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Layoffs are not a Sustainable Solution to Improving Long-Term Firm Performance

The Shift Index

For further context and insight on this topic, please reference the following sections of the 2011 Shift Index report:

Key Themes
Unemployment is a hot button topic in political discourse, media coverage and around the dinner table. The social effects of unemployment have been covered from many angles. A less-discussed topic, however, is the impact on firms. Why are firms laying off workers? What is the effect on firm performance? Are these employment trends sustainable in the long run?

Head count is one of the key levers firms use to improve performance, particularly in poor economic climates. While companies have long used layoffs as a means to cut costs, the practice has become especially prevalent in more recent economic downturns. Employment has constituted an increasingly larger portion of Real GDP loss in each subsequent recession since the event of 1973-1975. Firms’ decisions whether or not to lay off workers during these recessions dictate the degree to which employment bears the brunt of the downturn and the degree to which firms absorb GDP loss internally, taking a hit to productivity.

However, these short-term responses to longer-term pressures are not sufficient to address the real causes of declining performance. It is only when firms embrace the institutions and practices required to drive scalable learning and tap into the digital underpinnings of the Big Shift will they be better positioned to see a sustainable upward trend in ROA, rather than simply representing cyclical noise.

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Asset Profitability
To measure long-term corporate performance, we calculated economy-wide Asset Profitability (ROA) for all publicly traded firms (numbering greater than 20,000) between 1965 and 2010. We use ROA as a measure of firm performance for two reasons. First, as opposed to other asset-oriented metrics, such as Return on Equity (ROE), ROA is a comprehensive measure of firm profitability and is not affected by distortions associated with a firm’s capital structure.

This year, our analysis confirmed that the decline in ROA is occurring consistently across almost all sectors of the economy. With the exception of aerospace and defense and health care services, all other industries in the economy exhibited a downward trend in ROA. This suggests that the fundamental forces of the Big Shift are driving down Asset Profitability across the entire economy.

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Returns to Talent
As tangible assets play a smaller role in generating revenues and profits for U.S. companies, the so-called “creative” workers are increasingly important. These workers garner higher returns than other workforce classes and wield growing power relative to the firms that employ them.

As defined by Richard Florida, the creative class is made up of workers whose job is to create meaningful new forms and whose work is knowledge intensive or whose work is broadly relevant and transferable. The creative class (including the super-creative core) only accounts for 44% of the the total U.S. workforce’s head count but earns 65% of the workforce’s total compensation, or $3 trillion dollars. This compares with the $1.7 trillion earned by the remaining 56% of all workers who come from the working, service and agriculture classes.

As companies become more focused, they are better able to participate in (and eventually orchestrate) distributed, inter-firm organizational forms—such as open source initiatives—that are mobilizing tens (and even hundreds) of thousands of participants in flexible, diversely specialized and customizable configurations. These massive networks enable workers and firms to mobilize resources on an as-needed basis, encouraging (rather than stifling) the tinkering and experimentation that facilitate learning and talent development. Because they can react quickly to fast-moving, unpredictable circumstances, these “creation networks” are well suited for the Big Shift.

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