How to Really Cut People Costs

ABSTRACT

Labor costs drive a lot of other costs in organizations.  If an organization is serious about reducing costs then, sooner or later, it needs to look at its labor costs.  There are many examples of this being done without a lasting impact on costs and only a few where the impact was positive.  To be significant and effective, labor cost reductions need to be done as part of an organizational redesign.  For benefits to be realized and sustained, the process used needs to be well thought out so it doesn’t disintegrate into a random downsizing or flounder the first time it meets resistance from the organization.  This paper describes one approach that works.

BACKGROUND

The company is having a bad quarter.  Sales have dipped and management is looking for ways to reduce costs in order to make the quarterly earnings target.  The first announcement relates to a hiring freeze and reduction in non-essential business travel.  A month or two later, when it appears that the sales dip is going to last a little longer than expected, a second announcement appears.  There will be selective reductions in force.  This will be accomplished through a reduction in temporary labor and voluntary early retirements.  Another few months go by and market demand still hasn’t picked up.  There is a third announcement.  This one is concerned with a restructuring and a general reduction in force.  Over time, the market stabilizes but costs increase faster than sales.  The leadership team isn’t sure why this is happening but launches initiatives to find the root cause.  They never reach a firm conclusion but grow to accept the existing cost structure.

Back office functions are often the first to be cut but have the lowest impact on the cost base.

I assume that this sounds all too familiar.  It is a combination of short termism and management by wishful thinking.  The core issue is that work was never eliminated when costs were initially cut.  That business travel that was eliminated?  Demand for internal meetings and workshops built up during that period and, as soon as the policy was slackened, people made up for lost time.  The hiring freeze?  That lasted until the work could no longer be handled by remaining employees.  The early retirements?  They cost the company in retirement packages and none of the work that the individuals were performing went away.  Someone had to backfill for the people who left.  The temporary workers who were asked to leave?  They returned.  The restructuring?  It left the organization confused as to the decision making processes and nervous about future cuts.  The best and brightest updated their resumes and left.

BOTTOM UP OR TOP DOWN?

For costs to be reduced, work needs to be eliminated. For work to be eliminated, it must first be identified.  It might seem intuitively obvious then that costs must be reduced on a bottom up basis.  The process is assessed, perhaps using a lean methodology, and low value tasks eliminated.  This does work for small scale cost reduction efforts.  The problem comes when you try to do it on a corporate scale.  There simply isn’t the bandwidth inside large organizations to undertake all of the analysis that is needed in order to identify low value activities.  If the business needs to make immediate, significant reduction to labor costs then it must do so on a top down basis.  The way to make it successful is to marry it with a vision and narrative that provides guidance for the activities to be eliminated and those to be continued.

Those people whose abilities allow them to find work elsewhere are generally the ones who are most valuable to the organization.

When the objective is simply to cut costs, there isn’t much direction or energy to work on the initiative.  However, when the initiative is positioned as preparing the company for a change in direction then employees can rally around it.  This has to be genuine; attaching a branding effort to cost cutting in order to make it palatable is not likely to be successful.  The change in direction has to be well thought out and well communicated.  It needs to provide enough of a framework for employees to see their place in it (or to recognize that they may be better off elsewhere).  Most importantly, it has to offer a better vision for the company than the current situation.

For the vision to be effective in reducing costs, it has to provide enough direction for employees to recognize not just what they need to focus on going forward, but also to provide guidance on what they can stop doing.  Labor effort has to reduce for headcount numbers to be cut and, for a large corporation, that means cutting out entire processes, facilities, or departments.

During a cost cutting exercise, the most commonly asked question should be ‘what can we stop doing?’

Once the company decides to go down this path, the journey should be as quick as is humanly possible.  This minimizes the distraction to the business and the anguish of employees who will go through a period of not knowing if they have a role in the new organization.  It also reduces the scope for middle managers to second guess the executive team and stall in implementing the changes.  To be effective, there can’t be any way for managers to ‘opt out’.  The process that is used and the changes that are made need to be transparent to the entire organization.

MINIMIZING THE PAIN

It is all too common for executives to announce reorganizations, provide targets to individual business units and functions, and then wait for things to happen.  Nothing happens.  The business unit and functional heads don’t fill open positions and count this as headcount reduction.  Costs stay the same.  This is why there has to be visibility to the reductions.  One practice that this author has seen work effectively is to perform the organizational design work in a cascading fashion with all of the relevant stakeholders present for each tier of the organization.  This starts with the executive level and, if the changes are to be taken seriously by middle managers and if the rank and file are to retain respect for the executives, reductions need to also take place at the top level.  Once the executive structure is designed, the roles are filled and the new executive team meets to design the next level down. This process continues, with each level being designed and then the positions filled.  For a large organization, the number of people who are involved by the time you go down three levels is significant.  If the executive team has 12 members, then their direct reports might number 60 and the next level down might number 300.  Once you reach this number of participants, the design sessions become logistically challenging but it is still worthwhile.  It is best to stop at this level and allow the third level of managers to design the rest of the organization.  In a typical organization, the top level consists of senior vice presidents, the second level is vice presidents and the third level is directors.  It is therefore the directors who design the bulk of the organization.

Managers should be able to design their own organizations within the constraints of the headcount target.

There are several important points to remember when going through this type of process:

  1. Cuts must be made at every level. Reducing the number of SVPs and VPs sends a very strong message to the rest of the organization that this process is going to be fair.  Also, reducing the number of executives has a far larger financial impact than reducing other members of the organization.
  2. The vision must be communicated early in the process. As VPs and directors are designing their organizations, they need to know what they are designing them for.
  3. The maximum size of each organization needs to be determined in advance of the detailed design – often based on cost reduction targets and resource reallocations determined at the executive level – and this needs to be set in stone. For example, if the Finance VP’s are told that they have 60 positions in the new organization then they need to design an organization with 60 positions, not 65.  This will mean difficult discussions between Corporate Reporting, Treasury, Tax, and other departments but they need to reach the right number.
  4. Headcount numbers need to be clean when the process starts. People split their time, are loaned to other departments, or don’t do what their job title suggests.  This has to be reconciled so the design teams know their starting position.
  5. Everyone who might be needed to provide input has to be present. It is much easier to design each level of the design in a large workshop setting over a couple of days, with all of the business units and functions present, than splitting it up and doing it over a few weeks.
  6. Additions cannot be made after the design is completed. Information that was missed in the design workshops may result in updates to the design but this should require changes elsewhere so that the overall target is not exceeded.
  7. The selection of candidates for positions in the new organization should be conducted quickly after the design sessions to minimize the amount of time for gaming the process and for information to disseminate through the organization.

The general philosophy behind these statements is that headcount reduction is extremely difficult and emotional and so strict rules need to be adhered to in order for it to work. Even hard-nosed business executives will look for alternatives to reducing headcount in their organization even when they know rationally that it needs to take place.  You therefore have to remove all loopholes and delaying practices.

RELAUNCHING THE BUSINESS

Work doesn’t stop while the organization is going through the design and selection process.  As each level of the organization is selected, those individuals may have a larger span of control than they did previously.  The general rule to be followed during this time is that everyone who has not been informed that they have a new role should continue to do what they have been doing.  There is clearly going to be a great deal of uncertainty within the organization and the knowledge that they are expected to continue to perform the same role in the meantime can provide some stability during this period.  Once the new roles are built into the design and updated job descriptions developed, the individual can take on other responsibilities.  This should be done in waves so that everyone at the same level in the same part of the organization switches to their new role on the same day.

Fairness and respect are critical components of a reduction in labor. Transparency helps to achieve these goals.

To ensure that benefits are genuinely realized from the re-organization, detailed tracking of employee numbers and costs needs to be conducted.  The process that has been described should avoid the scenario where you find yourself squeezing on a balloon, i.e. you reduce headcount in one part of the organization only to see it increase by the same amount elsewhere.  However, the numbers need to be tracked and communicated on a transparent basis both as a check on the benefits realized but also to reassure people in the organization that the pain was genuinely shared.

If you would like to discuss this topic in more detail, please contact us at inquiries@aptussc.com.