Corporate Strategy of Downsizing: Definition, Nature and Types

In the mid-1970s, Chales Handy – a professor of management psychology at the London Business School, predicted a revolution that would potentially change the entire economic market by pushing thousands of firms into the situation that he calls “downsizing”. This phenomenon was ignored at that time (Dening, 1996), but has increasingly come true, and is now called the “corporate strategy of downsizing”.

In practice, in contrast to diversification, firms can choose to decrease the scale of their existing business fields to achieve other strategic goals in certain fixed periods. This decision may result from many reasons such as: restructuring, closing or selling one or some business to reduce the functioning costs, increasing labor productivity, improving managerial capacity, avoiding recession-crisis risks or risks in changing environments, or even concentrating organizational resources on other core SBUs (Palmer et al., 2009).

1. Definition, nature and causes of downsizing

In the literature, there are different definitions of downsizing. In general, downsizing is the situation in which a firm cuts a great quantity of existing full-time employees (frequently more than 10% of total employment) in order to improve the profit or financial health of the firm. According to Kozlowski et al. (1993), the term “downsizing” implies the action of cutting down a large amount of labor force, but in a very short period of time, in order to improve the performance of the firm. According to Huber and Glick (1993), downsizing is a set of management activities to increase the efficiency, productivity and/ or competitiveness of the firm. This strategy influences the size of the employees and the workflow of the firm. The definition of Huber and Glick (1993) covers all three types of downsizing, namely: retrenchment, downscaling and downscoping.

Some characteristics of downsizing are as follows (Huber and Glick, 1993):

• Downsizing is an intended action;
• Downsizing, not necessarily, but is often related to employee layoffs;
• Downsizing focuses on improving firm performance;
• Downsizing influences, either intentionally or unintentionally, the business processes;
• The possible consequences of downsizing are overloading and exhaustion because of increasing productivity, conflict, and loss of motivation;
• The positive result consists in increasingly productivity or work progress.

In practice, many firms implemented the downsizing strategy. For example, after the September 11 attacks in 2001, a supplier of special weapons to the US government fell into a decline in productivity. They decided to cut about 900 workers worldwide and to restructure their business for ensuring the weapons productivity face to the increasing demand. Finally, the weapon supplier chose to downsize by focusing on two new power plants. Another example is the case of Charles Schwab – the famous discount broker, who took a spectacular step to save his company in 2001. The Charles Schwab Corporation is an American multinational financial services company. It offers banking, commercial banking, investing and related services including consulting, and wealth management advisory services to both retail and institutional clients. Having a great number of salesmen, Charles Schwab Corporation get stuck in economic crisis. In 2003, the Group decided to cut nearly 25% of its existing workforce to reduce salary and bonus costs, thereby overcoming the difficult situation of severe decrease in profits (Cascio, 2002).

2. Downsizing and firm performance

Although the downsizing strategy has been increasingly implemented by firms face to turbulent and rival environment, its impact on firm performance is still discussed in the literature (De Mesu et al., 1994). Some scholars believe that the downsizing strategy positively contribute to firm performance because its competitiveness and profitability are improved on the basis of more appropriate business processes after downsizing, including: lean structure, encouraging creativity and new technology applications, etc. On the other hand, the key contribution of downsizing strategy consists in reducing corporate costs at minimum level of employee quantity (Cascio, 2002; Rigby, 2002).

In the literature, empirical studies on the relationship between downsizing, financial performance and market reaction of the firm. Burke and Nelson (1998) found that among 85% of firms implementing the downsizing strategy, 63% of them increase profits and 58% improve productivity. Whayhan and Werner (2000) also argue that corporate downsizing results in significant financial performance; firm revenue increase significantly in comparison with competitors who do not adopt such strategy, especially in short-term.

However, in some cases, the corporate strategy of downsizing may not lead to the desired impacts. It is not sure that downscaling contributes positively to financial results, but it easily pushes firms into a state of weakness and lame (Anthony et al., 1996). Usually, layoffs will immediately save salary expenses, but other significant costs of severance allowance or outsourcing may occur. Corporate strategy of downsizing may also reduce the quality of human resources and internal processes of the firm. “Survivor syndrome” demoralizes the remaining employees’ work motivation, by negatively affecting their productivity. Empirical studies indicate that the long-term performance of firms implementing downsizing strategy is often inferior to the one of firms which choose to limit staff cuts (De Meusu et al., 1994; David et al., 2003).

In general, growth and development are always the strategic goals of firms, but we cannot achieve them anytime. “Corporate downsizing”, in a positive perspective, can be consider as a break or a stepping stone for firms to restructure, to achieve stronger growth after a rapid growth period, to overcome instability, or to seize other better business opportunities.

Anyway, corporate downsizing immediately causes negative impact on economy when several workers lost their jobs; while the firm performance resulted from this strategy still is in the future. Therefore, firms should carefully assess their business situation, as well as the impact of downsizing, in choosing the right way and right level of “downsizing” in accordance with their specific characteristics and conditions. This requires firm leaders to have a good strategic vision, and to correctly determine time and level of downsizing in each development period of the firm.