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. 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 which 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 consequence 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

Chipmaker Taiwan Semiconductor Manufacturing Co. (TSMC) laid off about three percent of its 23,000 strong workforce after its revenues crashed due to a mix of factors in the first quarter of 2009. It also forced employees to take unpaid leaves to cut costs. During the second quarter of 2009, the company's revenues jumped by 80 percent and its factory utilization rate also showed an increase of 40 percent. As a result, it hired back 700 workers that it had fired earlier.