The Real Cost of Layoffs
Often, when businesses come into rough financial times, they consider layoffs as an easy way to boost the bottom line. Cut some overhead and reap the rewards, right? Not always. Layoffs often don't pay off, according to Bill Bliss, founder of Bliss & Associates, a human-resources consulting firm based in Fort Wayne, N.J. "Layoffs actually wind up costing more in the long run," he says.
So how does a company evaluate all of the short- and long-term costs involved to ensure that layoffs are the right action to take? In the near term, owners will incur the costs of severance and benefits continuance, but other indirect and direct costs come into play, which may make layoffs less appealing. And in the long run, the cost savings pale in comparison to what owners will spend on staffing once their businesses ramp up again.
Tallying the Short-Term Costs
"Companies conducting a layoff find that there is a price to pay in the short run for getting costs out," says N. Fredric Crandall, founding partner of the Center for Workforce Effectiveness, based in Northbrook, Ill. Besides a severance and benefits package, employers will pay out accrued vacation and outplacement-services fees. (Calculate your immediate costs using CWE's cost calculator.)
There are other short-term costs to consider, according to Bliss. "It takes time to process people out," he says. Managers have to take the time to sit down and break the news to employees, to assemble paperwork, to reallocate work to remaining employees, to train those survivors how to do the work they've absorbed, and to handle other employee issues directly related to the layoff -- all of which eats managers' and administrative staffs' time and, therefore, money.
The effects of layoffs on surviving employees have a less obvious, but still important, short-term financial impact. "Morale directly affects productivity," Bliss says. He estimates that each laid-off employee will cost the company 50% of the person's compensation and benefits for each week that the position is vacant, even if there are people performing the duties, and 100% of the person's compensation and benefits if the position is left completely open. Other indirect costs include lost knowledge, skills, contacts, and customers, which are all hard to quantify but are real factors in determining the short-term costs of laying people off.
Down the Road
In the long term, a business's initial cost savings can be obliterated by the cost it incurs to ramp back up. "The most ludicrous thing I've seen is that companies might make the balance sheet look good in the short term but later have to hire people back," says Bob Hoffman, a senior human-resources professional and principal of HR Advice.com. In essence, the cost savings only last as long as the company doesn't need to rehire employees, and in most cases, that's not a long period of time. "The majority of companies that lay off employees find themselves back to prelayoff employment levels within 18 months," Crandall says. Rarely do companies see any long-term benefit from employment reduction, he adds.
Looking at the implications of layoffs in the long term reveals some hefty costs to the company, especially if the organization decides that it needs to rehire employees. The employer will pay a premium price for attracting valuable replacements, including the cost of recruiting and screening candidates. An employer also will have to orient new employees and make supervisors available to offer additional guidance and support while those employees get up to speed.
Then there is an economic-opportunity cost incurred, according to Crandall, which is the difference between the productivity the company would have enjoyed had they retained the laid-off employee and the productivity of the replacement while he or she is learning the job. "Costs can run up to an amount equal to two or three times the annual compensation of the person laid off and is an additional cost above and beyond the annual salary of the replacement," he adds.
Beyond the sizable expenses associated with rehiring employees, there is the cost a company incurs when laid-off employees collect unemployment insurance. When the unemployment insurance account is reduced, a company's tax rate increases to build the account back up. Though the increase doesn't occur during the layoff year, it generally takes place over the next few years until the business's unemployment insurance account reaches its prelayoff rate.
Lastly, there are less tangible costs, according to Crandall, which include low morale, lost innovation, fear of more layoffs, angry customers, and lost market share.
So does it really pay to layoff employees? At first glance layoffs seem to be an easy fix, but they don't appear to be a strategic initiative that pays off in the long run.