Corporate 'right-sizing' means profits

by Stephen Butler

A picture in the New York Times showed an empty General Motors office building that recently housed over 10,000 engineers. Think about what that means beyond the 20,000 Hush Puppy shoes and pen protectors.

It's as many people as we had in the whole town of Springfield, Vermont where I grew up. It's hard to imagine how that many engineers could have found enough work to do considering how little in product development was happening at GM --- compared to its competitors. By comparison, all it took to develop the Ford Mustang, according to Lee Iacocca biographies, was a handful of engineers who used to meet secretly at Lee's house.

The hopelessly bureaucratic institution which was once the world's largest company is symbolized by that empty building, but the current recession is smoking out much of the non-productive side of corporate America.

A number of financial analysts have pointed out that about a third of everyone employed by the financial services industry were in what are described as "fluff" jobs --- management positions that could easily be abandoned. When times are good, management positions get created to reward superior employees with higher pay.

As the Peter Principle has it, these folks often get promoted to their "level of incompetence." When forced to leave through down-sizing, the costs of these managers' salaries and benefits drop right to the bottom line. Management effectiveness increases thanks to the fact that there is nobody to get in the way of employees who already know what they need to do.

In industries like payroll services, for example, there is a major effort at consolidation today as small companies lay off a few employees and decide to handle their own payrolls. This prompts the payroll industry to re-juggle sales territories so that fewer sales people handle a larger client base. Service may suffer, but it's a soft-dollar cost. Meanwhile, the people kept on are, hopefully, the best service and sales people who were capable of handling a lot more anyway. A general rule in selling is that 80 percent of the business is brought in by 20 percent of the marketing field force.

Some of the most successful companies in history have achieved that distinction by adopting creative management and compensation tools.

I'm familiar with Tyco Industries, which, in the twenty years prior to the Dennis Koslowski era, managed to create a steady march of profits and growth by buying rustbelt companies, throwing out the employee manuals and adopting an accountability and bonus structure. Typically, one quarter of the employees would walk out the door. The next twenty-five percent would be on the fence and half of those would leave in the next 12 months.

The roughly two thirds who remained would be making 50 percent more money, and what was once a sleepy company in decline was now a money-making machine contributing to Tyco's extraordinary growth from 4,000 to over 250,000 people.

What this sea change means for investors is that companies will come out of this period with income statements, balance sheets and operating practices that are scrubbed clean. It's no surprise that ten major banks are begging to pay back the TARP money. With thirty percent fewer employees, how can they not be making money on an operating basis? Their continuing profits will dwarf their troubled loans.

The spectacular stock market gains of the '90's were fueled by increases in productivity. Better communication thanks to the internet and more enlightened management techniques created companies that were more profitable. Greater productivity allows people to make increasing amounts of money without creating inflation.

This time out, increased profitability will undoubtedly come from companies having been pressured to "right-size" to reflect economic realities. In what is now predicted to be a "job-less" recovery, the profits of companies should increase dramatically when they generate more sales with the same number of people they have today.

People still working will see salary increases even during the recession if history repeats itself. For those of us waiting for our mutual funds to rise in value, these inevitable developments will contribute to a smug sense of satisfaction --- sooner or later.

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