No one likes to do layoffs. Even under the best circumstances, when layoffs are done over time and with some degree of planning and due diligence, they can be a challenge. As a layoff strategist, I, of course, recommend this more scientific approach. But unfortunately, in the real world, firms are often forced to shed “headcount fat” rapidly, with little or no planning or preparation. Well, if you’re a senior manager faced with the need to cut costs “by Wednesday,” this is how it’s done.
NOTE: The calculations here are detailed, so this piece might not be “easy reading” unless you are serious about layoffs.
Calculating the Amount of Costs That Need To Be Cut
- Dollar cuts in costs needed. Start by calculating the estimated dollar cost overrun (also known as “revenue shortfall,” which is the excess of costs over revenue) for the last six months. Then double the amount to get an amount to be cut during the next year.
The initial dollar amount that must be cut: $______________
- Calculate the current rate of growth in cost overruns. Because the rate of loss may have been increasing during the last few months, you must also calculate the rate of growth of your firms cost overruns (losses) over the last six-month period. Do that by converting each month’s dollar loss into a percentage of total revenues for that month. Then calculate the average percentage of the cost overruns for the first three-month period (of the last six months). Calculate it by adding the percentages for each of the three months together and then dividing by three. Compare the result to the average percentage of the overrun from the most recent three-month period. Multiply the total cost overrun amount (from #1 above) by that growth rate.
When the current growth in the rate of losses is increasing, the total dollar amount that must be cut for the next year must be increased by this amount: $_____________
- Forecast whether there will be a change in the rate of growth in cost overruns. Because the rate of loss may increase during the next year you must also extrapolate (forecast) the growth rate in cost overruns. Start with the revenue forecasts compiled by the finance or sales department and see (assuming all things remaining equal) if the rate of increase in cost overrun percentage will be increasing over the next 12 months. If you don’t have sales forecasts, assume cost overruns will get 12% worse (a 1% increase in cost overruns each month) for the next 12 months. Finally, multiply the final amount of projected cost overruns at the end of #2 by the difference in the percentage that the forecasted growth rate in #3 exceeds the current growth rate in cost overruns (which was identified in #2.) This will give you the total additional dollar amount that must be cut next year due to any projected increased future rate of growth in cost overruns: $______________
A. Final amount to be cut. The total dollar amount that must be cut is the amount from #1, plus the amount from #2, plus the amount from #3: $______________ Where Should the Cuts Come From?
- Reduce the amount that needs to be cut from costs by the projected savings from cutting “other” expenses. Calculate the average expense per employee (total variable expenses divided by the number of employees). Next, assume you can cut expenses 10% with little damage. Also, assume for each person that is laid off that you will save his or her expenses (their per-employee expense costs). Add the two numbers, but reduce the amount by 20% (because the estimated cost savings from the proposed cuts in supplies, equipment, travel, paperclips, etc. is almost always lower than what is forecast). The dollar amount to be cut from expenses totals: $______________
- Reduce the amount needed to be cut by slashing overhead costs. Tell the overhead managers that they must cut their departments’ costs by 20% if you are a large firm (and 10% if you are not). As a start, require that half of the overhead cost cutting must come from a 10% across the board cut in all overhead budgets. Next, have each overhead unit make a list of the key services and programs they currently offer. Next to each put its approximate cost (as a percentage of all overhead costs, or as a percentage of that overhead function’s budget). Then have the top two managers from your top performing business units and the one from the bottom performing business unit (based on profit goals met) act as a team to force rank the overhead programs. The other half of the overhead cuts (10%) must come from eliminating entire programs and services. Do it in reverse order of the ranking results (from the manager’s forced ranking). Give the overhead managers discretion in adding back a single “soon to be impressive” program or service, if they take out an equivalently, ranked one so that the total costs reduced remains the same (i.e. 10%). The dollar amount cut in overhead costs in this section totals: $______________
B. Reduce the total amount in item A above by the amounts in both #4 and #5. Costs associated with layoff administration
- Calculate the budget for the administration of the layoff process.This includes added staff, consultants, and legal advice.
- Calculate the total “after” layoff costs. The total calculated amount per employee to be spent on outplacement, counseling, extended benefits, closing facilities, retraining, and redeployment multiplied by the number of employees to be laid off (to be determined below).
C. Next, add back costs associated with the administration of the layoff process in #6 and #7 above to the amount in item B. Total dollar cuts to be made: $________________ Cutting People Calculate the remaining costs that must be cut from people costs. The remaining cuts (the amount from item C above) must come from people cuts. Calculating How Much Each Individual Employee Costs
- Average benefits. Calculate the average percentage of employee benefits as a percentage of the average employee’s total salary.
- Salary. Give each manager a list of his or her employee’s individual salaries.
- Total salary and benefits cost. Multiple the amount in #9 by the percentage in #8, and add it to total salary to get total salary and benefits costs for EACH individual employee.
- Add in bonus. Next, add to the amount in #10 any bonuses the employee earned last year.
- Severance package. Calculate the severance packages to be offered for each employee if they are selected for layoffs (normally one to three months’ salary). Add that amount for each individual employee to the amount in #11.
- Total cost per individual. Use this as the total costs savings for each individual employee (8,9,11 & 12) if they were laid off next year
Who Should You Actually Let Go? This is a tough part of the process. At a minimum though, follow these basic rules:
- Avoid giving managers a headcount number to cut. They might fire people and rehire them as more expensive consultants. Force them to cut people and save a specific amount of dollars from total people costs. Insist on actual dollar reductions in money spent on people and people services (salaries as well as consulting, outsourcing, etc.). In addition, make sure that 90% of any unit’s cost cutting comes from eliminating positions, not cutting supplies, training, travel, and equipment. Cutting just supplies too much will handicap the “surviving” employees’ productivity.
- Exempt key business units. Have your CEO or executive committee identify the top performing (such as top 33%) business units or key divisions. Exempt these business units from job cuts, with the exception of the bottom performing five percent in non-key jobs, who must be let go and replaced with new hires. Identify business units that are currently, or will soon be, in a “commodity” business. Because they will need a low-cost structure to survive, they are NOT exempt from layoffs.
- Exempt key jobs. Identify key jobs by asking each business unit manager to identify the 10% of their jobs that are essential for success. Exempt those jobs from cuts regardless of the division or business unit they fall under.
- Exempt top performers. Have managers identify the top five criteria for assessing performance in their business unit (with guidance from HR to avoid adverse impacts). Then require managers to force rank the top 20% of their employees. Wherever possible, get a second verifying ranking from one of the following sources: performance/output data, percentage of bonus received, a forced ranking by other employees, or standard performance ratings.
- Sales force. Cut the bottom 10% of the sales force (as ranked in meeting their sales goals). Then refill those 10% with higher quality people. There is a productivity impact, but no cost savings here.
- Managers. Cut the bottom 10% of your managers (as ranked in meeting their management goals or on the percentage of bonus target they met). Then refill those 10% – half internal promotions and half external with better quality external people. There is a productivity impact, but no cost savings here.
- Weak business units. Have the CFO identify the bottom performing (33%) business units or key divisions. Require them to cut 20% of their jobs off the top.
- Bottom performers. Just as you should do in assessing exemptions for top performers, have managers identify the top five criteria for assessing performance in their business unit (with guidance from HR to avoid adverse impacts). Then require managers to force rank the bottom 20% of their employees. Where possible, get a second verifying ranking from one of these sources: performance or output data, percentage of bonus received, a forced ranking by other employees, or standard performance ratings. Layoff or fire for cause these 20% from all business units except the top-performing 33%.
- Easy to replace. Identify easy to replace people and positions (have HR identify ease of recruiting and the performance of replacements). They are not exempt from layoff except in top 33% business units.
- Calculate the cost savings from the targeted individuals in #14-#18 and deduct it from the amount in C) above. Remaining amount to be cut: $_________________
- Middle performers in non-key jobs that are easy to replace. This is the target audience for your remaining layoffs. Have managers in the bottom two-thirds of your business units select employees until cost targets are met.
Quick and Dirty Options for Cutting Headcount
Here are a few quick and dirty options for cutting headcount quickly.
- If the above calculations are too daunting, you should have a fallback approach. If all else fails, cut the top performing departments (the ones that exceeded the average number in the percentage of their departmental goals that were met) by 5% and the rest of the departments by 15%. The average of a 10% cut is enough to show you are serious, but not too much to shock the shareholders and customers.
- If you weaken more, go with a “headcount cut.” Here you calculate the cost savings for cutting an “average” employee (take the total company’s salary and benefits expenditures last month and divide that by the total number of current full-time employees). Then divide this average salary/benefit costs amount into the total cost savings from people you need to achieve. Next, cut that number of “heads” across the board but exempt the top 10% performing divisions.
- Don’t do any calculations and just cut all departments headcount by 10%.
Before you announce anything, have your CFO, HR, and legal team review your plan and layoff list. Measure and quantify any potential legal impacts and risks. Then have your top business unit managers review it for any potential business impacts.