Employee Downsizing

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The First Phase Till the late-1980s, the number of firms that adopted downsizing was rather limited, but the situation changed in the early-1990s. Companies such as General Electric (GE) and General Motors (GM) downsized to increase productivity and efficiency, optimize resources and survive competition and eliminate duplication of work after M&As. Some other organizations that made major job cuts during this period were Boeing (due to its merger with McDonnell Douglas), Mobil (due to the acquisition of Exxon), Deutsche Bank (due to its merger with Bankers Trust) and Hoechst AG (due to its merger with Rhone-Poulenc SA). According to analysts, most of these successful companies undertook downsizing as a purposeful and proactive strategy. These companies not only reduced their workforce, they also redesigned their organizations and implemented quality improvement programs. During the early and mid-1990s, companies across the world (and especially in the US), began focusing on enhancing the value of the organization as a whole.

According to Jack Welch, the then GE CEO, "The ultimate test of leadership is enhancing the long-term value of the organization. For leaders of a publicly held corporation, this means long-term shareholder value." In line with this approach to leadership, GE abandoned policy of lifetime employment and introduced the concept of contingent employment. Simultaneously, it began offering employees the best training and development opportunities to constantly enhance their skills and performance and keep pace with the changing needs of the workplace. During this period, many companies started downsizing their workforce to improve the image of the firm among the stockholders or investors and to become more competitive. The chemical industry came out strongly in favor of the downsizing concept in the early 1990s. Most chemical and drug companies restricted their organizations and cut down their employee base to reduce costs and optimize resources.

As the perceived value of the downsized company was more than its actual value, managers adopted downsizing even though it was not warranted by the situation. A few analysts blamed the changes in the compensation system for executive management for the increase in the number of companies downsizing their workforce in 1990s. In the new compensation system, managers were compensated in stock options¹ instead of cash. Since downsizing increased the equity value (investors buy the downsizing company’s stocks in hope of future profitability) of the company, managers sought to increase their wealth through downsizing. Thus, despite positive economic growth during the early 1990s, over 600,000 employees were downsized in the US in 1993. However, most companies did not achieve their objectives and, instead, suffered the negative effects of downsizing. A survey conducted by the American Management Association revealed that less than half of the companies that downsized in the 1990s saw an increase in profits during that period. The survey also revealed that a majority of these companies failed to report any improvements in productivity.

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1] Stock option is an offer given by the company to purchase its common stock at a grant price, regardless of the stock’s price at the time of offer. Stock options as part of employee compensation techniques had earned high popularity during 1990s. Stock options were believed to increase the commitment of the employees towards the company as they had vested interests in the performance of the company’s stock.

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