Off with their overheads

The cut, cut, cut mentality is embedded in corporate culture. But what happens when costs can be hacked no further?

UNDER Sir Kit McMahon, Midland Bank led the way in taking its senior managers out of the field and basing them in head office as part of a massive effort to cut costs. Now, those same managers are returning to their positions in the branches.

Another strategic about-turn? Some old hands at the bank, now part of HSBC, think so. But it actually appears to be more than that: a realisation among top managers that the lowest-cost solution is not necessarily the best. Cutting may be a good idea when you are clearing up past mess, but it is a bad idea if all you are doing is damaging future prospects.

It is not a lesson many British or American managers have yet fully learned. The cut, cut, cut mentality is now deeply embedded in Anglo-Saxon corporate culture - every company says people are its greatest asset, but when life starts to get tough, again and again those "assets" are unceremoniously heaved over the side.

Professor Gary Hamel, visiting professor of strategic and international management at London Business School, has compiled a "Downsizing Hall of Fame", taking in such well-known companies as Westinghouse, Kodak, General Motors, Union Carbide and Du Pont. All have been aggressive in reducing "head count", but they are unlikely to make anybody's "most admired company" lists. "They tend to be a rogue's gallery of undermanaged or wrongly managed companies," he says.

It would not be difficult to compile a similar list of British firms. Hanson and most of the financially driven conglomerates, as well as GEC, would be well up on it. British Coal would have been on it - but it has cut itself out of existence. The clearing banks have had to prune because of technology and competition - but there is no doubt that they have now been thoroughly infected by the cutting bug.

Fortune magazine in the early nineties put it like this: "The chiefs of America's biggest companies seem caught in the grip of what might be called 'wee-ness envy' - my company's workforce is smaller than yours." Similarly, humourist Russell Baker observed in a New York Times column of the same time: "The boss of any large corporation that hasn't fired at least enough people to make up an army division has a lot of explaining to do to his buddies down at the CEO club."

Things are little better on this side of the Atlantic. Earlier this year, British Gas saw a l50 per cent upsurge in complaints caused in part by staff cuts. It is chopping 25,000 jobs, and there are suspicions that the quality of service is already suffering as result, including emergency gas leak cover. The company shows no sign, however, of reversing its policy.

Hanson has grown mighty on the back of its so-called ability to "manage decline". Most of its operations have been pared down to the bone in the drive for increased profits, but few suffered as much as Ever Ready, the battery maker it acquired at the start of its British buying spree in the early 1980s.

The conglomerate set the tone for the future by closing a research and development centre and shedding 900 of the company's 2,900 jobs. It was the first step in what one commentator describes as a campaign to make Ever Ready's decline "as extended and profitable as possible". By the time it was sold to US rival Ralston Purina for pounds 132m two years ago, Ever Ready's market share had slipped from more than 80 per cent to just 30 per cent. Ralston Purina also said Ever Ready's technology was 10 years behind! The real shame was that it was so unnecessary - firms that had invested in battery technology were buzzing along on the back of booming demand for electrically driven everythings.

In the US, the 1980s craze for leveraged buyouts forced companies to cut costs drastically. The Wall Street era was characterised by redundancies, morale- sapping pay cuts and a failure to invest in an effort to meet huge interest payments. The problem lies in an approach that marketing strategists call a "harvest strategy". Companies that cut costs while seeing no increase in revenue are in effect finding a way to sell market share profitably - something that Professor Hamel, a harsh critic of the preoccupation with cost cutting, calls a "no brainer".

As he explains in Competing for the Future, published last year with CK Prahalad, it all comes down to pressure to improve short-term financial performance as measured by return on investment (ROI): the ratio of net income after costs to investment, net assets or capital employed, which assumes god-like status among analysts crawling over a company's accounts.

Raising total income is "likely to be a harder slog than cutting assets and headcount". This requires senior management to think hard where new opportunities lie, anticipating customer needs, investing in new skills and the like. So it is far easier to cut jobs or flog parts of the company, as not only the break-up merchants but mainstream management has also been doing.

Professor Ham-el believes this method is so easy that "even accountants can do it", which perhaps explains why accountants are so prevalent in business management in the US and Britain. Both countries, it is widely agreed, have produced a generation of what he describes as lowest common denominator managers, who can "downsize, declutter, de-layer and divest better than any managers in the world".

It is thought that from 1987 to l991 - a period of economic growth - more than 85 per cent of US Fortune l000 companies reduced the size of their white-collar staffs. And since it is a rare profits announcement that is not accompanied by news of a restructuring of some sort, there is little reason to believe the picture was or is much different in the UK. Indeed, the thinking is so widespread that the phrase on everyone's lips at the recent annual conference of the Institute of Personnel and Development was "corporate anorexia". Professor Hamel claims to have invented the term to explain that just because companies are getting thinner does not mean they are getting fitter.

This is not to suggest that all cost-cutting is intrinsically bad. One has only to look at the nationalised industries of not so long ago to see how bloated and inefficient they were. PowerGen and National Power, the two non-nuclear electricity generators carved out of the old Central Electricity Generating Board, have cut their combined staff numbers from 25,000 to less than 10,000 since 1991 and generate as much electricity as they did before. And while British Gas is probably cutting too deeply, it undoubtedly had too many employees in its state-owned days.

Cost-cutting in Britain can be divided into eras. Until about 1980, there were not enough cuts. Post-bale out British Leyland employed more people in 1977 than it did when it went bust in 1975: that was daft. In 1980- 81 there was a violent recession accompanied by two million redundancies - most of them were driven by panic. Then came economic recovery and the onset of what gurus would later call "downsizing". Managers, terrified of expanding, took advantage of a union-crushing government to increase the size of their "wee-ness".

This led to a marked jump in productivity - but most of this came from cutting the wages bill rather than increasing income. There was pathetically little investment in new capacity in the mid-to-late 1980s, even though the economy was growing rapidly. As Professor Hamel puts it: "One half- expected to arrive at Heathrow one morning, pick up the Financial Times and find that Britain had finally matched Japanese manufacturing productivity - and that the last remaining person at work in UK manufacturing was the most productive son-of-a-gun on the planet."

The next era was the last recession. Balance sheets were in part protected because managers had become such astute cost-cutters - and companies that refused to cut, such as the aerospace and motor components giant Lucas, were punished in the stock market.

At least there is an excuse for cutting in recession. But, just as they failed to invest in the 1980s, British managers are failing to invest again. They are, indeed, continuing to cut. They are as one convinced that the current business climate is more difficult than anybody can remember (which is debatable, to put it mildly) and are ready to listen to management gurus and others who tell them they must not ease up just because they see the end of the recession.

Cost-cutting has become so addictive that management techniques such as Activity Based Costing and Business Process Re-engineering have been hijacked in its name. Both can be highly effective methods of ensuring that a business is concentrating on the areas that it should. But BPR, in particular, because it is often introduced in an atmosphere of "downsizing", has largely been discredited. Far from being seen as a way of refocusing a business on what it is trying to achieve, it is much more likely to be associated with finding ways of simplifying the process and so reducing the staffing requirements. Perhaps not surprisingly, it is reckoned to have failed in about 75 per cent of instances in which it has been used.

The plain truth is that in most cases cutting costs is not the way to salvage a company's fortunes. According to research from the US, the best predictor of whether a company will downsize in the coming year is whether it did so in the past year. According to another report, 57 per cent of organisations that reduce em- ployee numbers in this way end up replacing many of them almost immediately.

Nor do the desired improvements in productivity always arise. Surveys in the US suggest that only 22 to 34 per cent of restructuring companies increase productivity to their satisfaction. This is what leads to the downward spiral. Executives convince themselves that reducing the head count is the way forward, so that when it does not produce an immediate effect, they assume it is because they have not gone far enough. So they cut again, and so on down.

Similarly, it is not certain that profitability improves on the back of downsizing. Research by US academics quoted in an article by William McKinley, Carol Sanchez and Allen Schick, recently published by the Academy of Management Executive, discovered that net income relative to sales, return on assets and return on equity tend to increase in the first year following job cuts, but not in the next year. In no case out of the 210 surveyed did post-redundancy performance match the maximum levels achieved before.

So if the gains are at best temporary, why do companies continue to do it? The most common answer is that the US and UK financial markets like such expressions of firm leadership. Certainly, avid cost-cutters like Jack "The Ripper" Grundhofer, who, according to the Academy of Management Executive article, learned his firing skills at Wells Fargo before becoming chairman of First Bank System, are revered by many analysts. And announcements of job cuts are often greeted by strong rises in share prices.

But Professor Hamel says that to blame the markets is "a gigantic cop- out". The real reason for the continuing popularity of downsizing is an old chestnut: because everybody else is doing it. Organisations are forced to conform to institutional rules, to mimic the actions of the most prestigious members of their industries.

These are difficult forces to stop. But there are glimmers of hope on both sides of the Atlantic. McKinley, Sanchez and Schick quote PepsiCo chief executive Wayne Calloway as saying: "You can't save your way to prosperity. That alone won't get you there." And Neville Bain, the New Zealand-born chief executive of Courtaulds, the textiles group that has shed more than 5,000 people while reporting patchy profits in the past five years, laments the fact that too many managers coming through the system just know about "hacking and chopping".

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