By Itself, Downsizing Isn’t the Answer, It’s Just the First Step

“Downsizing” is today’s magic word. Is your company losing money? Lay off workers. Still losing money? Keep downsizing. It must work, because even healthy companies are doing it.

Well, before you send out the next batch of pink slips, consider this: Sometimes downsizing produces not a lean and mean company, but one so anorexic that it’s sicker than it was before.

This point should not be a surprise, because downsizing is just the start in a process that leads to recovery and renewed growth. But too many chief executives equate corporate downsizing with corporate turnaround. They don’t understand that downsizing is just step one of a three-step dance.

All too often, a company gets on the dance floor, does step one and then--instead of steps two and three--does step one again and again. As a result, the company never really recovers. It’s been downsized, all right, maybe a couple of times. But now instead of being a big money-losing company, it’s a smaller money-losing company.

Although some companies downsize to increase profits, most downsize because they are losing money big time. Deep cuts, made quickly and decisively, are needed. Downsizing an organization that may have taken decades to grow is not a joyful task, but it’s far better than holding a funeral because cuts were not made soon enough or deeply enough.

But too many managements fail to recognize that cuts, however quick or deep, are simply a time-buying process to permit the organization to rebuild. The trick is to cut costs enough to achieve a positive cash flow without jeopardizing the long-term prospects of the company.

Here many managers, maybe most, do a poor job.

For example, a favorite stratagem of troubled companies is to impose a salary freeze or, worse, across-the-board pay cuts. Either dictum automatically ties management’s hands in dealing with key employees.

In one instance, a star salesman’s scheduled raise was put on hold when the company announced a wage freeze. The salesman was outraged, and told everyone who would listen, “Either I get my raise or I’m outta here!” The company couldn’t back down, and the salesman wouldn’t. When he left, he took more than 20% of the company’s customers with him.

Another common mistake is to reduce the workweek for everyone. For example, four days’ pay for four days’ work. Everyone shares the pain equally. What could be more fair than that? Well, it’s not a question of fairness, it’s a question of effectiveness. Most hourly employees can’t get by on just 80% of their pay. They’ll leave for other jobs or, even if they are near minimum wage, the unemployment line.

If properly done, step one will stem the flow of red ink and the company will be ready for step two: stabilization of operations.

Key employees must be given an incentive to stay on board, typically with a multiyear employment contract with a cash bonus at the end. The rank-and-file must be reassured that the downsizing phase is over, so they can focus on working instead of worrying. This is why downsizing should be done as quickly as possible. Nothing’s worse for morale than continual layoffs over weeks and months.

Meanwhile, management must prepare a business plan and financial forecast. This means not only analyzing the company’s own business practices, products and procedures, but also examining those of the competition. One company analyzed two of its rivals--one successful and one troubled--and found one major difference between them: Both rewarded store managers with bonuses tied to profits. But the company in trouble paid on average about $1,600 per year to each manager. The successful competition paid a lower salary but a bonus that averaged about $8,000 yearly. Overall, the successful competitor paid about $6,000 more in total compensation per store manager, yet its per-store profits were $40,000 higher. The troubled company adopted a similar compensation plan and soon achieved similar per-store profits.

An ever-present danger when preparing a financial forecast is wishful thinking. The temptation is to forecast not what is likely but what is necessary to maintain the status quo. But hard-headed management must forecast revenues that are truly achievable and then budget for the activities needed to grow and compete--advertising, management information systems, product development, new stores or branches and so forth. Then--and only then--should management budget for operating expenses.

“But,” you say, “there won’t be enough money left for operating expenses.” True. There never is. But stick to your plan anyway. Spend the money necessary to grow and you will find ways to cut operating expenses. People do this in their private lives every day. If you’re saving to put the kids through college, you set aside the necessary amount every month. Somehow you find a way to pay for groceries, the mortgage, transportation, insurance and all your other operating expenses. But if you budgeted for these expenses first, you would never have enough money left over for tuition.

The last step in the turnaround dance is the upkick. With timely and accurate financial information, management will be able to measure progress against the plan. At first, it is vital to have this data on a weekly or even daily basis. This means cash accounting, where we keep track of the actual cash received and paid out every day, just like running a personal budget at home. It’s not as precise in the long run as accrual accounting, in which a sale to a customer is recorded as revenue even though the actual cash has not been collected--and thus cannot be spent. But numbers that are 90% accurate and 24 hours old are infinitely better than those 99% accurate and 5 weeks old.

Don’t say it can’t be done. Long before computers existed, hotel managers each morning received an abbreviated profit-and-loss statement from every department for the previous day. How did they do it? With ingenuity, innovation, hard work and long hours. In other words, with the same tools that managers today need to achieve a true turnaround, not just a downsizing.