“Job losses are never desired by employees, but necessary for investors.”
This is a quote from one of my university professors that I still have highlighted in my strategic management notes which I read from time to time to reacquaint myself with certain concepts.
The media, almost daily, has been heard announcing significant job losses at all sized corporations across the world as companies attempt to better position themselves for the deteriorating economic environment. In the past week Microsoft (MSFT) announced 5,000 job cuts, Rio Tinto (RTP) 1,000 (total of 14,000 during the past month), BHP Billiton (BHP) 6,000 and BCE (BCE) announced early retirement incentives for 1,500 of their employees.
While publicly and internally this looks negatively upon the management of companies who are announcing these layoffs investors need to realize that fixed costs should be a focus of management. Why?
As an investor you own a stake in the operations of the business and it’s important to understand that all companies have two types of costs: fixed & variable. Salaries are considered a fixed cost because each month, regardless of sales, this cost needs to be paid out by the company. Variable costs include items such as raw materials and energy to produce a product and are scaled to production of goods or services.
In a depressed economic environment the majority of companies will always find it difficult to grow revenues because consumers and businesses are consuming less. The focus of many fiscally responsible companies will be to look away from revenues if they become stagnant and look instead to decreasing fixed costs to maintain their existing margins.
Companies often struggle when faced with making difficult decisions on jobs, but have to realize that fixed costs are often the quickest method of maintaining your established margins. Employees not directly involved in production of goods or supply of services (non-revenue incurring) are disposable in a recession because their contribution to the bottom line of the company is reduced.
A caution to investors is observing the flurry of job cuts being announced now versus companies who began positioning themselves six months ago by concentrating on cost reductions as the storm clouds began brewing. An evaluation of management is important because as an investor you want to ensure that management has their pulse on the heartbeat of the business. A reactionary reduction in fixed costs now due to a decrease in quarterly profits doesn’t usually sit well with me as an investor. I would much rather a company be proactive on cost reductions than reactive for the simple fact that management should be able to evaluate their market conditions and respond accordingly.