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Big Employers Cutting Their Own Throats

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Like laboratory mice pushing the same button over and over again to get food, corporate executives often resort to the same tried-and-true tactics to try to help their stocks recover. What has worked in the past, however, is likely to backfire on them this time around.

You don't have to follow financial news closely to know that corporate America has been bleeding jobs left and right. Just this week, thousands of workers have gotten pink slips, with equipment-maker Caterpillar (NYSE: CAT  ) topping the list at 20,000 jobs lost. Starbucks (Nasdaq: SBUX  ) , Target (NYSE: TGT  ) , and Time Warner's (NYSE: TWX  ) AOL unit also added themselves to the long list of employers who've recently announced significant job cuts.

What's going on?
The layoffs seem like a natural reaction to falling profits. When times get tough, businesses look for ways to cut costs. Especially when business demand is down, reducing a company's workforce has an immediate and usually substantial impact on the bottom line -- which appeases investors and tends to boost share prices.

Or at least, that's how things worked in the past. The problem today, though, is that the economy is in a prisoner's dilemma. Companies rushing to minimize their individual losses are creating unintended consequences that will eventually do far greater damage.

Go ahead, everybody's doing it
When the economy is strong, a struggling company can take action on its own without worrying much about what its cuts will do. When Ciena (Nasdaq: CIEN  ) laid off workers in 2004, it only had to worry about whether its own business and the telecom industry in general would recover. When both did, shares soared.

The same goes for Charles Schwab (Nasdaq: SCHW  ) and its troubles five years ago. Once it emerged from the shadow of the tech bust, the discount broker returned to its roots and thrived in the midst of a huge economic expansion.

But now, everyone is trying to eliminate jobs at the same time. As a result, the typically beneficial effects of layoffs will quickly get overshadowed by the downward spiral that those layoffs trigger.

Businesses need customers
In the classic version of the prisoner's dilemma, two prisoners can either keep silent or confess. If they both keep their mouths shut, they both go free. If they both confess, they go to jail. But if just one confesses, the blabbermouth gets a much lighter sentence than the one who stayed silent.

With jobs, the dilemma is similar. If just a few businesses lay off workers, other companies can pick up the slack without too much effort, overall demand in the economy doesn't suffer, and the result is a big positive for the cost-cutting companies. But if a whole bunch of jobs get cut all at the same time, then you suddenly have a huge mass of unemployed workers who can no longer afford to buy the goods and services they did when they had jobs, and then everyone feels the effects.

If the layoffs are large enough, the problems can ripple outward throughout the economy. The businesses that used to serve laid-off workers will themselves have to cut back, and the cycle will continue.

Where it stops
The possible solutions are few and difficult:

  • Businesses can try to find a market for their products whose demand won't be affected by layoffs. For instance, a foreign car company like Honda (NYSE: HMC  ) can make workforce reductions in Japan without any impact on American demand. But laying off workers in its U.S. plants does potentially affect demand.
  • Company management has to recognize that although keeping on workers may not maximize profits in the short run, the long-term consequences of shedding those workers will exceed the near-term benefits for their core businesses. That's contrary to the way most managers have been trained -- and more importantly, it relies on other businesses to act the same way.

To me, it seems unlikely that companies will be able to cooperate enough to keep from pushing the economy further downward. Eventually, someone will find a way to put all this newly available labor to productive use. But until that happens, you shouldn't expect a lasting economic recovery to take hold.

For more on investing in a tough economy, read about:

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Fool contributor Dan Caplinger has never been a prisoner, though he often faces dilemmas of his own. He owns shares of Starbucks, which is also a Motley Fool Inside Value pick and a Motley Fool holding. Charles Schwab and Starbucks are Motley Fool Stock Advisor selections. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy is always willing to stick its neck out for you.

Read/Post Comments (6) | Recommend This Article (27)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 29, 2009, at 2:01 PM, wlmwillson wrote:

    It would be interesting to interview the CEO's of the companies announcing large layoffs and ask them to describe why they choose to target employees instead of costs. As an enterprise expense reduction consultant, we typically get 50% of the target by eliminating worthless cost as recommended by the employees before targeting staff. When we're done at least the employees know they were involved and listened to. Just sending people home without eliminating the work means everyone is miserable, those who lost their jobs and those that now have to do their own job and that of the people wholeft. I have a friend who is a long term employee of a large airplane maker. Their only requirement for layoffs is to send in the names. There isn't even a hint of a requirement that they eliminate any work.

    When things turn around, people will remember.

  • Report this Comment On January 29, 2009, at 6:06 PM, BigDog2all wrote:

    Hmm... I seem to remember saying the same thing when all of the Tech sector jobs migrated... or should I say stampeded off-shore. With so many layoffs happening within the techno-geek community, who was going to buy those whiz-bang gadgets? Certainly not the person in India making a tenth (in those days... but not anymore) of the salary of the worker who just got laid off... why was the Tech sector so hot to make a sub $200 laptop that people could use in their thatched huts in Africa when there was no infrastructure to support it? Just because there are people there, that doesn't make it a good idea to try to sell or even give them a computer! Put the money to good use... like stopping disease and hunger in the third world... we all learned to crawl before we could walk! DUH!

  • Report this Comment On January 29, 2009, at 6:15 PM, FoolKMP wrote:

    I say layoff the top 5 levels of management in any company given a bailout. Huge cost savings there. No severance, golden parachutes, nada. Don't let the door hit you in the ass.

  • Report this Comment On January 29, 2009, at 9:38 PM, thebruzer wrote:

    It happened at GE while I worked there (1979-1993), At the beginning of my tour of duty, Reggie Jones's leadership team treated employees as assets. By the time I left, the Jack Welch team had shifted employees to the liability side of the balance sheet. All that mattered is what their salaries and benefits cost the company. Never mind what those laid off employees knew about the company, and its suppliers and customers, and how it did business. Never mind about the good will lost in the process. Never mind that a unit within the company had enough money to pay for the people needed to do the work. It was all about head count.

  • Report this Comment On January 29, 2009, at 9:54 PM, TrailerParkJawa wrote:

    It doesnt seem a lot of analysis is done when mass layoffs occur. Even profitable units will be let go simply beacuse the upper management has a number in mind. Why 10%? Why not 7.5% plus turning out the lights at night and getting rid of some perks.

    Another down side is that if you lay off too much talent, they might end up working for the competition. So cut wisely.

  • Report this Comment On January 29, 2009, at 10:49 PM, unruhg wrote:

    The biggest expense a company has is its employees. If a company wants to trim costs fast they trim the largest expense line on their balance sheet and that is human capital costs. There are no other expense costs a company has that can achieve has much savings as fast as trimming the workforce. Plain and simple.

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