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In Defense of Downsizing

Sometimes layoffs are the only choice.

Mar 15, 2010, Vol. 15, No. 25 • By ANDREW B. WILSON
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Is corporate America downsizing itself to death? So you would think from watching Up in the Air, the popular movie starring George Clooney as a “downsizing expert” who racks up more than 10 million frequent flier miles going from city to city to terminate an endless parade of desperate employees.

In Defense of Downsizing

Scholarly support for this view comes from Jeffrey Pfeffer, professor of organizational behavior at Stanford University’s Graduate School of Business and the author of a February 15 Newsweek cover story entitled “Lay Off the Layoffs.” An “overreliance on downsizing” as a means of improving corporate performance, he writes, “is killing workers, the economy​—and even the bottom line.” 

Pfeffer cites Southwest Airlines as a model for how other airlines and businesses ought to behave during economic downturns. Following the events of September 11, 2001, Southwest resisted the “urge to downsize,” as Pfeffer calls it. Southwest did not lay off a single employee. In fact, it expanded and was rewarded with making a profit in the midst of the worst contraction in aviation history.

One may applaud Southwest Airlines on the successful execution of a gutsy and aggressive strategy. But is Pfeffer right in suggesting that other big airlines should have followed suit? The short answer is no.

To revisit some of the pertinent facts: After reaching a high of $93.6 billion in 2000, passenger revenues for U.S. airlines as a whole plunged to $80.9 billion in 2001 (the year not just of 9/11 but of the big dot-com bust) and to just $73.3 billion in 2002—a staggering 22 percent decline. Over the same two years, employment at U.S. airlines declined 11.6 percent—only half as fast as the decline in revenues. If anything, U.S. airlines were slow to pull the trigger in sending out pink slips.

With the strongest balance sheet and the lowest cost structure in the industry, Southwest was able to expand in a shrinking marketplace by moving into a small portion of the vacuum left by higher-cost carriers that were hemorrhaging cash and forced to retrench. While other carriers shed nearly 80,000 jobs between 2000 and 2002 and reduced available seat mile capacity by 8.5 percent, Southwest added 4,400 jobs and increased its capacity by 15 percent. In the process, Southwest’s share of total airline capacity rose from 6.3 percent in 2000 to 7.7 percent in 2002.

Pfeffer wrongly states that Southwest was the only airline to take this approach. In fact, two low-cost, low-fare upstarts—JetBlue and AirTran—expanded even more aggressively and also made money. More to the point, however, in lambasting layoffs as both cruel and unnecessary, Pfeffer ignores the harsh reality facing the established carriers. 

U.S. passenger airlines as a whole had negative net profit margins on total revenues of 7.2 percent in 2001 and 10.6 percent in 2002. They were losing more than ten cents on every dollar of sales in 2002. Without aggressive downsizing, they would not have been able to meet their payrolls. They would not have survived (and some did fail). 

“Layoffs don’t increase individual company productivity, either,” Pfeffer asserts. But recent history in the aviation industry provides overwhelming evidence to the contrary. As a group, U.S. airlines are far more efficient today than they were eight or nine years ago. Sales per employee have risen more than 60 percent since 2002. At the same time, the cost of labor, measured in cents per available seat mile, has been reduced by more than 25 percent—going from a little more than four cents per mile to under three cents. Unfortunately, over the same time, the cost of fuel has shot up from a little more than one cent per mile to more than three cents per mile. For the first time, the cost of fuel equals or exceeds the cost of labor.

According to the Newsweek article, 

A study of 141 layoff announcements between 1979 and 1997 found negative stock returns to companies announcing layoffs, with larger and more permanent layoffs leading to greater negative effect. An examination of 1,445 downsizing announcements between 1990 and 1998 also reported that downsizing had a negative effect of stock-market returns.

But to anyone who has lived through a major downsizing, all this is to state the incandescently obvious. Companies do not lay off huge numbers of people unless they find themselves in deep trouble.

With unemployment hovering at close to 10 percent and millions of people fearful of losing their jobs, it is easy to depict the CEOs and human resource directors of major (or, for that matter, smaller) companies as the cruel and heartless architects of much of today’s economic pain and suffering. But it makes no sense to do so. 

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