Mass layoffs come with surprisingly large hidden costs

February 1, 2023, 11:15 AM UTC
Toyota avoided laying off workers in the 2008 financial crisis even as competitors dismissed thousands.
Luke Sharrett—Bloomberg/Getty Images

Most U.S. CEOs expect a recession, with 98% of those surveyed by the Conference Board saying as much. In response, they’re battening down the hatches and looking for areas to cut spending. One of those areas is talent. 

By some estimates, more than 58,000 workers in U.S.-based tech companies have been laid off in 2023—and that’s just from one industry. More layoffs are almost certain to come, thanks in part to the bandwagon effect, a correction to overhiring in 2021, and what leaders foresee as tough economic conditions ahead. But are layoffs the right answer financially?  

The data suggests otherwise. But as this trend builds, CEOs pondering a reduction in force may want to look closely at the surprising reality of layoffs. Research shows that the anticipated benefits are often a mirage, while the costs are much greater than leaders realize.

Layoffs are costly

Layoffs are expensive from day one. And before they save an employer money, they cost a bundle. For example, Microsoft announced it would take a $1.2 billion charge to earnings to account for its layoffs’ immediate costs, including severance payments, benefit extensions, accrued vacation, and other costs that may be contractually required. That’s $120,000 per laid-off employee.

Economic conditions are cyclical, and employers often want to refill empty seats when  downturns end. Doing so takes more time and money since new employees require onboarding and training before they’re fully productive. Combine all these costs, and layoffs may not save a dime. “Job losses can produce greater costs than benefits,” says research from the consulting firm Bain & Company. That’s especially true if a recession turns out to be short and mild, as many economists expect in the U.S. this year.

Some companies learned this lesson the hard way in past downturns. In the prelude to the Great Recession, Northwest Airlines fired hundreds of pilots. When business recovered, it couldn’t hire pilots fast enough and lost millions of dollars of revenue from canceled flights.

Loss of knowledge

Valuable knowledge leaves when laid-off workers exit a company. It’s impossible to quantify, but companies can’t function at their best in a knowledge-based economy without the unwritten institutional know-how employees possess. And most of what leaves won’t come back. The damage can be more extensive than leaders may expect. “Employee downsizing not only runs the risk of destroying valuable organizational knowledge on the individual and social network levels but may also profoundly disrupt established procedures, routines, and the organizational culture,” conclude researchers in a comprehensive review of the relevant literature published in Management Learning. “These more indirect effects can have severe long-term consequences.”

Performance tanks

Productivity will sag before, during, and after layoffs, ultimately hurting profitability. Anxiety, rumors, and false information will proliferate. Those who remain will think more about themselves and less about the company, and time spent gossiping and preparing résumés will mushroom. Analyzing multiple studies, researchers from the University of Colorado, University of Portland, and Texas A&M cite “decreased productivity among survivors” among the costs of employee downsizing. In more quantifiable terms, research published by the American Psychological Association found that after a layoff, the job performance of those who remained fell by 20%.

Succession plans get derailed

The leadership pipeline suffers, especially when layoffs are large, diminishing an organization’s future intellectual capital. Banks and electric utilities witnessed the drawbacks to leadership discontinuity after laying off tens of thousands of mostly junior employees during the recessions of the 1980s. Those companies paid the price 20 years later when they needed experienced, knowledgeable executives to succeed the retiring generation and found only a broad, empty space in the ranks.

Survivors suffer

A study by Cigna and the American Management Association found that employees who remain after a layoff make significantly more medical claims than before, especially for mental health, substance abuse, and cardiovascular issues. Stanford University researchers, citing multiple studies, note that measures of job insecurity such as downsizing or mass layoffs are associated with “worsened health among surviving employees.” Those doing the firing also aren’t immune. Research from 45 U.S. hospitals shows that managers are twice as likely to suffer a heart attack in the week after they fire someone.

Wall Street may react

A Bain report found that if a company lays off employees as part of a larger strategic restructuring or merger, investors may push the stock up. But if a layoff is merely cost-cutting, Wall Street senses trouble and typically sends the stock down. Hasbro stock fell 9% when the company announced in late January it was laying off 1,000 employees. 

To be sure, layoffs may be unavoidable in a sudden, severe economic shock—say, a once-a-century global pandemic. But even in extremis, business leaders might want to consider whether a layoff is truly unavoidable. A few major companies have refused to make mass dismissals for 70 years or more, including during the pandemic, and have thrived. Toyota avoided laying off employees in the 2008–09 recession, even as General Motors, Ford Motor, and Chrysler dismissed tens of thousands. Lincoln Electric, a major Ohio-based maker of welding equipment with factories worldwide, hasn’t laid off employees in at least 75 years; its stock was recently near an all-time high. 

Layoffs are alluring in difficult times and when the next quarter’s earnings are in peril. But that may be the short-termism trap. As more CEOs consider downsizing their workforce, it would behoove them to question whether, in the big picture, the long-term case against layoffs is more persuasive.

Learn how to navigate and strengthen trust in your business with The Trust Factor, a weekly newsletter examining what leaders need to succeed. Sign up here.

Read More

Great ResignationDiversity and InclusionCompensationCEO DailyCFO DailyModern Board