Alternatives to the Ax

When hard times hit, many companies just hand out pink slips, while others find imaginative ways to cut costs but not employees

In a slowing economy, Charles Schwab Corp. (SCH ) has taken the road less traveled when it comes to cutting costs. To avoid layoffs, the No. 1 U.S. Internet broker has reduced the salaries of its 750 top executives by up to 50% as profits from trading commissions have shrunk along with the value of the stock market. The San Francisco-based discount broker also has a hiring freeze in place and even toyed with the idea of instituting three mandatory Fridays off for thousands of employees before discovering that the plan raised some legal concerns. Taking the three designated days off is now voluntary. But so far, no one has gotten the boot because of belt-tightening, spokesman Glen Mathison says.

"What [founder Charles] Schwab seems to be saying is that the top of the organization is going to lead by example," says Robert Duncan, a management professor at the Kellogg Graduate School of Management at Northwestern University. In fact, Schwab himself and his co-CEO, Dave Pottruck, have taken a 50% cut in pay for a quarter. "That is absolutely the right way to go," Duncan adds. "Senior managers are often the ones who screw up or make bad decisions. But when there are layoffs, they tend to involve other people."


  For the first time in nearly a decade, hundreds of employers are being forced by an economic downturn to reduce expenses, and in doing so, they're facing an age-old question: What's the best way to rein in employment costs? In many instances, the solution is a time-honored reaction: Chop heads and let the blood flow freely, more so down in the rank and file than up in the executive suite. On occasion, of course, a company's fortunes fall so quickly that such a step is unavoidable. And sometimes, when listless management has allowed an organization to become too flabby, there's fat to trim.

Oftentimes, however, it's simply more expedient to issue pink slips than to find an alternative -- like Schwab's -- that may require some imagination and be wiser over the long term. "Companies turn to head-count reduction because it is an easy way to calculate expected savings," says Thomas Kochan, a management professor at the Massachusetts Institute of Technology's Sloan School of Management. "They don't look often enough at doing things like concentrating on the most productive areas and moving people around to fill those jobs. You often lose very good people because when you lay them off, they're not going to sit there waiting to be recalled."

One casualty of a knee-jerk, let-the-heads-roll approach may be the notion that business units run better as teams where ideas and responsibilities are shared than as top-down outfits where bosses give orders. Having the bigwigs forsake corner offices to work in cubicles with the troops may help flatten the corporate hierarchy. But if managers respond to a downturn by sending those in the cubes around them packing, the idea of "team spirit" will no doubt suffer.


  Employee cynicism, certainly, could spike even higher: Already, surveys of employees show that nearly two-thirds don't trust their employers to keep their promises, management experts say. "Companies are always saying that human capital is their most important asset. But what they do at the first sign of trouble is let people go," says Jeffrey Pfeffer, a professor of organizational behavior at Stanford University's Graduate School of Business. "What I think it means is that talk is cheap."

Executives are nearly twice as likely to let employees go as they are to ax senior managers in a slowdown, according to a recent survey by Bain & Co., a global business-consulting firm. In the survey of 100 U.S. senior executives from various industries, nearly 40% said they would turn to layoffs in an economic slump. But Darrell Rigby, a Bain director, says too few corporations actually achieve their goals through such cutbacks.

"Although layoffs are sometimes necessary, they are never sufficient by themselves," Rigby says. "[Layoffs] are often symptomatic of an ailing strategy. One of the problems is that companies lay off employees without eliminating the activities of the people who were affected. So overhiring is followed by overfiring is followed by overhiring."


  If cooler heads prevailed, Rigby says, more companies could survive downturns without pushing out employees. Historically, he notes, the average recession has lasted only 11 months. Bain found employee turnover averaged 15% to 20% per year at 100 companies surveyed in various industries. The statistic suggests there are less-painful ways of whittling down workforces, he says. "If you have the strategic acuity and agility to just see a few months forward into what is going to happen, there is a good chance you can manage this," he adds.

Some argue that Merrill Lynch & Co. (MER ) lacked this foresight in the fall of 1998 when it faced problems in its fixed-income business in part because of Russia's financial meltdown. The No. 1 U.S. brokerage got rid of some 3,400 employees, or about 5% of its total workforce at the time, a far deeper cut than other firms made. When the market bounced back the following spring, Merrill initially had trouble finding bodies to power the division back up again, a senior Wall Street recruiter says. "Merrill found itself shorthanded when the market rebounded, and had to go out and try to hire people away from other firms," says the recruiter. "That costs a lot of money."

Merrill Spokeswoman Selena Morris says the firm doesn't comment specifically on personnel matters. But she adds: "We did what we thought was right at the time, and our results speak for themselves." Morris cites Merrill's profit report on Jan. 23 showing record earnings of $3.8 billion for 2000, an increase of 41% from the previous record of $2.7 billion in 1999.


  Still, mindful that the economy could pick up again soon, Schwab has decided not to go Merrill's route. Among its 750 executives who are taking cuts, senior vice-presidents are facing a 20% reduction in pay for two months, executive vice-presidents are taking a 10% hit, and vice-presidents 5%. Mathison declined to specify how much the initiative will save Schwab, which announced a 27% drop in its fourth-quarter net income Jan. 18. He also wouldn't comment on any plans Schwab may have to pare costs further, adding: "It's only prudent to have a variety of additional measures that we can take."

Why don't more companies cut salaries, top to bottom, or come up with other options to avoid firing employees? For starters, people at the top aren't generally in the habit of punishing themselves. Then there's the undeniable fact that eliminating a dozen lower-level jobs will save more in salary and nonwage benefits than cutting the pay of a couple of VPs. There's also a belief that asking employees to shoulder part of the burden via pay cuts may cause critical damage to company morale.

By contrast, "if I just lay you off and you're gone, you don't feel too good, but at least you're out of there," says Daniel Mitchell, professor of management and public policy at the University of California at Los Angeles. "Pay is kind of sacrosanct. Usually, most of the reasons that come up [for not cutting pay] are viewed as morale issues."


  Nevertheless, Mitchell argues that managers should consider the benefits, in tight times, of making pay rather than head count the variable. They must at least appraise how long a downturn is expected to last, he says, and whether the cost of keeping employees on board will outweigh the costs of hiring and training new ones when it's over. "You don't want to lose people who are going to cost you a lot to replace," Mitchell says. "You carry them over."

Indeed, a company that has a reputation for laying people off en masse when things get a little shaky can be a big turnoff for those hard-to-lure MBAs, say business-school professors. "When you are in a war for talent, how you handle [bad times] can become increasingly important," says Duncan.

Bain's Rigby says bloodletting can also sap the enthusiasm of the employees who remain. The hands left on deck after watching colleagues being tossed overboard tend to be less productive, less innovative, and more risk-averse. "They spend more time looking for new jobs," he says.


  What's more, a separate Bain study of companies in the Fortune 500 showed that layoffs don't seem to improve stock prices long term. The company analyzed stock-price movements of 288 companies from 1989 to 1992. In the first six month after a layoff was announced, a company's stock price on average increased a little under 1%. But the average impact was actually slightly negative over three years. "That isn't to say that layoffs have no impact on individual stock prices," Rigby says. "It says the effect is just as likely to be negative as it is likely to be positive.

Employers have other alternatives to giving employees the heave-ho, says MIT's Kochan. Among the possibilities, workers can be retrained for jobs in more profitable divisions. Employees on the company's payroll can perform work that previously had been contracted out. And as a rule, Kochan argues, companies should be careful to avoid overhiring in boom times, so they don't find themselves with surplus permanent employees when there's a need for austerity. "All these are efforts to do better human resources management," Kochan adds.

In that vein, Cleveland-based Lincoln Electric (LECO ), a maker of arc-welding and robotic-welding products that employs some 3,200 in Northwest Ohio, has drawn praise from management experts for its innovative ways of avoiding layoffs. When Lincoln's domestic sales dropped about 40% over 18 months during an early-1980s recession, the company shuttled workers around rather than cut them loose. In some cases, employees who worked on assembly lines making Lincoln products donned suits and went out on sales calls instead. "We believe in adjusting the workforce to put people where we need to if the economy goes a different way," says Roy Morrow, a spokesman. "It's a great investment to train people. You lose that when you have layoffs."


  Lincoln hasn't had mass layoffs in more than five decades, and it probably won't anytime soon: In 1959, it instituted a guaranteed-employment policy. After three years of service, employees get to keep their jobs until they retire as long as they agree to accept pay cuts or reassignments if necessary. One more requirement: They agree not to join a union.

Under the guaranteed-employment policy, employees may be asked to work overtime to meet surges in demand or to cut back on their hours if demand wanes. Pay can vary, too. An employee assigned to operate a machine for $15 an hour may be moved to a machine paying $10 an hour if business needs change. "What that avoids is massive layoffs followed by massive callbacks," Morrow says.

Policies such as Lincoln's can help strengthen an organization in hard times, management experts say. Employees are more loyal if they know the company is doing all it can to preserve their jobs. And they're more likely to help develop new ways to pinch pennies if they know their pay could depend on their ingenuity.


  "I think the modern corporation has to meet the expectations of multiple stakeholders," Kochan says. "Clearly, shareholders are an import constituency. [But] in many cases, the assets of a firm are the human assets. Corporations that depend on human capital are going to have to start giving employee interests a higher weighting in their decisions and behavior."

That may happen once companies starting asking themselves what the best way is to save money over the long term: by keeping employees who have learned to do their jobs well -- or by letting them go.

By Eric Wahlgren in New York

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