Leadership Lessons of the Great Recession: Options for Economic Downturns

 
 
In the new case study “Honeywell and the Great Recession,” Sandra Sucher and Susan Winterberg explore employer tradeoffs when a downturn hits: conducting layoffs vs. orchestrating furloughs. Plus: Video interviews with Honeywell CEO Dave Cote.
 
 
by Sandra Sucher & Susan Winterberg

With global markets in turmoil over the last several weeks, leaders throughout the world are starting to think about how they should respond if confronted with an economic downturn. Yet what do we know about how leaders decide what to do when demand suddenly falls? And how do these choices affect a company’s competitiveness after the downturn ends?

For the last five years, we have been studying layoffs and their alternatives. Our goal with this research is to help leaders understand when it makes sense for companies to use layoffs to address their financial and competitiveness challenges and when other approaches would produce better results for customers, employees, and shareholders and foster better long-term performance of the company.

“I’ve been a leader during three recessions, and I’ve never heard a management team talk about how the choices they make during a downturn will affect performance during a recovery”

A search for leaders who have taken alternative approaches to managing their workforce during economic downturns led us to Honeywell CEO Dave Cote, and drives the narrative of our new case study, Honeywell and the Great Recession. The case puts students in the shoes of Cote and his leadership team and asks them to consider the choices they would have made in the face of the extreme uncertainty surrounding future business conditions in the fall of 2008.

Cote joined Honeywell as CEO in 2002. The company was emerging from the 2001 recession and a series of mergers that had left the company in a compromised state. Over the next six years, Cote worked to turn Honeywell around through implementing a series of improvements in the company’s operating systems, forming a single culture from all the merged organizations, and instituting a disciplined approach to future hiring and M&A activity.

When the Great Recession hit in late 2008, Honeywell, like all diversified manufacturers, experienced a drop off in new orders. Yet after six years of improving operating efficiency, there was little room left to cut costs through additional efficiency improvements. Company executives would have to make a choice of whether and how to cut their workforce costs—either through mass layoffs or furloughs.

Our goal with the case was to explore the tradeoffs between these two forms of employee cost reduction. We also wanted to examine the long-term orientation that Dave Cote and his team brought to managing their company during the Great Recession.

The shift to managing companies for short-term financial interests has been an increasing trend among US businesses, leading to a focus on actions that are believed to yield immediate financial results to boost profitability and returns for shareholders. During the last two recessions, layoffs were an almost universal go-to cost-saving choice in the United States. Compared with other recessions since 1973, companies were much more likely to lay off workers than to suffer short-term declines in productivity, according to a report by the McKinsey Global Institute.

Yet the costs of this unbalanced approach to managing economic downturns are not always well understood by managers.

LAYOFFS ARE EXTREMELY DISRUPTIVE

In April, the Honeywell case was taught for the first time in Leadership and Corporate Accountability, a required course for first-year MBA students that examines the responsibilities business leaders have to their shareholders, customers, employees, and to society

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Cote visited Boston for the occasion, sitting in on two classes while students debated the choices they would make if they had been in Cote’s position during the recession. Among the options students were asked to consider were whether to use layoffs or to use furloughs (also known as work sharing or short-time work), an alternative to layoffs in which employees take temporary unpaid leaves and/or reduced work schedules, but still remain employed by the company.

In addition to weighing the financial costs and benefits, students discussed the fairness of each option. Some thought furloughs were the fairer option because they instilled a sense of “we’re all in this together.” Others argued that furloughs were unfair to high performers—that it was fairer to lay off the weak links and support the strong ones.

“It’s a little surreal to watch a room full of people discuss what you did,” Cote said following the class sessions.

Cote explained that he chose furloughs based on the logic that economic recessions don’t last forever. Cote had used targeted layoffs for permanent changes to Honeywell’s product portfolio after becoming CEO in 2002, divesting businesses that did not meet his requirement that each Honeywell business be in a “great position in a good industry.” Yet the benefits of using layoffs to manage costs during a recession didn’t make economic sense to him.

“I’ve been a leader during three recessions and I’ve never heard a management team talk about how the choices they make during a downturn will affect performance during a recovery,” said Cote. “There will be a recovery and we need to be prepared for it.”

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Cote also emphasized to students that, as important as it was to avoid the disruption of layoffs and to preserve the company’s workforce, Honeywell also continued its process of “seed planting”—investing in R&D programs and other projects needed to prepare for a recovery. He explained that during the recession suppliers would also be laying off workers, which limited their capacity to respond once the recession ended. Honeywell made arrangements—during the Great Recession—to be “first in line” with their suppliers to be able to quickly respond to a pickup in customer demand.

CUTTING EXPENSES AND PAYING BONUSES

In addition to furloughs, the Honeywell leaders cut production and financial expenses, focusing on efficiencies in managing their supply chains and reducing inventories, material costs, and payables. They also reduced other employee-related expenses by instituting freezes on hiring and wage increases, limiting employee rewards and recognition programs, and reducing the company match to employee 401k retirement accounts.

In light of the cost reductions imposed throughout Honeywell, Cote made the decision to recommend to Honeywell’s board that he receive a zero bonus for the year. After he told his executive team his decision, Cote was surprised that they all came back to him to say they would also forego bonuses for the year—an equivalent of taking six months of furloughs each.

“It still makes me feel really good that they would do that. It’s not like we made our earnings estimate because of it, so it hurt them a lot more than it helped the company financially overall,” Cote said.

While the executives did not receive a bonus that year, they did keep a bonus pool for employees in 2009, although it was lower than in previous years. To create potential upside, Honeywell’s management team took a portion of the bonus pool, and distributed it to employees as restricted stock, with the idea that as the economic recovery would begin, Honeywell would be able to grow faster than its competitors—and the stock’s value would increase.

And it paid off. Three years later, Honeywell had almost doubled the pace of the S&P 500 and had outpaced its nearest competitor by almost 23 points.

 

MAKING THE DECISION FOR FURLOUGHS

The practice of furloughs is commonplace in Europe but much less so in the United States. And it is no panacea. In the paper “Furloughs: An Alternative to Layoffs for Economic Downturns,” we discuss the factors leaders should consider before choosing furloughs.

A key challenge to implementing furloughs in the United States is navigating the myriad collection of complex regulations that vary by state. (Although, the United States has made some significant reforms to improve the ease of conducting furloughs since the Great Recession ended.)

Managers must consider economic conditions, as well. If the entire economy is suffering a recession, it may make sense to furlough certain employees as Honeywell did. But if an industry or company is suffering due to technological changes or market demands, that’s another story. If jobs are going away permanently, furloughs will only delay making layoffs or making other substantial workforce reallocations.

In some countries, employees must agree to voluntarily participate in a furlough, so companies need strong leaders who can make the case for furloughs persuasively. Companies should also be mindful of using furloughs in industries or countries where other companies are not conducting furloughs or reducing their headcount at the same time—as it may cause good people to leave.

Furloughs can also be difficult for morale in the short term. Cote admitted he received angry emails from several employees as the furloughs at Honeywell dragged on from days to weeks. “By the time we got to the fourth week, the anonymous feedback I got was, ‘By God, just lay some of us off; I can’t take this anymore,’” Cote recalled during his visit to HBS. “Whether it’s a furlough or a layoff, you’re negatively affecting people’s lives. You just are. So it’s not like one is necessarily kinder than another. There might be employees who are already living hand to mouth, who now have to survive on ten percent less for a while. That’s a hardship. I think it’s more manageable than being suddenly out of a job, but it’s all in the eye of the beholder.”

FINDING THE RIGHT BALANCE

For Honeywell, furloughs were the hard choice, but Cote believes they were the best choice for finding the right balance of interests for their shareholders, customers, and employees. Cote received a lot of pushback from Wall Street analysts and some members of his own staff for his decision not to conduct layoffs and continuing to invest in Honeywell during the recession. By the beginning of 2010, Honeywell’s orders began to return and the furloughs ended. It was only then that it became clear that that Honeywell had made the right choice. “Nobody thought it was possible,” Cote said. “But when the recovery started happening, then I began to look pretty good. But for that 15-month interregnum, there were a lot of questions about my sanity.”

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While Honeywell’s experience might be seen as blind luck, academic research on recessions backs up the approach they used. In December 2008, HBS professors Ranjay Gulati and Nitin Nohria, along with Franz Wohlgezogen, a doctoral student at Northwestern University, launched a study on the performance of 4,700 companies listed in the S&P Compustat database during the recessions of 1981-82, 1990-91 and 2001 and compared their performance before, during, and three years after. What predicted which companies came out ahead of their peer group in the recovery?

“According to our research, companies that master the delicate balance between cutting costs to survive today and investing to grow tomorrow do well after a recession …These companies reduce costs selectively by focusing more on operational efficiency than their rivals do even as they invest relatively comprehensively in the future by spending on marketing, R&D and new assets,” Gulati, Nohria, and Wohlgezogen wrote in their Harvard Business Review article Roaring Out of Recession. “Their approach doesn’t just combat a downturn; it can lay the foundation for continued success once the downturn ends.”

As business leaders begin planning for the coming year in the midst of all the market turmoil and uncertainty, this is one lesson it might pay to remember.

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