The Real Cost of the Virtual Workforce

Imagine meeting someone and falling in love. You tell the person, "I care about you and want you to be with me. Come be with me, take care of me, be loyal to me and devoted to my interests--and by the way, when I find you no longer interesting or useful, you're out." Let me suggest that this is not likely to be a very effective personal pick-up line. Nor is it a very effective corporate pick-up line, even if it is what many organizations are implicitly (or explicitly) saying to their workforce.

By Jeffrey Pfeffer

Reprinted by permission of Harvard Business School Press. Excerpt of The Human Equation: Building Profits by Putting People First by Jeffrey Pfeffer.

Copyright © 1998 by the President and Fellows of Harvard College. All rights reserved.

IN THE RECENT PAST, employees went to work for an organization expecting to stay with that employer if things worked out. The traditional, implicit "employment contract" was that if people worked hard and remained loyal to the organization, they would have careers and a long-term future in that organization, barring some economic catastrophe. Today, mobility across employers and even industries is expected. Downsizing, outsourcing, and the externalization of employment--the use of contingent work arrangements--reign supreme.
      The so-called "new employment contract" has redefined the relationship between organizations and their people. No longer do firms, particularly in the United States, offer the prospect of long-term employment in return for good performance and effort. No longer do firms think it wise to provide a career inside the company with all that implies, such as a sequence of positions and training and development opportunities. The word today is "employability"--organizations promise challenging jobs and interesting assignments that will help people build their skills but offer no long-term promises of a career. Instead, the only promise is that the work and the skills acquired on the job will help to make the people more employable if and when they have to leave. Meanwhile, there is the implied threat that since the organization won't look out for your interests anymore, you should look after them yourself.
      At Sun Microsystems, following layoffs in 1991, the company decided it wanted to foster "career self-reliance" and "career resilience." Sun established a partnership with an outside vendor to provide career services on site at various Sun facilities in the San Francisco Bay Area. Employees of this outside vendor meet confidentially with Sun employees to offer counseling and assessment of current skills, values, and interests, and to provide guidance on training and help in meeting work-family balance. What stuns me is that organizations are surprised by the consequences of all this. Although individual employees probably appreciate the career help, it is not at all clear that the firm itself has done something sensible. Having told people they need to be "career self-reliant" and after providing them the resources to be so, the companies are then surprised when they face the turnover that their very programs have helped to foster. I recall some years ago talking to a person who worked at human resources at Apple Computer, one of the firms that pioneered the idea of "employability." When this person was complaining about the turnover in the organization, I noted that the organization had told employees they would not offer them a career but rather the opportunity to "get ready for their next job." The consequences are not necessarily what Apple, Sun, or similar organizations either wanted or expected.
      Unfortunately, managers tend to take the view that all is for the best in this best of all possible worlds concerning these employment arrangements. They assume that what exists must be efficient and effective because otherwise it would not exist and believe that organizations adopting particular employment arrangements are doing so on the basis of sound reasoning and evidence. Worse than that, organizations tend to be followers of fads and fashion. If it is in fashion to have a virtual workforce with little attachment or connection to the firm--because everyone is doing it--then organizations follow the lead and fre- quently adopt practices even if they do not make much sense. Similarly, if many firms are downsizing and laying off employees, social pressures lead managers to do so also, almost regardless of the rationale or the consequences of these workforce reductions.
      The existing empirical evidence is inconsistent with the view that, for the most part, firms are adopting new labor force management practices strategically. Rather, what the data portray is an unplanned, haphazard approach to managing the employment relationship. This ad hoc character of managing people must certainly negate much prospect of achieving profits through people. A colleague teaching in a human resources executive program at Stanford on the subject of contingent work arrangements asked the almost 50 executives whether and how they evaluated these practices. Many of them did not measure their effects at all, and those that did relied virtually exclusively on the impact on direct labor costs, with little or no consideration of the consequences for quality, productiv-ity, customer relations, or other important outcomes. I have yet to encounter any evidence that contingent work arrangements are implemented in most organizations in a thoughtful, stra-tegic fashion.
      Perhaps the most telling evidence for the absence of much planning or strategic thought in many organizations' downsizing and contingent work ar-rangements comes from surveys that document the extensive rehiring as temporaries or contractors of previous employees who had just been laid off. Because in many cases the employers had paid severance and other costs as part of the downsizing process, rehiring the same people soon thereafter as contractors or temporaries is expen-sive at a minimum and foolish at worst. A Labor Department survey found that 17 percent of contingent workers had a previous and different relationship with the companies that now rented them. An American Man-agement Association survey of 720 companies reported that 30 percent had brought back laid-off employees either as outside contractors or as rehired employees. The New York Times reported that at one temporary help service that does a lot of business with Pacific Bell telephone in California "former employees make up 80 percent of the 900 to 1,000 people that the agency supplies to the phone company on an average day." Even employers recognize and will occasionally admit their lack of planning and foresight: "Michael Rodriguez, Pacific Bell's vice president for human resources, conceded that 'some of the work did not go away as quickly as we would have liked.'"

THE CONSEQUENCES OF DOWNSIZING
THERE HAVE NOT BEEN many systematic studies of the effects of a contingent workforce on organizations. Such is not the case with organizational downsizing, where the evidence is much more comprehensive. And what that evidence indicates is that downsizing is guaranteed to accomplish only one thing--it will make the organization smaller. But downsizing is not a sure way of increasing the stock price over a medium- to long-term horizon, nor does it necessarily provide higher profits or create organizational efficiency or productivity.
      A Wall Street Journal article examining what happened to the stock prices of downsizing firms showed that following an initial increase, after two years in two-thirds of the cases, the stock prices were lagging those of comparable firms in the industry by 5 to 45 percent, and in more than half of the cases, stock prices lagged the general market by amounts ranging from 17 to 48 percent. This result is not sur-prising in the context of other studies that show that downsizing does not necessarily increase productivity or profits. One methodologically sophisticated study published by the National Bureau of Economic Research examined the approximately 140,000 manufacturing plants that were in operation in both 1977 and 1987 and found that more than one-third of the plants that had cut employment experienced a decrease in productivity, while 52 percent of the plants that grew employment over the period increased productivity.
      In some sense, the limited economic benefits to downsizing are not so astonishing. Merely cutting staff, after all, will not necessarily fix problems with the organization's products or customer service, its process technology, its time to get products or services to market, or even, as it turns out, its cost structure. Second, cutting staff is an activity that is readily copied, so as a source of competitive advantage over a long period of time, its efficacy is necessarily limited. And third, downsizing has a number of often unmeasured or unanticipated costs associated with it that also limit its economic benefits. A Louis Harris Survey of more than 300 large companies in the United States reported that in 40 percent of the companies, downsizing resulted in undesirable consequences for the organization.

TENURE, TURNOVER, & CORPORATE PERFORMANCE
BECAUSE THEY DIMINISH the connection or attachment between employees and employers, the new employment arrangements lead to more turnover and potentially a less motivated and committed workforce. There is accumulating evidence that there are important organizational returns to tenure in the form of enhanced customer service and satisfaction as well as productivity. Given this evidence, then, adopting strategies that encourage reduced tenure on the part of the workforce would appear to be shortsighted.
      As reported in some articles from the professional journal Human Resource Planning, a study of 1,277 employees and more than 4,000 customers from a personal lines insurance company revealed that both employee job satisfaction and satisfaction with their ability to provide service increased linear-ly with firm tenure. Another study of 771 Sears stores correlated employee tenure with results of a "60-second survey" conducted semiannually with a sample of the stores' best customers, measured by their charge purchases. There was a clear inverse relationship between turnover and service--the lower the employee turnover in a particular store, the higher the store's score on the customer service measure. The study also examined the relationship between tenure and full-time em-ployment status and customer service as assessed by the survey of customers. This analysis revealed that "stores with more regular employees also score much higher on customer satis-faction measures." A third study--of Ryder Truck Rental's turnover rate and workers' compensation claims, covering some 87 districts and about 10,000 employees--provided further evidence on the economic benefits of employee attachment. Districts that averaged less than 9.5 percent turnover in 1988 and 1989 experienced a workers' compensation claim rate of 16.1 percent. Districts that experienced a 20 percent or higher voluntary turnover rate had a workers' compensation claim rate that was some 50 percent larger, or 24 percent. The Ryder study also examined the relationship between tenure and financial performance. Districts that had average employee tenure of greater than 8.33 years earned 120 percent of the firm's average return on net controllable assets, while districts with average tenure of less than 5.75 years earned only 82 percent.
      Because turnover invariably increases under contingent work arrangements and with frequent dismissals, explanations have emerged arguing that turnover is not so bad for organizations. After all, turnover can bring in new blood and help introduce new ideas. However, according to an article in Industrial Relations, a national sample of 333 hospitals showed that turnover among registered nurses was linearly related to nonpersonnel operating and personnel costs per patient day and found no evidence that a modest level of turnover positively affected performance.
      Tenure not only affects customer satisfaction and economic performance, it also affects the ability to accomplish the workplace transformation that can help customer service and workplace productivity. Nor is it the case that turnover or its converse, employee tenure, is some exogenous factor, like an act of God, outside of management's control. For instance, Starbuck's provides all employees, even part-timers, with health insurance, stock options, and training and career counseling. It has experienced turnover of about 60 percent annually, which is well below the 300 percent that is average for the restaurant industry, says Business Week. Chevy's, a restaurant chain, has held turnover to 31 percent in management and 91 percent among hourly employees by using a combination of benefits that are unusually generous for the restaurant industry, quar-terly meetings that give employees a chance to discuss work-related issues, tangible financial rewards for length of service, a sense of ownership and involvement in the organization, and listening to and respecting employees. Said Fred Parkin, vice president of human resources for the chain, to the San Francisco Business Times: "If you take care of the employees, they'll take care of the guests, and the business will take care of itself."
      A company that sends the message that it will lay its employees off at the first sign of trouble and that employees should always be apprised of the labor market encourages its workforce to be continually job shopping and at risk, therefore, of job-hopping. It is continually at risk of losing its best employees first, thereby exacerbating the performance problems that brought on the downsizing in the first place.

COMMITMENT COUNTS
IF YOU WANT TO SEE the sheer foolishness of the new employment contract, try going home to your spouse and children with the following definition of the "new family contract": "Because of increasing instability in the econ-omy, I can no longer make credible long-term commitments for your support and education. I face career insta- bility, and therefore, how can I promise that I will provide ongoing financial support? In this era of rapid change, we need more family unit flexibility to deploy our personnel resources as the situation dictates. In fact, what I will help you do is to become family circumstance resilient, so that you are better able to cope with changing family circumstances." I suspect your family members will think you are nuts and, moreover, if you attempted to act on the basis of such beliefs, I doubt if your family would stick around very long.
      You have just violated a universally held social norm--the norm of reciprocity. Reciprocity has been uncovered in every human civilization ever studied and has even been observed among baboons--it is truly a ubiquitous rule of behavior. The norm of reciprocity means that favors get returned and social obligations are repaid. Commitment is reciprocal--to be committed to you requires that you, in turn, be committed to me, or else the situation will be unbalanced and inherently unstable.
      Jack Stack, the successful chief executive of Springfield Remanufacturing Corporation, had this to say about mutual commitments and employment security: "I had always figured out how to maintain full employment, because I totally believe that when you bring people into your workforce, they're taking on debt, they're building families. They're trying to go forward in terms of their lives. To pull that out from under them is probably one of the biggest disgraces I could ever imagine!"
      And the company lives by these values. When in 1986 General Motors canceled an order that represented about 40 percent of Springfield's business for the coming year, the firm averted a layoff by telling its people what had happened and letting them figure out how to grow the company and achieve productivity improvements that would obviate the need for layoffs.
      Much as they might like to, corporations cannot repeal the norm of reciprocity or the mutuality of obligations. To tell employees that the organization has no long-term commitment or obligation to them is fine, as long as the company is willing to bear the consequence of a mutual lack of long-term attachment and commitment on the part of its employees. As we have seen, turnover is expensive and downsizing solves little, particularly if one takes a longer-term view. The "new employment contract" purchases presumed flexibility at what is frequently a very stiff price.

HOW TO AVOID DOWNSIZING
SOME READERS WILL SAY, "Trying to offer a secure working environment and building long-term relationships with employees is fine for companies that are doing well and are growing consistently. But what happens in times of economic stress that come because of economic fluctuations to even the best-managed companies? What do we do about our people when, because of changes in technology or market conditions, we simply don't need and can't afford the same number as the firm has had in the past?"
      The first thing to realize is that downsizing and layoffs are not inevitable and that there are a number of things firms can do to avoid laying off workers in the face of economic pressures. The most straightforward steps to avoid downsizing or mitigate its impact are:

• Reduce work hours proportionately so the pain of reduced employment costs is spread across the entire workforce.
• Reduce wages for all employees (possibly weighted so that the highest paid take larger pay cuts) as a way of reducing the wage bill without layoffs.
• Take work previously outsourced (such as maintenance or subcontracting) back into the organization.
• Build inventory while demand is slack.
• Freeze hiring.
• Have people do other things (attend to deferred maintenance and repair, take training courses) that they were otherwise too busy to do when business was better.
• Don't hire to staff peak demand so that reductions in employment are almost inevitable when demand turns down.
• Put production or staff people into sales activities to build demand.
• Encourage people to develop new products, services, or markets so their skills can still be used by the firm.

There are also even more creative things organizations can do if they are serious about avoiding or minimizing layoffs. Consider these examples reported in Personnel Journal.
      When Minnesota Mining and Manufacturing faced the prospect of layoffs in the early 1980s, it implemented a policy called the Unassigned List. People whose positions have been eliminated have six months to find another job within the company, and during that period, workers receive their salaries and benefits and even salary increases if they are due. A similar approach is used by Hewlett-Packard, another firm that tries to provide some measure of employment security. When, for instance, the company exited the fabrication business at its Loveland, Colo., division and had 400 surplus workers, it facilitated their moving to other locations within the region, relocated employees and gave them priority in moving to another Hewlett-Packard location, loaned employees to divisions with short-term hiring needs, and permitted employees to be reclassified to lower pay levels and other jobs. More than 50 percent of the employees were retained in the company.
      If the company is facing only a temporary slowdown because of seasonal fluctuations in demand or a downturn in the economy, one option is to "loan" surplus workers to nearby firms--which is what Brooks Beverage Management, a soft drink bottler, did. Or the company can develop projects internally to absorb the surplus labor. At Harman International, with 8,000 employees worldwide in the business of manufacturing high-quality audio and video products, the company developed a program called Off-Line Enterprises that involved creating "a job bank of projects that assembly workers or employees supporting assembly operations could be temporarily redeployed to work on until demand for their labor picked up again." Among the things the company did was to train employees to become salespeople; build products customarily purchased from outside suppliers; provide service personnel, such as security guards, usually obtained through outside suppliers; and convert waste byproducts into salable products.
      If companies are serious about seeing their people as assets and as the key to profits and, as a consequence, avoiding layoffs, almost anything is possible. Consider the case of Pinnacle Brands, one of the top five trading card manufacturers--and the only one that survived the baseball strike that began in 1994 and extended into the following season. With no baseball being played, not too many baseball cards were sold, and the company faced a loss of $40 million in trading card revenue. What the company did was to issue a challenge to its employees: If they could find a way to replace the lost revenue, they could keep their jobs. Employees, working in teams that often crossed departmental boundaries, figured out ways to cut costs and came up with new product ideas that replaced lost revenue. Instead of laying off 190 people, the company wound up getting through the crisis without layoffs. The fundamental question confronting organizations facing economic stress is: Are they serious about treating their workforce as assets rather than costs?

IF YOU MUST: DOWNSIZING THE RIGHT WAY
EVEN FOR FIRMS that need to reduce the number of employees, there are ways to accomplish downsizing consistent with viewing employees as important assets and seeking to maintain morale and trust. By contrast, there are ways of downsizing that reduce morale, diminish trust, and signal that, whatever the rhetoric, management neither respects nor values its workforce.
      Reports Mitchell Lee Marks of the William M. Mercer consulting firm: "At Tenneco, where 1,200 employees were laid off over a six-week period, many learned of their fates when confronted by armed guards carrying boxes for them to use in clearing out their desks. At Allied Bank of Texas, department heads called meetings and then read the names of those to be laid off in front of their coworkers."
      Contrast those incidents with the experience of the New Zealand Post. When the postal service became a state-owned enterprise on April 1, 1987, it was expected to operate as a commercial enterprise and to become efficient. At that time the organization had about 11,500 employees and was overstaffed. Within a few years its employment had fallen to about 8,500, a decrease of almost 30 percent. But the reductions were accomplished in a way that did not leave the organization weakened from a distrustful and unmotivated workforce.
      One of the things the organization did right was to do a large number of the eventual layoffs, although not all, almost immediately. This step got a lot of the pain out of the way and communicated as well the fact that change was necessary. The Post also shared a lot of budgetary and financial information with people and established clear targets and goals, including an emphasis on customer service and productivity, that motivated the workers and made clear what was needed and why.
      he New Zealand Post endeavored to treat its people, including those being laid off, well. When people could not be placed elsewhere in the organization during the restructuring, they received handsome redundancy packages, averaging $20,000. The management told the truth about what they were doing and why, and the credibility helped tremendously. But the key was that the "people went with dignity." The company let staff know as far in advance as pos-sible about departures. Unlike those companies that announce who is laid off and then escort them out the door with guards, the Post sponsored parties for those leaving. The organization offered assistance in helping individuals look for other jobs and prepare resumes. And the Post used the workforce to help identify those who might actually be more willing to leave--in some instances, people who weren't to be laid off offered to go in place of those who had been targeted. Finally, a number of the Post managers told me that because New Zealand has a safety net--a program of income maintenance--individuals did not fear the future as much as they might otherwise have.
      Virtually all of the things I have described that either avoid layoffs or make them less traumatic cost resources, both time and money. Generous severance is obviously more expensive than less generous payments, and giving people assistance in finding other jobs and time to do so and to say good-bye also incurs costs. I asked Elmar Toime, the current chief executive of the New Zealand Post, why the organization was willing to incur these costs. He replied that they weren't really costs at all but instead an investment in building a relationship with the remaining workforce that would permit the organization to prosper in what is, after all, a people-dependent, service business. Toime's answer reflects a time horizon and perspective that is, unfortunately, all too rare.
      Following is a summary of actions to reduce organizational losses from downsizing. These are lessons from organizations that have shed people in ways that did not destroy their culture or the commitment and motivation of those who remained.

• Reduce staff levels promptly once the decision is made.
• Reduce employment levels, to the extent possible, all at once rather than in repeated waves.
• Share economic and performance data on the reasons for downsizing.
• Provide notice of the decision.
• Involve people in the decision process--how many staff to cut and who should leave.
• Provide people with fair severance and benefits.
• Provide assistance with career transitions, such as outplacement, career and vocational interest assessments.
• Let people leave with dignity; have ceremonies such as social functions to let them say good-bye.

The two decisions considered here--where to draw the organization's boundaries or how much temporary help and contract employment to use and what kind of implicit or explicit agreement about the continuity of employment to offer to the firm's people--are two of the most basic, important, and fundamental choices organizations make.
      Downsizing may cut labor costs in the short run, but it can erode both employee and eventually customer loyalty in the long run. Outsourcing is about more than direct labor costs and should be assessed accordingly. The question is not just what people cost, but what they do and what value they create for the organization. The question for managers is whether they will be swept up in the fads and rhetoric of the moment or will recognize some basic principles of management and the data consistent with them. As Peter Hartz, the senior personnel executive at Volkswagen reminds us, the competitive environment defines the requirements, but each company can define the solutions. In fact, that is precisely the job of leadership--to craft creative responses to competitive conditions that build competence, capability, and commitment in people, not to do things that destroy organizational memory, wisdom, and loyalty.