By Michelle L. Zorn, Patricia Norman, Frank C. Butler & Manjot Bhussar
During the Great Recession of 2008, companies around the world downsized. American firms alone laid off more than 8 million workers from 2008 to 2010. Even in healthier financial times, such as now, firms often downsize to reduce costs, adjust structures and create leaner, more efficient workplaces. But our new research indicates that downsizing may actually increase the likelihood of bankruptcy.
Downsizing firms lose knowledge when employees leave. The remaining employees struggle to manage their workloads, cutting short the time they have to learn new skills. Employees also lose trust in management, leading to less engagement and loyalty. And these effects may have long-term consequences, like reduced innovation, that aren’t captured in short-term financial metrics.
We found that downsizing firms were twice as likely to declare bankruptcy as firms that didn’t downsize. While downsizing may produce positive outcomes in the short term, such as saving money, it can put firms on a negative path.
We sought to understand why some firms survive the negative effects of downsizing while others don’t. For post-downsizing firms, having plentiful financial and physical resources didn’t replace the downsized employees, who fulfilled multiple roles as workers, knowledge bearers and cultural contributors.
Intangible resources helped reduce the likelihood of bankruptcy. Employee knowledge can revamp processes that have been interrupted or replace them with more effective ones. Firms may also be able to use their resources to attract partners that can fill the gaps left by downsizing.
Before deciding to downsize, leaders should consider whether positive short-term returns will outweigh the potentially severe long-term consequences, and examine their resource portfolio to determine whether their firms are protected from downsizing’s negatives.
Michelle L. Zorn is an assistant professor in the Harbert College of Business at Auburn University. Patricia Norman is an associate professor of management at Baylor University. Frank C. Butler is an associate professor of management at the University of Tennessee, Chattanooga. Manjot Bhussar is a doctoral candidate at Auburn University.