Troubled Companies

The following text has been prepared by Arthur Lipper III for British Far East Holdings Ltd. and is intended to be part of a book, “Troubled Companies”. No reproduction or publication of these writings is authorized, except with written consent of the author and owner.

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Chapter 6

Downsizing - Symptom of More Trouble or First Sign of Recovery?

Competition is all about getting bigger and those who shrink are losers - unless the shrinking is a necessary step in the process of survival and rejuvenation.

Disappointing revenues, though usually the rationale for downsizing is the wrong reason to shift focus in a company. The more appropriate reason to reallocate assets is that of an activity area not being sufficiently profitable. Of course, a lesser level of revenues than anticipated by the level of overhead will cause a decline in profit margin, but profit deterioration can also occur during periods of revenues being on target with projections. Good managers are ever-conscious of segment profitability and reassign assets accordingly. Managing companies and investment portfolios are similar activities. The better manager allocates assets by predicted ROI.

Not all problems can be solved. This is a basic truth all too frequently denied by managers spending other people’s money and the tendency, for so long as the money is available, is to spend more to solve a problem - rather than admitting an error in judgment and terminating a project.

Perhaps it is a better statement that “Not all problems can be solved on a cost effective or ROI reasonable basis.

Downsizing, especially if the company elects to take a write off for associated charges, is a technique usually resulting in higher reported earnings in subsequent quarters. It is also indicative of problems which may impact others competing in the same general area - and perhaps should signal an exit by investors from the “being forced to become more efficient” area.

The problem of downsizing or the factors leading up to the recognition of the need to downsize is that a company’s best employees become more available for recruitment by competitors and the natural reaction of executives and lesser level staff as well is to negotiate deals which afford some protection from that which is sensed to be a perilous period.

It takes an element of courage on the part of a company’s managers to recommend a downsizing before the CFO points out there is no other option. The earlier the downsizing the less painful, even if there has to be a series of downsizing exercises.

The downsizing should be discussed with stakeholders; customers, suppliers, vendors and staff prior to any announcement so as to have as much damage control as possible. In making the announcement industry background details should be included so as to make the action being taken more understandable to the readers.

Although the stock of companies announcing massive lay-offs frequently rise in the expectation of improved earnings no one likes to downsize. It is a painful and embarrassing exercise and imposing hardship on employees is not what capitalism should be all about.

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