Introduction

In this guide on workforce reduction, we will discuss:

• What is a workforce reduction
• How to plan for a reduction in your workforce
• Three key pieces of information that you need
• Five steps to prepare your workforce reduction plan
• Workforce reduction strategies in a downturn economy
• How a reduction in headcount can affect employees

What is a workforce reduction

A workforce reduction refers to decreasing the number of staff in an organization. The main reasons for this are usually to improve operational efficiency or cut costs. Unfortunately, people represent a large cost in many companies. Therefore, when times are tough companies will look to save costs through staff reductions (which have been a frequent occurrence in 2023).

How to plan for a reduction in your workforce

If you are reading this guide, then it may be a difficult time for your organization. The first step is to share this understanding with your workforce, as you work through the options available to reduce headcount.

The key thing is to foster a culture of transparency. This does not mean every little detail, but be up front when things aren't going well, because odds are that employees will know anyway. Therefore when it comes to the announcement of cost cutting you can maintain your employees trust. This will especially help with retaining top talent, which is critical to the future success of your organization.

Before getting started, there are a few key pieces of information that Management should equip themselves with outlined in the next section.

Three key pieces of information that you need

Planning for a workforce reduction can be overwhelming. Focus on gathering these three pieces of information to start out on the right foot.

1. Baseline

The most important piece of information is the baseline number of Full-Time Equivalent ("FTE" check out our blog here), people costs, and outsourcing costs. The baseline is the starting position from which the reductions will occur.

In your calculation of FTE you should include all employees, contractors, volunteers and the number of people supporting you at outsourced providers (note: you may need to contact them).

People costs typically include salaries, bonuses, employment taxes, health insurance, and all other employee benefits. Basically, include all costs that are related to people in your organization. You can even include training costs, which will typically be lower when headcount is reduced.

To get this information you will need input from your Human Resources and Finance teams (so get to know your Finance and HR managers now).

2. Benchmarks

Now that we have the baseline, we need to compare this to something in order to determine the efficiency of the business. Enter internal and external benchmarks.

Internal benchmarks are typically for larger businesses which can be split by country, region, or a subsidiary. Through comparing the number of employees in these smaller groups, Management will be able to identify which parts of the business are more efficient.

Meanwhile external benchmarks are relevant for all businesses. They are used to measure the performance of a business, or part of a business. However, the key challenge is that benchmarking data can be hard to source, so Management sometimes skip this step and go with their gut feel.

Looking for external headcount benchmarks? Search here with CompanySights

This is a common mistake that can have long term negative consequences for a business. With headcount benchmarking providers such as CompanySights, Management should always be taking a data-driven approach to layoffs.

3. Employee sentiment

This will require an employee engagement survey and view of overall performance by function to get a feel for the company culture (typically sourced from performance reviews). Your team of HR professionals will likely summarize this information for you because it can be highly sensitive.

This qualitative information is often overlooked by Management because of it's subjective nature. However it is critical to understand this before you reduce workforce in specific areas, so you can anticipate how much effort will be required to improve productivity and culture with remaining team members.

Five steps to prepare your workforce reduction plan

1. Split functions as profit or cost centers

A profit center is a part of the business that generates revenue, while a cost center is a part of the business that only incurs costs. By nature reducing headcount in profit centers can have a higher risk of negatively impacting revenue moving forward. Most commercial functions such as Sales, Marketing, and Customer Support are typically categorized as profit centers.

Nearly all other functions are cost centers, such as the supporting functions of IT, Finance, Legal and HR. It is these cost centers that have an indirect relationship to revenue that mean Management typically focus on cost centers first for people cost savings. However, it is very important to note that cutting too deep in these functions will eventually restrict the ability of the profit centers to generate revenue.

In this step, simply categorize the functions in your business as either a profit center or a cost center.

2. Benchmarking

First, calculate the revenue per employee in your organization. Then compare this to the industry average (tip: use CompanySights free search for revenue per employee benchmarks per the image below). With these data points you will be able to confirm the overall efficiency of your workforce. This is important as it will set the tone for the rest of the workforce reduction plan.

The next level to benchmarking is to split the company FTE by function (remember the baseline information that you gathered?), and compare these levels to external functional headcount benchmarks. This will help steer the layoffs to functions which are less efficient, and therefore more suitable to headcount reduction (usually through the reprioritization of tasks and improvements to operational processes).

The goal of this step is to note down whether headcount by function is in the 25th percentile, mid-range, or 75th percentile of the benchmarks.

3. Rate the employee sentiment levels

Draw up a scale from "very positive" to "very negative" to rate the sentiment of employees by function. As mentioned in the information gathering section, it will be important to get input from your HR team to perform this exercise.

4. Set the overall Workforce Reduction target

This is more of an art rather than a science. In fact, I have seen many different methods and influences that drive the target number over the years. Useful data points for working this out in your organization include:

Revenue per employee ("RPE")

How far are you from the median RPE external benchmark? Divide the latest annual revenue of your company by the median (or 25th percentile) benchmark and compare this resultant headcount figure to your baseline FTE.

If your baseline FTE is higher than the benchmark, then the variance can be a helpful starting point for the potential reduction in terms of the number of affected employees.

Monthly net cash deficit

This is the difference between the opening and closing amount of cash in the company's bank account for the last month (or average difference for the last three months - choose whichever is higher). This method assumes the closing balance is less than the opening balance.

Multiply this monthly figure by 12 months and then divide it by the average fully loaded cost of an employee in your business. This resultant figure is the amount of cost (presented in terms of the number of affected employees) that you need to remove from the business to break even from a cash perspective. It is typically the minimum headcount reduction target to get the business back on track.

Like any big decision, the overall staff reduction target usually takes a bit of time to fully consider and agree upon. It can be helpful to provide a target range rather than a fixed amount, to factor in the uncertainty surrounding the situation. For example, this could be 20%-30% in overall workforce reductions.

5. Bring it all together

This is a lot of really useful information and analysis, but the real value for decision makers comes from when you bring it all together in a simple format. Prepare something like the table below:

Equipped with this table, Management can have data-backed discussions to determine where and how many heads are to exit the business by function.

Workforce reduction strategies in a downturn economy

Workforce reductions are a common occurrence in a downturn economy (a.k.a. recession). This possibility can add stress and anxiety to current employees, even if it is only a temporary layoff on the horizon. The most common strategies to mitigate the impact of layoffs in a downturn economy include:

• Hiring freeze - Use the power of a hiring freeze combined with natural attrition to avoid paying severance benefits, meaning that you do not backfill roles where people have resigned (unless it is deemed critical to business goals, a particular team or process).
• Reduce hours - Management can lower costs by reducing the average number of work hours in a week and therefore quickly reduce costs. This was a common strategy in the hospitality sector at the beginning of Covid-19, with many staff going from five to four or even three day work weeks.
• Voluntary layoffs - There will likely be a population within your workforce that will be happy to find a new job (or have a long vacation). Offer them the chance to do so, then your company can save labor costs quickly without the risk of upsetting high performers.

How a reduction in headcount can affect employees

Layoffs impact all employees in an organization. Terminated employees are likely to be upset, anxious, or both (based on common feedback from exit interviews). Providing proactive and clear communication can really help, especially around notice periods and severance packages.

Remember to show compassion and empathy to these people. Not just because we are all human, but also because some will go and write reviews on websites like Glassdoor. You want these to be as positive as possible to attract top talent when it comes to new employment opportunities in the future.

The remaining employees may not feel secure or motivated. In order to avoid turnover contagion, the worlds best companies invest time and effort to improve employee trust following a round of layoffs. This is especially true for retaining those key employees with a critical skill set.

Conclusion

In this guide, we have walked through the difficult task of planning for layoffs. It is a process that no one enjoys, but many have to go through in life. Remember to plan using real data, communicate clearly, and show compassion to minimize the impact for all of those involved.

Looking for headcount benchmarks? Search here with CompanySights