Many companies turn to downsizing as a way to cut costs and improve efficiency. However, a new study suggests this strategy comes with significant risks - including a higher likelihood of bankruptcy.
Key findings:
- Downsizing firms are twice as likely to declare bankruptcy compared to non-downsizing firms.
- The negative effects of downsizing can persist for up to 5 years after the event.
- Intangible resources (like brand value and intellectual property) can help mitigate the risk of bankruptcy for downsizing firms.
- Surprisingly, having more financial or physical resources does not significantly reduce bankruptcy risk for downsizing firms.
Why downsizing increases bankruptcy risk:
- Disrupts organizational routines and processes
- Reduces productivity and increases stress among remaining employees
- Impedes knowledge transfer and organizational learning
- Can damage the company's reputation and relationships
Implications for managers:
- Carefully weigh the risks vs. potential benefits before downsizing. The long-term consequences may outweigh short-term cost savings.
- If downsizing is necessary, focus on leveraging and building intangible resources to help the company recover and avoid bankruptcy.
- Don't assume that having substantial financial reserves or physical assets will protect the company from negative outcomes.
- Consider alternatives to layoffs that may be less disruptive, such as reduced hours or voluntary retirement programs.
- If downsizing occurs, invest in supporting remaining employees and rebuilding organizational capabilities.
The bottom line: While downsizing may seem like a quick fix for financial troubles, it can set companies on a dangerous path. Managers should approach workforce reductions with extreme caution and have a solid plan to mitigate the associated risks.
Reference: Zorn, M.L., Norman, P.M., Butler, F.C. and Bhussar, M.S., 2017. Cure or curse: Does downsizing increase the likelihood of bankruptcy?. Journal of Business Research, 76, pp.24-33. Download Paper