As a group, Americans are not known for planning ahead. We have had a negative savings rate in this country for many years, until the Great Recession demanded we rethink our profligate ways. We’re borrowing against our futures as a country, in both the public and private sectors. If you ask a random sample of people what their long term plans are, they typically talk about events within a one to two year horizon. If you ask a random sample of stock analysts the same question in the morning, they will describe their observations and projections before lunch. So now that the advent of a slowing and possible downturn in our economy is upon us, the idea of planning ahead for current events seems contradictory. But that doesn’t stop someone from picking up the binoculars once the ship is on the rocks.
“How do you prevent the need for layoffs?” Bill asked, looking up from the morning’s business headlines. “Is there any way to do that? At one time Hewlett Packard was committed to their no-layoff policy, and stuck to it for many years. But eventually they too had to use staff reductions to address waning profits.”
“No one can absolutely guarantee a plan that would prevent the need for reducing staff due to revenues declining” I responded. “But there are many things a company can do to lower the probability.” I outlined the major principles for Bill.
First, a company must recognize that labor costs are almost always the highest single category of expenses, both direct and indirect. Typically, in most industries around 40-60% of operating expenses are attributable to salaries, benefits, payroll taxes, workers’ compensation insurance, and other perquisites. And this does not include the facility costs or supplies and equipment that each individual might use. Two keys to being able to adjust this category of costs when revenues decline, without having to let people go out the door, is to target base salaries at or just below the midpoint of applicable labor market estimates for the specific talents required by the company, and to place more of total compensation in variable methods.
Profit-based incentive plans that reward teams first, and individuals second will increase an individual’s total remuneration towards the higher end of the market estimates during good times, and will allow the company to retain the employee longer in bad times because as revenue declines and profits shrink, so will labor expenses. I’ve used compensation and total expense models in my own businesses that allowed up to a 30% decline in revenues without causing a need to reduce staff. This is a primary objective, because if hired carefully, people are the most precious resource any company has. Think of the time spent in recruiting, training, developing and leading valued team mates. When a strong performer leaves, she takes with her years of investment and all of the contributions she could have made in the future.
Secondly, a company must activate the minds and hearts of its employees to be as concerned about the future as leadership is. The profit-based variable compensation will assist in this process, but it takes more. It takes education and information sharing. Many company leaders are reticent to share the financial information of their organizations. They worry about trade secrets getting to competitors, employees criticizing leadership’s monetary decisions, revealing too much about leadership’s personal compensation and profit-taking, etc. To be sure, following the principle of “open book” management requires careful planning and commitment to educating employees about the numbers they are seeing. In my experience, sharing the books has been a key reason why our consulting firm logged forty-four consecutive profitable quarters, spanning two economic downturns, with no reductions in force. The more educated your staff is about how money is made, the better decisions they will make before you even know there was a need for the decision. For example, our firm never had to conduct cost-containment meetings or programs. My challenge was just the opposite, i.e., to convince the staff that they should spend money on strategic investments and expenses.
Thirdly, a company has to be able to say “no” to certain types of growth opportunities. Isaac Newton taught us that “what goes up, must come down” (absent a big booster rocket). The business corollary to this axiom is “what goes up fast, comes down fast”. Huge growth in any market typically attracts new entrants. Supply races to catch up with demand and doesn’t think about the curve in the road coming up as the equation reverses. I’ve seen far too many examples of companies staffing up to meet huge demand, lagging behind for months and possibly years. Then as the trajectory flattens, they’re unable to stop the hiring juggernaut when the early indicators of slowing growth flash yellow warning lights. Hiring overshoots the mark and the company suddenly has a labor cost structure that erodes or eliminates profitability as reduced demand slows the revenue rate. It’s hard to say “no” to opportunities that appear huge, but it can pay off. In the late nineties, our consulting firm said “no” to chasing the dot.com boom dollar. We maintained steady growth through that industry’s meteoric rise, and subsequent dive.
Finally, a company’s leadership has to plan ahead. Way ahead. I’m talking five to ten years. It’s not easy, but it can be done, if leadership spends the time learning about the larger forces in their industry and interpolates effects on the organization.
While these tidbits might be a day late and a dollar short for some organizations, perhaps it’s not too late to begin preparing for the downturn after this one.