Michael_A._Hitt,_R._Duane_Ireland,_Robert_E._Hosk

226 Part 2: Strategic Actions: Strategy Formulation

The loss of human capital is another potential problem of downsizing (see Figure 7.2).

Losing employees with many years of experience with the firm represents a major loss of

knowledge. As noted in Chapter 3, knowledge is vital to competitive success in the global

economy. Research also suggests that a loss of valuable human capital can also spill over

into dissatisfaction of customers.^108 Thus, in general, downsizing may be of more tactical

(or short-term) value than strategic (or long-term) value, meaning that firms should

exercise caution when restructuring through downsizing.

Compared to downsizing and leveraged buyouts, downscoping generally leads to

more positive outcomes in both the short and long term. Downscoping’s desirable long-

term outcome of higher performance is a product of reduced debt costs and the empha-

sis on strategic controls derived from concentrating on the firm’s core businesses. In so

doing, the refocused firm should be able to increase its ability to compete.^109

Whole-firm LBOs have been hailed as a significant innovation in the financial restruc-

turing of firms. However, this type of restructuring can be complicated, especially when

cross-border transactions are involved^110 ; moreover, they can involve negative trade-offs.^111

First, the resulting large debt increases the firm’s financial risk, as is evidenced by the

number of companies that filed for bankruptcy in the 1990s after executing a whole-firm

LBO. Sometimes, the intent of the owners to increase the efficiency of the acquired firm

and then sell it within five to eight years creates a short-term and risk-averse managerial

focus.^112 As a result, these firms may fail to invest adequately in R&D or take other major

actions designed to maintain or improve the company’s ability to compete successfully

against rivals.^113 Because buyouts more often result in significant debt, most LBOs have

been completed in mature industries where stable cash flows are the norm. Stable cash

flows support the purchaser’s efforts to service the debt obligations assumed as a result

of taking a firm private.

Figure 7.2 Restructuring and Outcomes

Emphasis on

strategic controls

Alternatives Short-Term Outcomes Long-Term Outcomes

Reduced debt

costs

Reduced labor

costs

High debt costs

Leveraged

buyout

Downscoping

Downsizing

Higher risk

Higher

performance

Lower

performance

Loss of human

capital