Does laying off salespeople actually hurt firms?
Tuesday, October 2 2018 01:00pm
Associate Professor Dr. Nick Panagopoulos weighs in on the implications of downsizing sales teams
The following news feature is an adaptation of an article written by Dr. Nick Panagopoulos, associate professor of marketing and director of executive education & international sales for the Ralph and Luci Schey Sales Centre at Ohio University. Panagopoulos is the recepient of the American Marketing Association's 2018 Excellence in Research Award for his study titled "Salesperson Solution Involvement and Sales Performance: The Contingent Role of Supplier Firm and Customer–Supplier Relationship Characteristics."
Salespeople are consistently one of the top positions laid off each quarter. Indeed, the popular press is replete with stories that confirm this trend. In a recent overhaul of its workforce, for example, Microsoft laid off thousands of sales employees in an effort to re-organize its business and focus on its cloud business unit. While downsizing the sales force can help streamline costs and boost short-term operational efficiency, little is known about the impact a decision like this might have on a firm’s financial-market performance in the long run.
A new study conducted by an Ohio University researcher and published in the Journal of Marketing, sheds light on the topic by suggesting that downsizing the sales force can actually hurt firms. The study, conducted by the O’Bleness Associate Professor Dr. Nick Panagopoulos in collaboration with Dr. Ryan Mullins (Clemson University) and Panagiotis Avramidis (ALBA Graduate Business School), draws from a novel, longitudinal dataset of 314 U.S. public firms over 12 years to take into account different cycles in the American economy.
According to the study, laying-off salespeople is not necessarily a good idea.
Specifically, the higher the number of salespeople laid off, the higher the uncertainty investors will feel, due to their limited knowledge regarding the firm’s ability or intentions to effectively compete in the market and secure future cash flows. This happens because of information asymmetries – that is, firms have more and better information regarding a decision to downsize the sales force compared to investors. In turn, this heightened uncertainty is manifested in future increases in firm-idiosyncratic risk, a key metric that reflects volatility in a firm’s stock returns and that is widely employed by financial analysts to issue the risk ratings of stocks.
“What’s basically happening here is that the sales force has a strong influence on how a firm acquires and retains customers. In particular, when a firm decides to cut a large number of salespeople, this sends a threatening signal to investors that the firm might not be able to secure future cash flows. This is so because having fewer salespeople call on customers might destabilize existing customer relationships or lead customers to feel uncertain about the future of their relationship with their supplier, whereas ‘surviving’ salespeople will face increased workloads, which makes new customer acquisition difficult,” Panagopoulos said. “In other words, downsizing can increase the volatility and vulnerability of future cash flows, thereby leading to investors feeling less certain about the firm’s future outlook.”
But there’s more happening when sales force downsizing crops up.
“Because investors are uncertain about the firm’s quality or intentions, they will try to resolve this uncertainty by vigilantly scanning the environment to collect and examine observable cues that help to draw inferences about a firm’s ability or intentions. First, they’ll look for changes in rival firms’ products relative to the downsizing firm’s products in an effort to diagnose whether the firm is able to compete in the market against potential competitive threats and thus fulfill investors’ demands. If the firm is not able to keep its products ahead of current and emerging rivals’ offerings and thus differentiate from competition, investors’ uncertainty regarding the downsizing firm’s future outlook is heightened, which can make things worse,” Panagopoulos said.
Next, investors will look for information that indicates the firm’s propensity to obscure its intentions. Perhaps the easiest way to do this is to ascertain whether the firm engages in accruals management – that is, delaying the recognition of losses to increase net income, or vice versa. Because accruals management can indicate management’s propensity to hide information about firm fundamentals from capital markets, it can cloud investors’ ability to ascertain the true state of future cash flows. As such, investors’ uncertainty about the downsizing firm’s future is further increased and so is the firm-idiosyncratic risk.
So is there anything that senior leaders can do to mitigate these problems when downsizing their sales forces?
Panagopoulos said that this is possible. Specifically, CEOs need to actively engage in a signaling process to reduce investors’ uncertainty about the firm’s ability and intentions. First, CEOs need to signal their ability to effectively compete in the market and separate themselves from competition by increasing advertising spending. When a firm increases advertising expenditures, investors may interpret the action as a positive signal that larger sales force reductions do not threaten the firm’s ability to compete in the future. Rather, increased advertising signals the firm’s competitive viability and commitment to growth.
Second, CEOs need to signal their intentions to effectively compete in the market and, thus, secure future cash flows. To do so, CEOs need to communicate a strategic external focus to entities like customers or competition in the Management Discussion & Analysis section of a firm’s 10-K report, which is submitted to the Securities and Exchange Commission. In particular, an external focus implies high levels of firm preparedness in terms of formulating and implementing strategic actions designed to cater to customer needs or fence off competitive threats. In this way, external focus can help investors interpret the intent of larger sales force reductions as a long-term strategy that takes emerging customer needs and competition into account.
Overall, the study conducted by Dr. Panagopoulos and his team place the sales force as a lever within the firm’s risk-management and financing strategy. This also suggests concrete implications for C-suite leaders. For example, leaders can quantify the economic significance (i.e., cost of capital) of sales force downsizing by including risk in their decision metrics. Managers can also use the study’s findings to make more informed resource allocation decisions for managing cost of capital, as well as other downstream effects of firm-idiosyncratic risk. In particular, findings suggest that sales force management decisions merely driven by cost management concerns, actually have unintended consequences that will offset any potential cost efficiency gains. This is because laying off the sales force increases the firm’s cost of capital.
“Marketing leaders are advised to communicate the expected increase in cost of capital with other C-suite leaders (e.g., CEOs, CFOs) as important input into management decision making related to sales force layoffs,” Panagopoulos said.