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Is There an Upside to Economic Downturns?

Matt Palmquist

Matt Palmquist is a freelance business journalist based in Oakland, Calif.

 

Bottom Line: Forward-looking companies used the recent recession as an opportunity to restructure their workforce through a combination of hiring, layoffs, and training.

When a recession hits, firms confront many challenges, including disruptions to their supply chain, dips in consumer demand, and a reduction in access to capital financing. But one of the most vexing problems is how to handle personnel decisions.

Swift declines in manufacturing output and sales result in a glut of people on the payroll, many with a lot less work to do. Firing excess employees is certainly one way to address this — and many companies take that path, though often reluctantly. Companies know that recessions will eventually pass, unlike, for instance, technological breakthroughs that can permanently alter the business landscape. The immediate cost savings from a lowered payroll could pale against the expense of recruiting and training when business picks up again, in addition to the effect of sales lost during the ramp-up.

But the other possibility is also problematic. Taking the best and the brightest off the production line and shifting them into professional improvement programs may sound attractive, but many companies cannot financially afford to stockpile particularly skilled workers.

With no perfect options, it turns out that companies’ strategic orientation — specifically, whether they were more apt to seek out innovative opportunities or exploit their existing capabilities and market advantages — largely determined whether they fired, hired, or retrained employees during a recession, according to one of the first studies to empirically examine how companies reshuffled their workforce during the 2007–08 global crash.

The authors found that innovative firms often used a combination of all three tactics, although it may seem counterintuitive to add and subtract members of the workforce simultaneously. In effect, more creative firms treated the recession as an opportunity. They laid off redundant employees or those with more general, rather than firm-specific, knowledge; hired new people from an expanding pool of cheaper available labor; and bought time by training the especially skilled workers already on their payroll. By contrast, companies that were strategically tied to reducing operating costs and squeezing profits out of their established businesses typically relied solely on layoffs to weather the economic storm.

To arrive at their findings, the authors analyzed data from an extensive survey about the effects of the economic downturn completed by more than 1,000 CEOs at medium-sized and large European firms. After dividing the companies into two groups — one following an innovation strategy, the other a cost strategy — the authors examined employee turnover rate, retention policies, and training programs.

To ensure that their conclusions accurately reflected company responses to the downturn that were based on their choice of the two strategies and not on business conditions that may have uniquely affected individual firms, the authors used accounting data from 2007. This way, they could assess the demand and credit problems each firm faced before the recession kicked in. The authors also controlled for a number of factors that could partially explain why firms chose to hire or fire — including company size, age, prerecession profits and debt, and percentage of employees with more than four years of higher education, who would presumably be more valuable to retain or retrain.

The decision by innovative firms to expand training programs for their best workers during the recession isn’t hard to explain: These companies rely on institutional and industry knowledge to propel new products and operational ideas, so enhancing aspects of their employees’ expertise makes perfect sense. But the fact that innovative firms jettisoned some employees while bringing others aboard proves that the companies also effectively exploited the spillover effects of an economic downturn, especially the increased supply of low-cost talent on the open market. In essence, the authors found, these companies financed their hiring and hoarding of highly skilled employees through the layoffs of those with more generic abilities.

“The reduced costs of training and other productivity-boosting activities can create advantages that will be difficult for other firms to imitate once demand picks up,” the authors write. “This may imply that such firms rise from a recession…smarter than they were before the recession.”

On the other hand, most companies in the survey tended to emerge from the recession with a lower number of employees on their payroll, and the authors found no indication that they used the larger pool of available labor as a chance to reshuffle or retrain their workforce. These companies instead tried to lower their operating costs through a mixture of implementing layoffs and streamlining their supply chain.

Telling certain employees they’re fired while hiring others presents a challenge for managers.

Obviously, announcing layoffs is never easy on workplace morale. And as the authors point out, telling certain employees they’re fired and simultaneously hiring others presents an even more delicate communication challenge for managers, who can’t simply use the recession as a justification for their actions. The authors suggest that managers can mitigate the negative impact somewhat if they spread the combinations of hiring and firing throughout different departments and business units, so that employees don’t necessarily view the moves as paradoxical, but rather as part of a more holistic approach to personnel changes.

Source:Hire, Fire, or Train: Innovation and Human Capital Responses to Recessions,” by Eirik Sjåholm Knudsen and Lasse B. Lien (NHH Norwegian School of Economics), Strategic Entrepreneurship Journal, Dec. 2015, vol. 9, no. 4

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Is There an Upside to Economic Downturns?