History shows that downsizing should never be treated just as a balance sheet exercise.  
 
Story Melissa Wilkinson  
 
Leaders in today's market conditions have a difficult hand to play. They face intense pressure to keep their company in the black in the short term and sustainable and profitable in the long term. They're faced with the tricky challenge of cutting costs and increasing revenue in an environment where consumer and business confidence have already slumped to record lows.  
 
Part of the problem for many managers is that they simply haven't had extensive experience in managing during a downturn. This increases the risk that they'll react with knee-jerk responses to growing pressure from shareholders and the market. Deep cuts in the wrong places, particularly when they're people-related, can spell serious trouble in the long term.  
 
In the professional services sector, it will be those firms who understand the true value of their human capital that will come out on top. They'll be the last to cut head count and the first to capture market share when the economy eventually turns the corner. In a business where your people are your biggest asset, there will be no excuse for leaders to get this part of their overall strategy wrong.  
 
The impact of an ill-thought-out and haphazard approach to downsizing is far-reaching and importantly, long-lasting. There are no parts of an organisation left unscathed - all elements like strategy, leadership, culture, critical skills, systems and processes are affected.  
 
Dr Ian Williamson, associate professor of human resource management at Melbourne Business School, says that 2009-10 will be a story about how well an organisation can accurately value and manage its human capital.  
 
“It will really depend on what perspective leaders take. Are they expense-orientated? Do they cut head count immediately in difficult times or are they asset-orientated and use their people to help drive more value? If you believe that your employees are going to be a key factor in helping you through this difficult period, then you'll try to hold onto them at all costs.”  
 
Williamson says that the old adage of 'fire in the downtimes and hire in the uptimes' is not the way to drive long-term performance.  
 
“Skilled practitioners like accountants are not assets which are developed in the short term. The timeline to develop high performing people in a professional services firm is always much longer, in most cases about 10 years. That's why effective resource allocation is a basic business strategy issue, which should currently be front and centre for every leader.  
 
“Downsizing is not just about making the numbers look better. Many firms make the mistake of overestimating the savings and underestimating the value of their people to the entire business. Letting the wrong people go, particularly the ones who have strong relationships with clients can have disastrous results.”  
 
He says that today's conditions highlight how important it is to have a well run, all-year-round performance management system.  
 
“Firms can be a bit lax in boom times about evaluating and measuring the performance of their people. In contrast, slow market conditions and constraints on resources force firms to look carefully at who is actually adding value to the firm's bottom line. A good performance management system with clear evaluation criteria makes it easier for managers to make decisions in a fair way. The key with downsizing is to evaluate the predicted costs savings and the actual costs of re-staffing when the market recovers. When are you likely to see an economic return and how much does it cost to re-hire top notch accountants?”  
Although Williamson is clearly not a fan of sacking staff, he says that there are situations where downsizing is appropriate. These typically involve board-level decisions like the dropping of a dud product line or the decision to stop servicing an unprofitable market segment.  
 
There has been some media noise suggesting that companies are using the softer market conditions as an excuse to get rid of dead wood and shed underperforming staff. Regardless of the motivation, managing people out still needs to be done with considerable thought and care.  
 
MASS REDUNDANCIES  
There is enough research through the last two major recessions to show that firms are often left worse off than before the supposed right-sizing. HR and recruitment firm Drake International surveyed more than 6300 employees and managers in 2009 who have experienced downsizing in their businesses. The white paper, Downsizing - The Right Way, revealed that 63 per cent of those surveyed reported that their business' downsizing process had been managed badly. Approximately 40 per cent of staff left behind after the downsizing became less motivated and 41 per cent lost respect for their employer.  
 
The white paper's author David Edwards, who is also Drake's strategic manager, says that the value proposition associated with retrenching staff is a financial equation that accountants must understand well.  
 
“The shorter the downturn period, the lower the costs savings achieved from the downsizing. Those companies which do not plan the downsizing process well, often face a large fall in critical capability. Key skills can be lost through voluntary redundancy or untargeted rationalisation. That's why the potential for re-hire creep is so high. The research found that within six months after the downsizing, approximately half of the companies surveyed had started re-hiring staff to fill those roles which had been previously made redundant.  
 
“Downsizing needs to be managed in three key phases: the planning phase, the implementation phase and the refocusing phase. Managers should remember that they also need to spend time planning for the period after they've downsized. Employees that are left behind need to be supported and the firm needs to be able to quickly start focusing on the future.”  
 
Rapid workforce reduction which is not handled with sensitivity and respect creates considerable hostility and bitterness among both retrenched and retained employees. Like any major organisational change that gets bungled, irreparable damage to a firm's culture and employer branding can quickly result.  
 
According to the Drake survey, 46 per cent of remaining staff from a downsizing were less likely to recommend their employer to a colleague looking for a job. The concept of survivor syndrome has been well documented, with the people inside the business after the downsizing left de-motivated, overworked and disengaged. Very few firms are actually able to make productivity savings, and some even become less efficient. The research shows that when the market turns, these disenfranchised employees are often the first to pack their bags if they've had a bad experience at their firm.  
 
Julie Mills, chief executive of the Recruitment and Consulting Services Association, says that it's not that difficult for employees to work out when things are not going well.  
 
“When managers walk around with furrowed brows, it's pretty clear that changes are afoot. If workforce cuts have to be made, then the key issue will be how they're made. If they're ad hoc and poorly planned, it can result in a real mess. People should never be retrenched on a Friday and told to finish work on the following Monday.  
 
“Leaders need to remember that the person you treat badly today is likely to end up as a potential client tomorrow. That's why companies should not be too reactionary and implement large redundancies en masse.  
 
You can easily make decisions that are ill-informed because the financial statements don't tell you everything. You simply can't put a value on good people management. The benefits of keeping your staff as long as possible far outweigh the short-term savings from retrenching them.”  
 
FINANCIAL IMPLICATIONS  
In addition to the human and social costs of downsizing, there are also significant financial costs of retrenching staff. The actual process of laying off employees is expensive and often cuts take at least six months to hit the bottom line. Redundancy payments are typically based on two to four weeks for each year of employee service. More money should be factored in if outplacement services are also provided.  
 
As a result, payouts can really add up if the average tenure for an employee is four to five years. Plus, the costs associated with hiring someone else when the market recovers can be up to 20 per cent of an employee's annual salary. Hidden costs like lost management time, poor workforce productivity and slipshod client service should also not be forgotten.  
 
ALTERNATIVES TO DOWNSIZING  
While it may be difficult to consider all the different options under pressure, there are realistic alternatives to downsizing. These can usually be implemented quickly and with the full co-operation of employees.  
 
It's not surprising that people can get very creative with solutions when their jobs are on the line. Companies that work hard at developing a new menu of rewards will be able to keep employees engaged and loyal for longer.  
 
Some of the alternatives to downsizing include senior management forgoing bonuses, encouraging employees to take sabbatical leave or asking employees to work flexible hours. Staff might also be allowed to use 2010 holiday leave in 2009. If pay cuts are required, then it's a good idea to start these from the top. The research suggests that chief executive pay in Australia dwarfs average worker earnings by about 100-to-1. So it's not hard to see why it's going to be critical from a morale point of view to look at senior management packages first.  
 
According to David Reynolds, executive general manager for Chandler Macleod Group Consulting, firms are simply going to have to be more innovative in the way they use and access their talent.  
 
“These changes to companies' people strategies can only be good for an organisation in the long term. Recessions make people think differently because when you're in the good times you're often not focused on driving for excellence.  
 
“Now is the time to be looking at your workforce differently and looking for ways to do things better.”  
 
It seems workforce optimisation will be the name of the game for the next 12-18 months. It will mean that managers must have a deep understanding of the human drivers of their business and what is required to succeed. With an understanding of how many staff are actually required to achieve a certain output, companies can improve the way decisions about head count are made.  
 
ALUMNI ARE CRITICAL  
One of the key benefits of treating exiting employees with care and sensitivity is that they represent a valuable strategic asset in the future. Used by consulting firms like McKinsey, active alumni programs are a powerful way to create a talent pool of people who know your firm, understand how it works and who can quickly step in on short-term projects when required. Plus, they're also able to make word-of-mouth recommendations when clients are shopping for suppliers.  
 
Williamson says that the goodwill generated from an alumni network should not be underrated.  
 
“The value in past and present employees is not only calculated in terms of cost, but also in terms of the knowledge and social value they represent. By staying in contact and forming positive ties, there is an opportunity to form new business relationships, share knowledge and ideas. There's a lot of uncertainty associated with hiring professional services firms, because you don't know until the firm has done the work whether they should have been hired.  
 
“That's why an alumni of ex-employees is an important source of potential leads. Word of mouth is critical in demystifying the consulting process. Alumni programs can also cut recruitment costs which can go into the millions when you have to use headhunters.”  
 
It's important to invest time in building an alumni program which delivers value to your ex-employees. Some ideas include creating a special portal on your website where ex-employees can download white papers, create their own communities and stay in touch with former colleagues. McKinsey's program, for example, has been going in Australia since 1962 and grows exponentially every year. The prestige associated with being an alumnus of McKinsey is demonstrated by the frequency with which former employees are quoted in the press as ex-McKinsey.  
 
 
IMPLICATIONS FOR LEADERSHIP  
There's no doubt that the next 18 months will put even the best leaders to the test.  
 
 
Leaders will need to make well-thought-out decisions about how to steer their business safely through the uncertainty associated with an economic recovery. They'll be forced to clearly articulate their vision at every opportunity so that all stakeholders understand where they're going and how they'll get there.  
 
David Brown, chief executive of HR consultancy firm Hewitt Associates, says that a fundamental change in leadership is on its way.  
 
“We used to see a lot of authority or position power being used in organisations. This is where leaders push through changes based on their status as the boss. We're now starting to see a real transition to personal power where leaders are relying on their ability to influence at the personal level. Messaging is much more about 'we're all in this together'.”  
 
This concept of personal power is based on the work of Dr Gary Yukl, one of the long-time management gurus on leadership, power and effectiveness. In Yukl's book Leadership in Organisations, he argues that effective leaders rely more on personal power than position power to get things done.  
 
In his book he says: “The potential to use position power for influence with peers or superiors is much more limited and personal power is clearly the predominant source of influence.”  
 
This need for greater personal power means that now is not the time for leaders to hide in their bunkers looking for ways to cut more costs. People engagement will be critical as staff look to their leaders for hope, clarity, direction and feedback on how things are going.  
 
Given the current environment, most employees are smart enough to realise that changes in the way their firm operates are likely to be on the cards. Leadership will be required to manage this change and its associated impact on employee anxiety levels. Any vacuums in communication can quickly fill with rumour and speculation if leaders are not proactive and clear in their communication.  
 
David Hand from operational improvement firm Newport Consulting, says that the way leaders react and respond to downsizing can have significant implications.  
 
“One of the biggest sins that can be committed is when senior managers who are responsible for the downsizing appear to be immune to the changes,” says Hand. “Employees will feel totally disenfranchised if senior management seem to be disconnected from the whole process. If you are going to downsize and cut costs, then executives need to modify some of their values and approach otherwise they can do a lot of damage. If you don't do this, then it's very difficult to get people to go the extra mile and essentially do more with less.”  
 
The bottom line is that firms will need to get their house in order, starting with their people strategy in order to survive and prosper over the next financial year. Firms will need to make sure that their performance management systems are working and regularly reviewed.  
 
Now is not the time to pay lip service to human resource issues as firms need all the goodwill, flexibility and nimbleness that they can muster in order to face any other economic shocks that emerge in the future.