Furloughs, Layoffs, and Planning for the Recovery: Leveraging your Human Capital


The exit from lockdown is on the horizon, with easing restrictions on public gatherings and some schools already opening in the UK. Yet, consumer demand may not return quite so quickly. While the timing of the Covid-19 recession seems relatively predictable, that ‘certainty' brings forward the timeline for answering some uncomfortable questions: how long should companies wait before furloughs become layoffs? And just how important are staff?

While many companies may take the view that holding on to staff through a downturn makes it easier to hit the ground running in the upswing, that view is often trumped by market and investor pressures – and that will be even more likely in the event of a prolonged pandemic.

Yet that pressure can be somewhat countered by looking at the 2008 global financial crisis. Back then, staffing decisions helped determine how quickly a company recovered. American companies with the lowest decreases in staffing during the financial crisis saw their subsequent profits grow at almost double the rate of companies that had the largest number of layoffs, a trend replicated in Europe.

Perhaps the biggest difference between then and now is the huge increase in furloughing rather than permanent layoffs – although we wait to see if this changes as companies are asked to pay an increased percentage of the costs of furloughing over the coming months.

So far, there are three reasons for the use of furlough schemes rather than layoffs. The first is that the consensus is that we face a short – although deep – crisis, and most are therefore planning for a painless restart. The second is that there is a risk of reputational damage in laying off, or even furloughing, staff that exists today, perhaps more so than in most other crises. This is particularly the case for large, profitable, or high-profile companies – the outcry around the actions of some football clubs being one case in point– but there have been numerous others. The third is that, simply, staff have increasingly become more important to companies.

Human capital assets

There are several metrics we can look at to determine the importance of staff – albeit none is perfect. First, companies now make far more profit from each of their employees than they did in the past. Large American companies generate more than $55,000 per staff member each year (up from around $38,000 pre-financial crisis) and European companies generate just over €33,000 (a little higher than the pre-crisis level, however, a strong climb since its aftermath).

We can value employees more directly, however, by using the ISO standard on human capital reporting. To calculate human capital return on investment (HCRoI), we conducted a deep dive into the financial accounts of individual European stocks and, while the results can be muddied by outsourcing policies, we found some unexpected conclusions.

One surprising result is the relationship between HCRoI and subsequent share price movements, returns on equity (RoE), and a firm's overall staff costs. In short, the higher a company's staff costs, as a proportion of its total operating costs, the lower its HCRoI. This suggests that in firms where staff costs are not a large proportion of the cost base, managers have less pressure to justify new hires, and they bring lower returns as a result. This might be easy to explain if these companies were young, high-growth companies. But this is not the case; the sample was dominated by energy, utility, and consumer firms.

It is also quite striking to see which companies exhibit the strongest relationship between RoE and HCRoI. Companies in the top quartile for RoE see very little correlation with HCRoI, while the worst stocks have the strongest positive relationship between RoE and HCRoI. Struggling companies may therefore have the most to gain: if the worst-performing firms can increase the efficiency of their hiring decisions, this can have a substantial effect on their returns.

The good news for all is that firms are in better shape to hold their breath for longer during the current crisis. Cutting staff may be the easy, short-term fix, but not the best long-term decision.

Read more in Deutsche Bank's latest research report, Furloughs, layoffs, and recovering from Covid-19