, bringing benefits without putting the organisation’s growth at risk.
If someone asks me which is the easy road, the answer is simple and takes one word: downsizing. In that case, though, we forget about growth! Growth gets you out of the rut. Not downsizing!
As you can see, the subject has many dimensions and cannot be exhausted in one post!
And of course, the right title for this article should not be Downsizing & Growth. It should be Downsizing vs Growth.
I will be glad to hear your views!
First published on the blog We Talk About Business on 11 March 2015.