When downsizing hurts profitability

When I reported on Eastman Kodak Co. for the Rochester (NY) Democrat and Chronicle in the 1990s, I talked to stock analysts who really did think that layoffs were a key to profitability, and applauded each of Kodak’s layoff announcements.  It is true, of course, that you can get a short-term kick to profitability by laying off some workers and making the rest work harder.  But you can’t, in the long run, have a profitable company that is understaffed, and whose workers are exhausted, resentful and scared.  This certainly wasn’t true in the case of Kodak. [1]

The New Yorker recently reported on Uniqlo, a Japanese retailer who recently opened a store on Fifth Avenue.  Uniqlo hired 650 people and pledged to keep employment at a minimum of 400.   The store chain is highly profitable just because it is fully staffed with a well-trained sales force.  This approach has wider application, the writer said.

A recent Harvard Business Review study by Zeynep Ton, an M.I.T. professor, looked at four low-price retailers: Costco, Trader Joe’s, the convenience-store chain QuikTrip, and a Spanish supermarket chain called Mercadona.  These companies have much higher labor costs than their competitors.  They pay their employees more; they have more full-time workers and more salespeople on the floor; and they invest more in training them. (At QuikTrip, even part-time employees get forty hours of training.)  Not surprisingly, these stores are better places to work. What’s more surprising is that they are more profitable than most of their competitors and have more sales per employee and per square foot.

The big challenge for any retailer is to make sure that the people coming into the store actually buy stuff, and research suggests that not scrimping on payroll is crucial.  In a study published at the Wharton School, Marshall Fisher, Jayanth Krishnan, and Serguei Netessine looked at detailed sales data from a retailer with more than five hundred stores, and found that every dollar in additional payroll led to somewhere between four and twenty-eight dollars in new sales.  Stores that were understaffed to begin with benefited more, stores that were close to fully staffed benefited less, but, in all cases, spending more on workers led to higher sales.   A study last year of a big apparel chain found that increasing the number of people working in stores led to a significant increase in sales at those stores.

The reasons for this aren’t hard to divine.  As Fisher, Krishnan, and Netessine show, customers’ needs are pretty simple: they want to be able to find products, and helpful salespeople, easily; and they want to avoid long checkout lines.  For a well-staffed store, that’s no problem, but if you don’t have enough people on the floor, or if they aren’t well trained, customers can easily lose patience. 

One of the biggest problems retailers have is what is called a “phantom stock-out.”  That’s when a product is in the store but can’t be found.  Worker-friendly retailers with more employees have fewer phantom stock-outs, which leads to more sales.  And happy workers tend to stick around, which saves the costs associated with employee turnover, like hiring and training.

Some 10 years ago, Darrell Rigby of Bain & Co. (Mitt Romney’s old company), wrote an article showing the stocks of downsizing companies perform worse than equivalent companies.   You might say, of course, companies that are in trouble will lay off workers.  But Rigby compared similar companies with equivalent sales growth, and the downsizing companies on average did worse.

That’s not to say layoffs are never justified.  Companies that are reorganizing, especially after a corporate merger, may need to eliminate duplicate jobs.  And of course a company that’s in trouble may have no choice but to lay off workers.  But normally downsizing for a company is like surgery for an individual.  You may have to do it, but you would avoid it if it wasn’t necessary.

Click on How Hiring Makes Uniqlo a Successful Retailer for the full New Yorker article.

Click on Look Before You Lay Off for the full Harvard Business Review article by Darrell Rigby.  The link will give you the main points of the article; to read it in full, you have to register with HBR.

Click on Ted Rall’s Rallbog for more Ted Rall cartoons and commentary.

[1]  To be clear, I don’t claim that layoffs were the source of Kodak’s problems and I don’t say layoffs are never necessary.

Tags: Down side of downsizing, Downsizing, Layoffs, Uniqlo