Employee Layoffs May Cost More Money than They Save

Employee layoffs may appear to be a panacea for weak profits or a means of positioning a firm for future growth, but the long-term financial impact of such a strategy typically is less than positive.

Research has not found any support for the overall idea that layoffs help firm performance. That’s according to Peter Cappelli, Ph.D., George W. Taylor Professor of Management at The Wharton School of the University of Pennsylvania-Philadelphia, who spoke to Knowledge@Wharton, the school’s online business journal. Cappelli, who also serves as director of the school’s Center for Human Resources, said that although it appears to be true that layoffs “help firms” when there is over-capacity—e.g., during market downturns—the effectiveness of cutting manpower to improve profitability beyond the “immediate, short-term accounting bump” has never been proven.

One negative effect of layoffs is a decline in share price; even if powerful shareholders love the idea, the action may subsequently backfire and punish them further. According to Knowledge@Wharton, Matthew Bidwell, Ph.D., associate professor of management at The Wharton School, cited American Express as an example of what happens when companies attempt to use layoffs because “it’s a way to be seen as responsive,” only to face a “chimera” later on. About a year ago, American Express was “making money, but not enough to quell investor concerns,” Bidwell explained. The company had a revenue growth target of 8%, and decided to meet it through a cost-cutting initiative that included layoffs. “After announcing that it would shed 4,000 jobs, American Express’s stock price took an immediate slide, and remains down by about 25% since that announcement,” Knowledge@Wharton said.

“For every layoff of one employee in a company, five more employees will voluntarily leave within a year.”

Costs incurred to execute the layoff process can also be considerable. In addition to severance and benefits packages, companies must shell out for accrued vacation and outplacement-services fees. according to Inc. Just as significantly, human resources consultant Bill Bliss told the magazine, there is a price to be paid for employee exit procedures. That price, he said, is derived from the time managers must devote to breaking the news to employees, assembling paperwork, reallocating work to remaining employees, training layoff “survivors” to do the work they have inherited, and handling other related issues.

Bliss estimated that each laid-off employee costs firms 50% of the person’s compensation and benefits for each week that the position is vacant, even if there are people performing the duties, and 100% of the person’s compensation and benefits if the position is left completely open. Other indirect costs encompass lost knowledge, lost productivity due to low morale among remaining employees, lost contacts, and lost clients or customers, all of which are difficult to quantify, but are real factors in determining the short-term costs of laying people off, Inc. said.

Unemployment insurance, too, runs up the layoffs tab. When companies’ unemployment insurance account is reduced as a result of layoffs, its tax rate increases to build the account back up. While this increase usually does not hit during the layoff year, it generally takes place over the next few years, until the unemployment insurance account is at pre-layoff levels, Bliss told Inc.

Finally, layoffs can leave companies understaffed—and with a need to quickly start hiring that can easily eliminate any anticipated savings from the initial decision to let employees go, according to the Huffington Post. Research conducted at the University of Wisconsin School of Business, Madison, Wis. and cited by the online publication suggests that for every layoff of one employee in a company, five more employees will voluntarily leave within a year.


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