In today’s Finshots, we explore why tech companies across the world are resorting to layoffs

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The Story

Only one thing dominates every headline today — layoffs!

Meta, Microsoft, Amazon, Alphabet, Spotify, Yahoo, Twitter, and Zoom have all handed the pink slips to 5–20% of their workforce. And the list keeps getting longer and longer each day.

But why’s this happening?

Well, there are multiple theories. One theory is that these companies are bracing for the worst. A recession, so to speak. And when that day comes, they want to be as nimble as possible. Trim the fat, cut the excess and run a lean organisation to survive the winter. But there’s also another theory. A theory that argues that tech companies are simply doing this because they can. After all, some of these companies are sitting on piles of cash and they could easily weather the recession if it came to that. But they’re still going ahead with the layoffs because it’s okay to let go of a few employees and pad the bottom line some more. Everybody is doing it. So the damage is limited.

But before we dive deep into both theories, let’s look at all the damage layoffs inflict on the employees and the company itself.

First, there are the intangibles. One study pointed out that being handed the pink slip is the 7th most stressful event in a person’s life. Going through such a traumatic experience breaks trust. And that could affect the pool of high-quality potential candidates who are looking to join these companies. They’ve seen the way employees are treated and they don’t want to live through a similar experience.

Then there are the immediate costs to the company. Alphabet’s layoff cost is estimated to be around $2.5 billion. Meta and Microsoft will shell out nearly $1 billion. This is because companies typically dole out standard severance packages. There’s cash payouts for unused vacation days. And a whole bunch of other stuff that costs some more money.

And finally, there’s the long-term impact. Or the domino effect. Visier, a human-resources analytics company, found that when employees are let go, the chance that their teammates will also leave increases by nearly 8%. When attrition increases, companies have to find replacements for these folks. And it can cost nearly 2 times the employee’s annual salary. It could be because they have to pay a higher salary for a new recruit. It could be the training costs involved. A myriad of things.

Even the survivors go through a 20% decline in their productivity and performance. They become disenchanted with their jobs. And this could hurt innovation and new product development in tech companies. That’s what research tells us anyway.

So the singular question is — do layoffs actually improve profitability then?

The answer is complicated! Researchers pored over company data spanning two decades and didn’t find any clear evidence to conclude that layoffs actually added value.

So you have to ask again — Why on earth do companies resort to layoffs?

See, in 1976, capitalism changed forever. Two researchers published a paper titled ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’ in the Journal of Financial Economics. The authors believed that professional managers who ran companies were only concerned about themselves. They didn’t care about the real owners — the shareholders.

People took notice of this paper. Especially CEOs who were just starting to stamp their authority. All of them swore up and down that the most important thing a business could do was to maximise shareholder wealth. And two people who lived and breathed this credo were Roberto Goizueta of Coca-Cola and Jack Welch of General Electric. Both of them took the over in 1981 and flipped things around. They focused on shareholder wealth — The era of ‘shareholder capitalism’ had begun.

And what do shareholders most care about?

Stock price performance!

Remember that letter from hedge fund manager Christopher Hohn that went viral recently? He’d asked Alphabet to resort to even more job cuts. Now of course he wants to ride a quick share price surge if that were to happen. So you can understand his motivation.

Anyway, since a large part of CEO compensation is tied to stock prices, they too make choices that focus on this one metric. Ones that are invariably short-sighted. Like layoffs which create an optical illusion of efficiency but don’t seem to actually help in the long run. And when shareholders celebrate and stock prices jump on such announcements, they believe that it’s the correct decision. Even if hard data says otherwise.

In 1979, less than 5% of Fortune 100 companies announced layoffs despite the US heading straight into a recession. But in 1995, almost 45% of these companies handed out the pink slips. CEOs simply feared that a recession was on the cards. Even though it didn’t really materialize.

So yeah, that’s the practice that continues to this day.

Then there’s a psychological theory. Stanford professor Jeffrey Pfeffer calls it social contagion.

And it’s a fairly provocative idea because he’s essentially saying, “Look, companies have a massive amount of data on their hands when it comes to hiring. And firing. But, when it comes to actually making decisions, they just copy what peers are doing.”

When the tech boom began in the midst of the pandemic, everyone hired in a frenzy. They believed that good times will keep rolling. No one knew exactly for how long. But if peers were hiring, you didn’t want to be left behind. You wanted top talent too. And you’d pay through your nose for it. Everyone was taking notes from the same playbook. And if they didn’t have the playbook, they just copied the others.

Now that the tide has turned, everyone’s following the herd again. The future is ambiguous. You overhired and now you need to trim the excess. And you don’t really have hard data to tell you that if you fire x% of employees, you’ll be fine and dandy. So you look around and see your peers, the tech giants, laying off 5–7% of their workforce. You think that the ‘sweet spot’. So you do it too.

You’re just jumping on the bandwagon. No one can blame you for going with the herd.

And as the Wall Street Journal points out, even CEO explanations for the layoffs seemed to be a part of this ‘social contagion’. The communication is pretty much a copy-paste template.

“I got this wrong,” said Meta Chief Executive Mark Zuckerberg, “and I take responsibility for that.”

“We hired too many people,” said Salesforce Chief Executive Marc Benioff, “and I take responsibility for that.”

“I grew the company size too quickly,” said former Twitter Chief Executive Jack Dorsey. “I apologize for that.”

But most of these tech giants who say they overhired aren’t really in a financial crisis. They’re all making money.

So there you go. The dirty secret behind these layoffs could simply include — shareholder capitalism and social contagion!

Until then…

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