Knee-Jerking or Down-Sizing?

HBS Professor Teresa Amabile and psychologist Steve Kramer write on the HBR Blog Network how “knee-jerk downsizing” is a bad idea. The article responds to a recent WSJ article on how already lean companies are ready to cut even further to successfully ride out the hard economic times following the financial crisis. Based in established research, Amabile and Kramer point out that downsizing might not make the companies better off. For two reasons:

First, downsizing often leads to worse, not better, financial performance for firms […]

Second, downsizing can dramatically — and negatively — alter the work environment in the organization, diminishing the motivation and performance of remaining employees.

While these points are well taken, the more fundamental issue in business, as well as behind both these reasons, is mysteriously unnoticed. Granted, the article is about the psychological (negative) effects of downsizing rather than the phenomenon of downsizing per se. But it serves to illustrate a rather common oversight that is of more general interest to readers of this blog: the role of entrepreneurs and entrepreneurship within organizations.

In the specific case that Amabile and Kramer bring up, entrepreneurship explains both companies’ responses to the failing economy and their resorting to downsizing. The financial crisis may have been unforeseen by most, but the future is always uncertain – and entrepreneurship serves to overcome this “obstacle” through making uncertain and risky investments for profit. Individuals with superior judgment can profit from somewhat correctly imagining the future state of things and arranging capital [goods] to exploit such opportunities, which is the source for entrepreneurial profits. Failure means a loss of their investment, and this ultimately keeps speculation at a reasonable level and investment comparatively conservative.

This has interesting implications for the situation of companies today. Those who were not sufficiently judgmental and failed to predict or foresee (and therefore prepare for) the crisis face the consequences of entrepreneurial errors: they make losses (sometimes severe losses). This is where Amabile and Kramer talk of “knee-jerk downsizing” and how it may be a disastrous way to go. But they fail to mention that it is not downsizing per se that is a problem – the problem is knee-jerking. It does not matter if companies respond to harsher economic times with knee-jerk downsizing or knee-jerk investments or knee-jerk do-nothing.

What firms making losses  suffer from is poor entrepreneurship (since they failed to foresee and prepare for the crisis), but the poorest kind of entrepreneurship is always the lack of it. Whether firms downsize or not is not really an issue, what matters is whether it is done as an entrepreneurial response to exogenous (or, for that matter, endogenous) changes. Non-entrepreneurial, by-the-book responses threatens business. In contrast, entrepreneurship is an asset.

It is true that people’s well-being may suffer from downsizing. But it is not a solution to simply refrain from cutting when the cost situation is unsustainable. In such a situation, cutting may be the only way to go and therefore necessary. But it may also be a preferred way, from an entrepreneurial point of view, in order to meet and prepare for imagined future opportunities. The firm is not primarily about the well-being of those employed by it; a firm must make profits to have the means to keep employees salaried and satisfied. And this can only be done through entrepreneurship – no matter what the entrepreneurial act is. Knee-jerking is the problem, entrepreneurial down-sizing is not.

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