Chapter 3
Planned Downsizing

5 lessons
Broadened objectives
Match organization + strategy


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Chapter 3

Planned Downsizing: A Sustainable Alternative

Excerpt from Downsizing: Reshaping the Corporation for the Future

By Robert M. Tomasko


Concern about the unintended consequences of demassing has left some thoughtful executives feeling caught between the proverbial rock and hard place. They are reluctant to make deep, quick cuts in their organize size because of the disruption, human costs, damage to their ability to innovate, and lost loyalty that may result. Perhaps they are not even certain excess staffing is their highest priority problem. But, they also feel legitimate concerns about how the number of management layers have grown and staff experts proliferated. They want to avoid the difficult situations faced by A.T.&T., Brunswick, General Motors and many others. Maybe they have recently purchased another business and they realize they will receive few benefits from the acquisition until they eliminate duplicate staffing. Is there a middle ground available, they wonder?

They may agree with a letter writer to Business Week who does not think cost cutting is the best way to revitalize American industry. He feels that "the slimming of corpulent bureaucracies may be a laudatory goal, [but] cost-cutting, by its very nature, can only affect the short term. To arrest American industrial decline, companies must expand their markets, provide better service and products to their customers, upgrade their plants, and maintain, if not improve, their employees' morale."

Some companies have been able to address these concerns, while charting a course between demassing and doing nothing. TRW, Inc., with its long term strategy of simplifying its organization and reducing its manpower, is one. Dana Corporation, which has worked hard to keep its management size in direct proportion to its production workforce, is another. Xerox has obtained some hard won experience in ways to keep its headquarters lean, and even in the price roller coaster-driven oil industry two companies have made fewer reductions than most: Schlumberger and the Shell Oil Company. Both of these oil firms have European parents, which given the labor regulations there, may explain the care they have taken to keep constant control over their staff size. Shell has followed the injunction of IBM's founder, Thomas Watson, who warned that prosperity can be more dangerous for a company than depression. According to John Bookout, Shell's chief executive: "We didn't let staff get out of hand during the upswing. We didn't cut like others in the downswing."

These, and companies like them, have long practiced "planned downsizing."

Five lessons
The experiences of these and other successful downsizers suggests some lessons for others to consider. Some of these companies that have done a good job of managing their size up to this time may not perform as well if business conditions change significantly. Few companies are good at all aspects of managing their size, but it is possible to identify practices that work for some that suggest general principles for all to consider. Here are five of these principles. They form the basis for the topics covered in the rest of this book.

- Start before you have to.

- Prepare for the downside.

- Use a rifle, not a shotgun.

- Continually manage size and shape.

- Go after more than costs and jobs.

Too many companies have found they had no choice but demassing because they waited until they were forced to prune their overgrown organizations. For some that face a sudden bankruptcy threat, this might be the only alternative, but overnight changes from riches to rags happen to few vigilant businesses. Foreign competition and new product introductions by domestic competitors usually provide several warning signals before making a meal of market share. Take over attempts and raider's attacks come with less notice but, as many executives have commented, if your company stock is publicly traded, the business is up for sale every day the market is open.

Being forced to make deep, quick staff cuts leaves the business open to all the negative consequences of demassing. Some are recoverable from, but others will have lingering effects than may cancel out much of the payroll savings. Cuts like these drastically limit an executive's options for dealing with a bloated staff and management. Streamlining your company over a longer time span opens many possibilities for reducing staff without firing people. Chapter Seven reviews these alternatives available to planned downsizers. But to utilize these, you must move before you are forced to.

Taking action on your schedule, not a junk bond supported raider's or short term focused stock analyst's, also allows time to prepare the company for the new style of management that downsizing will require. Running a lean and mean business is not a natural act for many executives. For some companies, it may be riskier than maintaining a bloated payroll. Reducing the number of managers while keeping the same degree of oversight is not impossible, but it does require a good bit of planning. Avoiding the business moving from "analysis-paralysis" to "out-of-control" requires some careful consideration of what it takes to operate a downsized company. Downsizing has a downside, but it can be managed. The prerequisites for doing this are discussed in Chapter Eight.

Avoiding some of demassing's pitfalls requires pinpointing excess staff and management layers, not holding all units to the same across-the-board reduction target. Use a rifle, not a shot gun. The problems of pruning a management hierarchy are different from those of reducing the scope of headquarters staff. And different considerations come into play when cutting back internal auditors than do when downsizing an in house publications unit. How to treat each differently is the subject of the next three chapters.

Achieving one time employment reductions is often difficult and painful. But the experience of many companies has shown that these cutbacks will not necessarily sustain themselves. Changes need to be made in organization structure, compensation systems, career ladders, hiring and training practices, and at times the overall corporate strategy to stay streamlined. Chapter Nine outlines these steps to insure that the hard won gains from downsizing persist.

Finally the hoped for results from downsizing should be planned for at the outset. Too often only near term headcount reductions are sought after, at the expense of longer term efficiencies. Other benefits such as speedier product development are left to chance. Let us start by consider some of these high payoff, but harder to quantify objectives.

Broadened objectives
Companies have a number of stated objectives for downsizing, but the one they pay the most attention to implementing is headcount reduction. Others, such as speeding decisions and improving line management morale, are frequently tossed out as justifications for the cutbacks, and then forgotten. Few companies have figured out what the "mean" part of the "lean and mean" state to which they aspire, really means.

Companies good at getting the most mileage out of management and staff reductions, the ones we call "planned downsizers," have broader objectives than job elimination. For them the overall goal is to build the most efficient and effective organization they can, and then to put practices in place that will keep on delivering this kind of organization. They seldom use the meat cleaver approach to slimming down, because one of their objectives is to come out of whatever downsizing they need with a strong and committed workforce. When they plan downsizing they choose among a wide range of objectives and tactics for achieving them. This range includes:

- Lowered Costs: doing this implies minimizing non-salary as well as salary expenses. Many planned downsizers search hard for other alternatives before reducing employment to cut costs. Some manufacturers have been able to save more by adding staff to their purchasing department and obtaining savings through shrewder raw materials buying and materials management. When they need to cut payroll, targets are expressed in employment dollars saved, not people terminated. Total costs of employment are examined for saving possibilities, including salary and benefit reductions, eliminating overtime and vacation-carry-overs, and converting jobs to part time.

- Faster Decision Making: achieving this commonly sought objective means specifying in advance which decisions, how long they now take to make and what the target times for making them are to be with a more streamlined structure. Otherwise this becomes a pie-in-the-sky hope, not an aspect of the business whose performance is actually managed. Companies such as Ford and Pacific Telephone have gone to great lengths to chart out steps in making important, recurring decisions. Then these flow charts are closely examined to identify shorter paths. Out of this examination come targets for pruning: extra management layers, unneeded committees, excess staff inputs, etc.

- Quicker Response to Competitors' Actions: improvement here means shortening the path between those who first hear of a competitors move, those who decide what to do about it, and those that implement the decision.

- Less Distorted Communications: a combination of management layer reduction (see Chapter Six) and investment in computer information networks (Chapter Nine) can help here.

- Greater Action-Orientation; Less Analysis-Paralysis: this usually implies reducing the headquarters staff role in decision making, or using something like IBM's contention system that requires the constant collaboration of staff and line to reach major decisions. Achieving this commonly hoped for objective also usually implies changing the mix of skills of your managers as well as their number.

- Quicker Diffusion of New Ideas: making your company more innovative is an important objective, especially for those businesses facing stalemated positions in maturing markets. Becoming more innovative frequently is facilitated by giving fewer people veto power over new ideas. As we have already discussed, while moderate organization streamlining can be helpful, demassing can bring with it a new corporate culture inhospitable to innovation.

- Facilitating Synergies Among the Company's Divisions and Departments: the easiest way to bring this about, structurally, is by reducing the number of divisions and departments that need to interact; then limit the hierarchy in each that can stand in the way of the interaction. As with promoting innovation, downsizing is not enough to encourage increased cooperation across organizational lines. Coordinating mechanisms, such as carefully chosen committees and task forces, as well as incentives and rewards for behaving this way are needed.

- Higher General Manager Morale: this can come when staff groups that tend to second guess line managers are reined in (assuming the individual managers are able to solo without their "support." Reducing the overall number of managers can, to a point, increase the morale of those remaining by giving them full time management jobs. We will cover this in more detail in Chapter Six.

- Focusing Managers' Attention on Customer Needs, Not on Internal Procedures: this requires a combination of limiting the hierarchy between key managers and key customers, and managing the operation with a short rule book.

- Placing Power and Authority in Hands of Managers Closest to Customers: this, also, can result by reducing management layers and delegating decision making on matters of immediate concern to customers to those who deal with them most frequently.

- Easier to Pinpoint Individual Responsibility for Business Performance:
this should be a natural result from creating a streamlined organization structure and a test if it is sufficiently streamlined. Responsibility for economic performance should not be lost among overlapping layers of managers. Key managers should have both performance targets and most of the resources needed to achieve them.

- Increased Management Productivity: on a manager-by-manager basis this usually happens by increasing the number of people reporting to each. Company wide, management productivity can be tracked by watching for improvements in "management value added."

Return on management
Too few companies directly track how much value their management adds to the business. The value added concept an underused way to set overall downsizing objectives and keep track of progress toward meeting them. Its calculation is not extremely difficult, as some seem to assume. Paul Strassmann, a retired Xerox vice president for strategic planning, has developed a ratio he calls return on management (ROM). It is analogous to return on investment (ROI) and is also a measure of management productivity. He defines ROM as management value added divided by management costs. Management value added is simply the difference between the total value a company adds (calculated the way economists customarily do, the difference between what companies sell their goods and services for and what their total costs are in producing them) and the portion of that value added which reflects a company's total operating expenses (which include labor and the capital expenditures involved in business operations). Management costs are the combination of:

- Manager's salaries, bonuses and benefits

- Capital expenditures related to management (computers, etc.)

- The services that managers purchase (travel, consultants, etc.)

Strassmann has found this a useful indicator to monitor. How productive a management structure is can be overlooked when global indicators of productivity tell a good story. The Strategic Planning Institute reports a situation where traditional measures such as revenues/employee and value added/employee both increased by 33% over a two year period, while at the same time ROM decreased by 1.5%. This decrease can be an early warning sign of trouble to come.

According to Strassmann's calculations the ROM for all of American industry is 1.2, not an indicator of very high productivity. Thirty-five percent of U.S. companies have a ROM of less than one. This means that, for many of them, their managements are paid more than what they deliver as value added. The linkage between these measures and organization is that companies with the highest ROM are ones that have limited vertical integration. Strassmann says: "They buy more and more of their overhead from outside. One of the big problems with low performance organizations is that they're trying to own too much of their overhead. That approach creates hierarchy, because each group of experts enters into the game of getting their cut of the budget."

Concepts, such as this and benchmarking described in the next chapter, have enabled Xerox to become one of the more thorough planned downsizers.

Match organization with strategy
We have considered a range of objectives beyond simple headcount reduction that can be achieved, at least in part, by taking a planned approach to downsizing. The benefits they provide can have a longer term significance, but acquiring them needs to be a managed activity. Becoming better at product innovation, or faster at making key decisions are not qualities that just happen by accident. Because the management effort required for any one of the dozen objectives above can be considerable, some basis is needed to select those with the biggest payoff.

The best reference point for deciding what the outcomes of downsizing should be is the company's strategic plan. Typically this will focus on a several year period and be oriented toward directing resources to be invested in areas of the company's most sustainable advantage over its competitors.

For example, a large supermarket company was concerned that its return on equity was lower than a number of its competitors. Its executives felt this was reflected in a lower stock price than was warranted, given the company's strong competitive position in many of the regions it served. This bargain stock price might, they feared, attract unwanted suitors. These key managers also worried about the company's ability to maintain its lead over the competition, because its competitors were, increasingly, smaller companies and owner-operated stores. They all had less management hierarchy than this large supermarket company which allowed their store managers to respond more quickly to changes in what customers wanted to buy. In this company, on the other hand, decisions about product selection, store layout and pricing were all made at a large central headquarters.

The first alternative considered was a large, across-the-board personnel cut. This would provide an immediate boost to earnings and possibly could help "clear away some of the cob webs" at headquarters. After much debate this was rejected. It would be viewed as too heavy handed by many of the new, rising managers whose loyalty the company needed to retain. This supermarket has historically treated its employees paternalisticly; the top management felt this mutual commitment on the part of workers and management was something they needed to build on to outperform their aggressive competitors.

Instead the put their attention on the wide range of businesses and activities that over time had come under their corporate umbrella. A list of the "businesses" they were in included:

- Full Service Supermarkets

- Discount Food Warehouse Stores

- Drug Stores

- Food Packing and Manufacturing (to make their private label brands)

- Trucking and Warehousing (to get the food to their stores)

They also had a large headquarters staff in which the bulk of the employees did:

- Store Design and Construction Management (this company built or
remodeled several stores each month)

- Planning and Deciding What Food to Sell at What Price

- Food purchasing (to sell in the stores)

When they looked at these businesses and activities they asked themselves: which of these are we really best at? In which do we have the greatest advantage over our competitors? Because many of these were interrelated, it took some careful analysis to piece apart this company's "value chain." But when they looked at the performance of each activity individually they realized there were two things they did exceptionally well:

1. They knew how to buy food at wholesale prices extremely well.

2. They were very good at merchandising food in their stores.

They were not doing a very good job running pharmacies, the synergies between them and the supermarkets never emerged. They also made little money in their food plants when they realized they could purchase private label goods from other manufacturers at about what it cost them to make their own. They had a great deal of money invested in their logistics operations, which penalized their return on assets, but they were supposed to be in the food business, not in trucking.

This analysis led them to plan a downsizing program that was to be gradually implemented. The drug store and manufacturing businesses were sold off when good purchase offers were obtained. Relatively few employees were laid off. The company started to convince the managers of its trucking and warehouse operation to buy, using a leveraged buyout loan secured by long term contracts with the supermarket, this business from the company and run it as an independent entity. Again the company's workforce was reduced considerably, but few workers lost their jobs.

At headquarters the streamlining targeted the store design group for elimination. Services just as useful could be purchased from outside contractors. They helped their employees get work with some of these. The skilled food purchasing group was protected from cutbacks, while the unit that set prices and planned the details of store operations was gradually disbanded as soon as the individual store managers could be trained to handle their work on a coordinated, but decentralized basis. This required an increased budget and staffing for the headquarters management development function. Eventually they found they could eliminate a layer of line management as these better trained store managers required less close supervision.

The net result of these changes: a streamlined company in which top management could spend their time on the activities that would have the greatest payoff.

Other companies have discovered the virtues of linking their downsizing closely to their strategic plan. Donald Kane, General Electric's manager of organization planning, considers across-the-board cutbacks to be the height of idiocy at GE because the company depends on counter cyclical trends in many of its businesses to maintain overall good corporate performance. This does not imply GE has been free from downsizing, their experience has been quite to the contrary. But they do put more attention into linking the management of the size of their organization units with the needs of the individual businesses they are in than do most companies. They have not faced the problems of a large steel company where the chief executive has been accused by one of his top managers of using a "machete" to attack a cancer. Another manager at that company was concerned that the blunt approach to streamlining may have adverse affects on the quality of the company's products - in a marketplace where quality is one of the few sources of strategic advantage left.

Kodak has also than a planned, broadened-objective approach to streamlining. To maximize the benefits from the painful reduction described in the last chapter, it has given major attention to quicker decision making about new products. This has helped a digitalized medical imaging device reach customers much sooner that would otherwise have been the case, an event which may help reduce the concerns of the industry analyst mentioned in Chapter Two.

The bottom line: better performance
This chapter has encouraged a planned approach to downsizing, one that is closely keyed to the strategic plan rather than in reaction to the management fad of the moment. Such planning is intended to avoid the unintended consequences of demassing and to serve as the basis for building a lean organization structure than stays lean.

Do streamlined companies really perform better than others? One multi industry study that looked at the organization structures and economic performances of well managed businesses indicates the answer to this question is clearly yes. This research effort, conducted by A.T. Kearney, Inc., examined twenty-six companies such as Allied, Coca-Cola, Dana, Digital Equipment, General Electric, Hewlett-Packard, IBM, Johnson and Johnson, Merck, 3M, Nucor, Schlumberger, and Xerox. It matched these, and other relatively leanly organized firms, with others in their individual industries to track over five years the connection between organization and business results.

Compared to their appropriate industries, these twenty-six did much better. Comparing their average annual percent increases during the 1979 to 1983 period with composite industry averages, the lean companies had double the sales growth, four times the earnings growth and over five times the market value increase than the average increases for their industries.

How different were the organizations of the twenty-six from their industry peers? In both management layering and number of staff not directly involved in production, the differences were considerable - three fewer levels of management and almost double the average span of control.

These measures imply the leanly managed companies, on average, were able to get almost twice as much management work out of each of their managers. This resulted in their being able to operate with organization structures that were, on average, only two-thirds as tall as their competitors. As we will consider in Chapter Six, the taller the organization the more likely decisions take longer to make and information is distorted.

Regarding nonproduction staff, the number of staff per million dollars of sales varied widely, depending on which industry was being considered. This study found that the leaner, better performers averaged one-half staff person per million dollars in sales less than the industry averages. This difference is not as inconsequential as it may seem. For a billion dollar company it implies managing with 500 fewer people. When the average salaries paid to these people are considered, the cost of these five hundred is almost equal to the average net profit most corporations earn on a billion dollars of revenues.

Many of these companies in this study have managed their management size carefully over many years. Most corporations are less streamlined, and are starting to find that demassing alone will not reshape the way they organize managers and staff. To do this a careful examination of the work done by each, and a consideration of how it can be changed, is necessary. The purpose of the next three chapters is to suggest ways to do this planning and reorganizing. Because staff work often seems more mysterious and harder-to-get-your-hands-around than line management, the first two cover it.


© Robert M. Tomasko 1987, 1990, 2002

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