An interesting news article came by Chief Healthcare Executive came across my desk a few months ago announcing that "thousands of employees at hospitals and health systems have lost jobs in recent months." Hospital leaders are citing mounting financial pressures, the impact of grant terminations from the National Institutes of Health, uncertainty in federal funding for graduate medical education, looming cuts in Medicaid programs, and increased supply chain expenses as reasons to cut labor costs, which is the largest expense for hospitals and health systems. By cutting labor costs, hospitals can decrease pressure on their operating margins, at least in the short-term. Whether this is the right move for the long-term future sustainability of these organizations remains to be seen.
Last year, I wrote a post about corporate lay-offs entitled "Nobody every cut their way to greatness...", in which I stated "There are actually a number of studies that show that lay-offs are frequently deleterious for the organization, with a so-called "dirty dozen" of detrimental effects. I then cited one particularly well-known study from the aviation industry ("Airline downsizing and its impact on team performance") that provided concrete evidence of these twelve adverse effects to corporate lay-offs. Given the current state of the world in which we live, I wanted to re-visit this topic and provide additional supportive evidence suggesting that in our VUCA world, organizations are better off if they "double down" and focus on growth and efficiency at the same time.
Ranjay Gulati, Nitin Nohria, and Franz Wohlgezogen studied 4,700 public companies during three past global recessions (1980-1982, 1990-1991, and 2000-2002), specifically analyzing their strategy and performance during the three years prior to the recession, the recession years themselves, and the three years after the recession (see "Roaring Out of Recession" from the March 2010 issue of Harvard Business Review). Seventeen percent of the companies did not survive the recession - they either went bankrupt, were acquired, or became private. Most of the surviving companies were able to partially recover, but the recovery was particularly slow. Nearly 80% of the surviving companies had failed to regain their pre-recession growth rates for sales and profits three years after the recession. Surprisingly, nine percent of the companies not only survived through the recession, they flourished afterwards, outperforming their rivals by at least 10% in terms of growth rates in sales and profits. But again, it wasn't the companies that cut costs faster and deeper than their competitors that flourished - actually, these companies were the ones that had the lowest chance of surviving through the recession.
Gulati, Nohria, and Wohlgezogen described four different strategies that the firms they studied could employ during a recession:
1. Prevention-focused companies: Focus on avoiding financial losses and minimizing downside risks (i.e. primarily a defensive strategy)
Gulati, Nohria, and Wohlgezogen write, "Confronted by a recession, many CEOs swing into crisis mode, believing that their sole responsibility is to prevent the company from getting badly hurt or going under." These CEOs work to reduce operating costs by eliminating discretionary spending, lowering head count, postponing new investments (including research and development, capital investments, and new lines of business), and preserving cash. Unfortunately, these companies typically make across-the-board cuts ("Every department needs to reduce head count by 10%"). Rather than learning how to operate more efficiently, these organizations end up trying to do more with less. Unfortunately, these cost-cutting measures often create pessimism and lower morale within the organization (see "Airline downsizing and its impact on team performance" mentioned above). Employees lose trust in the organization and the leadership, which will take a long time to rebuild (if at all). Few prevention-focused companies do well in the long run, and most do not even survive.
2. Promotion-focused companies: Focus on making investments that maximize upside benefits (i.e. primarily an offensive strategy)
Some leaders pursue growth opportunities every chance that they get, even during a recession. They use the recession as the proverbial "burning platform" in order to push through changes in the organization. They continue to make strategic investments, and they often leverage the fact that many companies are cutting back on investments and talent acquisition to grow their own organizations. Gulati, Nohria, and Wohlgezogen find that "Organizations that focus purely on promotion develop a culture of optimism that leads them to deny the gravity of a crisis for a long time." In the end, these organizations are blindsided by poor financial results, as the changes required to become more efficient are implemented too late, or even not at all. Only 26% of the promotion-focused organizations significantly outperform their rivals after a recession.
3. Pragmatic companies: Focus on making targeted investments (i.e. offensive play) AND minimizing downside risks to avoid financial losses (i.e. a defensive play)
The CEOs at pragmatic companies recognize that cost-cutting measures are necessary to survive through a recession, but they also know that strategic growth is equally important. Balance is their goal - they try to decrease costs and increase revenue at the same time. Gulati, Nohria, and Wohlgezogen found, "Companies typically combine three defensive approaches - reducing the number of employees, improving operational efficiency, or both - with three offensive ones: developing new markets, investing in new assets, or both." Nine different combinations of approaches are therefore possible. However, the most successful approach combines (1) improving operational efficiency with (2) developing new markets AND investing in new assets.
In other words, as Gulati, Nohria, and Wohlgezogen emphasize, "Companies that attend to improving operational efficiency fare better than those that focus on reducing the number of employees." While layoffs reduce costs quickly, they undoubtedly make recovery more difficult later. As I stated above, it's hard to earn back trust after layoffs, and the cost - both in terms of the trust factor and the actual monetary costs - are higher in the long run, as organizations often find themselves having to rehire new workers to replace the ones that they laid off during the recession.
4. Progressive companies: Similar to the pragmatic companies, but focused on maximizing both financial upside benefits (through more than just targeted investments) as well as cutting financial losses
After a recession, companies that make investments in both existing and new businesses, while at the same time, focusing aggressively on operational efficiency, are usually the most successful organizations in the long run. Gulati, Nohria, and Wohlgezogen write, "Companies that respond to a slowdown by re-examining every aspect of their business model - from how they have configured supply chains to how they are organized and structured - reduce their operating costs on a permanent basis. When demand returns, costs will stay low, allowing their profits to grow faster than those of their competitors."
As Ranjay Gulati noted in a more recent follow-up article (see "Investing in Growth Through Uncertainty"), the combination of an offensive and defensive approach has been found over and over again to be the most successful strategy during an economic downturn. Walter Frick adds ("How to Survive a Recession & Thrive Afterward"), "Some layoffs are inevitable in a downturn...However, the companies that emerge from crisis in the strongest shape relied less on layoffs to cut costs and leaned more on operational improvements." Making targeted investments in growth, even during a time of uncertainty, is equally important.
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