Mass layoffs in the tech sector don’t mean mass profits

Investors may be taking the wrong lesson from the massive job cuts across the technology sector.

On Monday, Spotify Technology SA SPOT-N became the latest high-profile tech company to boost its share price by vaporizing a significant portion of its work force. It joined a host of other tech titans, including Alphabet Inc. GOOGL-Q, Amazon.com Inc. AMZN-Q, Meta Platforms Inc. META-Q, Microsoft Corp. MSFT-Q and Salesforce Inc. CRM-N, that have also announced large layoffs in recent months.

The stock market is applauding this bloody-minded determination as tech companies head into earnings season. Wall Street analysts see the job cuts as encouraging evidence that management is reining in pandemic-era excesses and doing what is necessary to defend profit margins.

Unfortunately, history suggests a different takeaway. More often than not, widespread layoffs are a precursor to more problems ahead, according to researchers who have studied the impact of job cuts on stock prices and corporate performance.

“Layoffs do not increase productivity,” Jeffrey Pfeffer, a professor at the Stanford Graduate School of Business, warned in a recent interview. He argued that the wave of job cuts across the tech sector is “basically an instance of social contagion, in which companies imitate what others are doing.”

Just as tech companies went on a mass-hiring spree during the pandemic, they are now cutting staff en masse. More than 50,000 tech workers are losing their jobs as a result of decisions announced in recent months.

The stock market loves it. The NYSE FANG+ Index, which tracks 10 of the best-known tech giants, lost more than a third of its value during 2022. Over the past month, though, the index has reversed direction and climbed more than 12 percent.

A good chunk of these gains reflect the belief that tech companies are adjusting to reality and trimming the excess hiring they did during the pandemic.

Many companies have declared themselves guilty of this sin. Shopify Inc. SHOP-T, the Ottawa-based e-commerce pioneer, said last year that it had made a big bet during the pandemic that the transition to e-commerce would continue to accelerate. “It’s now clear that bet didn’t pay off,” chief executive Tobi Lutke wrote in July as he was eliminating 1,000 jobs, or about 10 percent of the company’s work force.

Meta Platforms (the former Facebook) said in November that it was cutting 11,000 jobs, or 13 percent of its workforce. It also blamed a surge in online activity during the pandemic for making it too optimistic.

Meanwhile, Microsoft, which announced last week that it was eliminating 10,000 jobs, or about 5 percent of its work force, said the cuts were designed to “align our cost structure with our revenue.” Spotify, which said Monday it was letting go about 600 employees, or 6 percent of its workforce, also acknowledged that it had let spending run ahead of revenue.

These explanations all suggest earnings will resume growing at a rapid clip once jobs are cut.

Maybe so, but they also raise deeper questions. Consider Microsoft. It made almost US$73-billion in its fiscal 2022. Both its income and its revenue have expanded at a double-digit pace in recent years.

Granted, many analysts expect it to post only modest gains in 2023. However, consensus forecasts still see its revenues and earnings rebounding to double-digit growth in 2024.

So why cut 5 percent of staff now? It’s not as if the company is squeezed for cash – on Monday, it confirmed to the Financial Times that it had made “a multibillion-dollar investment” in artificial-intelligence pioneer OpenAI. If Microsoft’s revenue grows at anywhere near the rate that analysts expect, it will be looking to hire again within a year.

A skeptic could make a similar point about most tech layoffs. If tech companies are going to grow over the next few years at anywhere near the rates that analysts expect, the payoff from cutting 5 to 10 percent of staff now is difficult to discern once severance costs and disrupted work flows are taken into account. The companies will need many of those laid-off workers back on the job in short order.

The idea that layoffs may turn out to be counterproductive or beside the point does not surprise researchers in the field. “Contrary to popular belief, there’s not much evidence that layoffs are a cure for weak profits,” a 2015 review by the Wharton School of business at the University of Pennsylvania concluded. Tech investors may want to bear that in mind.

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