What Is Downsizing?

Downsizing is the permanent reduction of a company's labor force through the elimination of unproductive workers or divisions. Downsizing is a common organizational practice, usually associated with economic downturns and failing businesses. Cutting jobs is the fastest way to cut costs, and downsizing an entire store, branch or division also frees assets for sale during corporate reorganizations.

Key Takeaways

  • Downsizing is the permanent reduction of a company's labor force by removing unproductive workers or divisions.
  • While it is generally implemented during times of stress and a decline in revenues, downsizing can also be used to create leaner and more efficient businesses.
  • Downsizing is not always positive and can have an adverse long-term impact on a company's bottom line.

Understanding Downsizing

Downsizing is not always involuntary. It is also used at other stages of the business cycle to create leaner, more efficient businesses. Eliminating any part of an organizational structure that is not directly adding any value to the final product is a production and management philosophy known as lean enterprise.

According to the production principles of lean enterprise, any component of a business enterprise that fails to directly benefit a final product is superfluous. What is valuable (and conversely, what is not valuable) is determined by the customer based on the amount they are willing to pay for a good or service.

Downsizing can also be carried out to align the firm's skill and talent with the broader market. For example, a company may pursue downsizing to weed out employees with obsolete skills that may not be useful in its future direction.

Consequences of Downsizing

However, there is evidence that downsizing can have adverse long-term consequences that some companies never recover from. Downsizing may actually increase the likelihood of bankruptcy by reducing productivity, customer satisfaction, and morale. Firms that have downsized are much more likely to declare bankruptcy in the future, irrespective of their financial health.

Losing employees with valuable institutional knowledge can reduce innovation. Remaining employees may struggle to manage increased workloads and stress, leaving little time to learn new skills—which can negate any theoretical gain in productivity. Losing trust in management inevitably results in less engagement and loyalty.

Because severe long-term consequences can outweigh any short-term gains, many companies are wary of downsizing, and often take a gentler approach, by cutting work hours, instituting unpaid vacation days, or offering employees incentives to take early retirement. Some companies also offer employees the chance to retrain themselves by subsidizing part of their tuition costs. In some cases, they also rehire laid-off workers after revenues stabilize.

Example of Downsizing

In the wake of the 2020 economic crisis and lockdown, many companies downsized their workforces due to the economic impact of government-ordered business shutdowns that were intended to slow the spread of the virus.

The airline and hospitality industries were particularly impacted, as people were confined to their homes and discretionary travel was all but halted for several months. After announcing in April 2020 that it would eliminate 10% of its worldwide workforce of 160,000—reportedly through voluntary layoffs, natural turnover, and involuntary layoffs—Boeing eliminated more than 12,000 U.S. jobs, including 6,770 involuntary layoffs, in May 2020. Boeing also announced that it had plans to layoff several thousand more employees, although it did not disclose when this would occur.

Boeing is one of the largest American plane makers, but it has been forced to restructure in the face of the 2020 economic crisis. In addition to the crisis, one of Boeing's jets—the 737 MAX—had been grounded in 2019 after a second fatal crash. In April 2020, the company recorded zero orders for the second time in 2020, and customers canceled another 108 orders for the 737 MAX. These two factors compounded created its worst start to a year since 1962.