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Photography: Getty Images

The Thought: When the Great Recession hit, many companies "restructured" and laid off thousands of workers. By asking employees to take unpaid leaves instead, Honeywell positioned itself for the recovery.

When I arrived at Honeywell, in 2002, the company had gone through a challenging period. In 1999 it merged with AlliedSignal and shortly afterward closed on the acquisition of a company called Pittway. The 3 cultures were never integrated, Honeywell had repeatedly missed earnings, and the company had announced cumulative write-offs of $8 billion. Having been in the chemical manufacture for more than than 100 years, it had environmental liabilities that had never been dealt with. Honeywell had gone through three CEOs in four years and had had a lot of turnover at the managerial level equally well. Virtually no pipeline of new products existed, because managers had been disinvesting to boost profits.

In my first v years hither, nosotros worked to fix many of those bug. We instituted more-conservative bookkeeping and addressed our ecology liabilities. Nosotros invested in new products and services, and nosotros expanded abroad. The share of our revenue coming from outside the United States increased from 41% in 2002 to 54% in 2012. We congenital our direction bench strength to the signal where 85% to 90% of our top-level vacancies are filled by internal candidates; previously merely fifty% had been. Most important, we established a "One Honeywell" culture in which we focus on business acumen, listening to the customer, and doing what we say nosotros're going to practice. By the end of 2007 we had reestablished our credibility with investors, our share price had more than doubled, and nosotros were significantly outperforming the Due south&P 500 and our peer grouping averages.

In September 2008, though, we began to see a shift in our business organization. Suddenly orders were being canceled, and no new ones were beingness placed. It soon became obvious that the U.S. was in a recession and that nosotros, as a big industrial visitor, were going to see our results soften. The only businesses in our portfolio that held upwardly well were defence force, aerospace, and energy efficiency. Everything else was downward.

Businesses like ours have two primary costs: the textile nosotros use to make products, and people. In a recession, material costs (direct costs) drop naturally—you just buy less stuff every bit your incoming orders reject. You can also work around the edges past seeking opportunities to lower indirect costs such as travel and other non-business organisation-critical expenses. Cutting the costs of people, which in an industrial visitor usually business relationship for thirty% to xl% of total costs, is more hard. Companies typically react past "restructuring": They cut, say, 10% of the workforce, take a big accuse confronting earnings, and move on. We did do some restructuring in 2008–2009, simply I've never been fond of that arroyo to a recession. So we fabricated sure that any restructuring nosotros agreed to during that period would be permanent—in other words, not solely in response to the recession but, rather, what was best for business efficiency and profitability over the long term—and would take no impact on our power to outperform in recovery.

As my leadership squad began looking at options, nosotros kept coming back to the idea of furloughs: Workers have unpaid leaves just remain employed. The conventional wisdom is that considering furloughs spread the hurting across the entire workforce, they hurt everyone's morale, loyalty, and retentivity, and then you'd do ameliorate to lay off a smaller number, focusing on weak performers. They're as well a challenge logistically. To implement them, we needed to comply with individual state laws and besides laws in other countries where we do business. The procedure didn't go perfectly. Looking back, I recognize some clear mistakes nosotros made, and if I had to practice it again, I'd do a few things differently. Simply on the whole, our determination to utilise furloughs rather than layoffs was a success.

Peter Cappelli is the George W. Taylor Professor of Management at The Wharton Schoolhouse and the author of Why Good People Tin't Go Jobs: The Skills Gap and What Companies Can Practise About It (Wharton Digital Press, 2012). He spoke with HBR virtually why furloughs have go unusual.

Historically, most companies used furloughs to reduce payroll costs during recessions. When did layoffs replace furloughs?

More recently than yous might think. Until 1985 the U.S. Bureau of Labor Statistics didn't fifty-fifty take a category for permanent job loss. Until then the assumption was that if a company laid y'all off, it would rehire you when the economy picked up. That changed during the 1981–1982 recession. Companies had become bloated with managers during the slow growth of the 1970s, as talent management practices failed. Since then the risks of losing a task every bit a manager take been greater than the risks facing blue-neckband workers.

Practice managers tend to underestimate the costs of layoffs?

Yep. Most organizations have near no thought of their turnover costs, their hiring costs, or the costs of keeping a job vacant. They do know what information technology costs when someone is in the chore—the amount they're paying that person—and then they know how much they'll save if they get rid of him or her. That's one of the big bug in talent management: CFOs can give u.s.a. labor costs to the penny, merely they tin't measure the value of employee contributions, which creates a bias toward cutting.

Since the 1990s Wall Street has reacted positively to layoff announcements. Are there any signs that attitude is irresolute?

Researchers have begun looking at that question lately. It'south truthful that companies don't see big payoffs (in stock cost) from layoff announcements anymore. 1 theory is that the investment community has gotten smarter and knows that layoffs frequently aren't worth the costs. The other is that investors have realized that companies making large layoff announcements often fail to follow through with all the job cuts. Nosotros're non sure which theory is correct.

Source: Challenger, Grey & Christmas

The False Promise of Layoffs

When I arrived at the company, I thought we had likewise many people. Over the next five years nosotros managed to go along employee numbers flat—even as sales increased at a compound annual growth rate of x%—and we eliminated some lower-performing employees by doing more than-rigorous performance reviews and not filling jobs that were vacated through normal compunction. When the recession hit, our head count still wasn't every bit low as it could have been, so if nosotros did layoffs, nosotros wouldn't exist "cutting into bone." But we opted for furloughs, for several reasons. Most managers underestimate how much disruption layoffs create; they eat everyone in the arrangement for at least a twelvemonth. Managers besides typically overestimate the savings they will achieve and neglect to understand that even bad recessions usually end more quickly than people wait. We wanted to be ready for recovery equally soon as it came, whether it was soft or V-shaped, and furloughs were 1 way of positioning us for whatever issue.

To empathize that reasoning, look at what actually happens when yous do layoffs. Each person laid off gets, on average, about half-dozen months' worth of severance pay and outplacement services. So in essence, it takes six months to get-go saving coin. Recessions normally last 12 to eighteen months, after which demand picks upwards, so information technology's pretty mutual for a company to have to start hiring people about a twelvemonth or so afterwards its big layoff, undoing the savings it began realizing just 6 months earlier. Think for a minute about the costs of a layoff the way you'd retrieve about a traditional investment in a plant or equipment. Imagine going to your boss and proverb, "I desire to spend $10 one thousand thousand on a new factory. It will take us half dozen months to pause fifty-fifty on it, and so we'll get to run the manufactory for six months. Merely at that point nosotros're going to demand to shut it downward." Yous'd never do that—nonetheless when it comes to restructuring costs to lay off employees, everyone seems to think it makes sense.

That's because when faced with a recession, managers find information technology hard to look ahead toward recovery. If you worry that a recession is going to concluding forever, you may believe that the savings achieved by a layoff will be permanent. But that's not really how information technology works. I've been a leader during 3 recessions, and I've never heard a management team talk well-nigh how the choices they make during a downturn will touch performance during the recovery. Merely in 2008 and 2009 I kept reiterating that point: There will exist a recovery, and nosotros need to be prepared for it.

Both layoffs and furloughs can create behavioral problems and costs, and you could debate that furloughs are tougher in some ways. But i fact remains: Layoffs are much more disruptive to an organization in both the short and the long term. Even employees who stay are extremely distracted, because they've lost friends and are worried about their ain jobs. To me, that'south no mode to run a railroad.

The Challenges of Furloughs

We told our businesses to ask every worker to take a serial of unpaid weeks off during the showtime half of 2009. The number of weeks varied past business—the average furlough was three to 5 weeks, taken in 1-week blocks—and business leaders reassessed their situations every few weeks to run across if additional furloughs were necessary. This arroyo presented its own difficulties. Some states have very strict laws near what constitutes piece of work, then nosotros sometimes had to take away people'due south smartphones and laptops to ensure that they didn't bank check office email during a furlough. In some strange countries, government regulations and approvals prevented u.s.a. from doing furloughs at all. But in near places the plan went pretty smoothly, at to the lowest degree in the beginning. During the first week or ii we received positive feedback: People felt good almost making sacrifices, considering they knew they were helping to save jobs—maybe their own, maybe a colleague's. As the furloughs kept going, however, their attitude began to modify. Some people complained, "I tin can't live on this salary." Some concluded that they wouldn't have been amid the people laid off, and then they started to resent the sacrifice.

We also faced challenges when our acme executives—my direct reports—felt that they, too, should be furloughed, as a symbolic gesture. To me this was mistaken solidarity and shortsighted. I told them nosotros couldn't afford to take leaders absent during this catamenia. I likewise reminded them (and our employees) that as leaders, they received more than one-half their annual bounty in the form of a bonus, and so although employees were losing v weeks' pay, on boilerplate, leaders would exist losing far more. "Trust me—on a percentage basis, yous're going to be severely affected," I told them. The bottom line was that nosotros needed them to stay at work.

The rap on furloughs is that they penalize acme performers and cause them to exit. Simply our "regrettable turnover" decreased significantly.

By the summer of 2009 people were pretty anxious. They wanted to know how many more weeks of furloughs might be necessary. We still didn't consider layoffs, but nosotros did begin looking at benefits costs, to see if we could find ways to save more than coin without putting people out of piece of work. I tried to explain to everyone—both employees and my top executives—that we had three constituencies whose interests nosotros needed to residue: customers, investors, and employees. Penalizing customers wasn't an option, and production programs had to get forwards. So the pain would have to be divided betwixt investors (in the form of lower returns) and employees (in the class of reduced pay). Finding the correct balance was a challenge, merely I think we accomplished that.

Prepared for Recovery

The economy stayed soft for virtually of 2009. During the get-go nine months of the twelvemonth, our unit leaders had difficulty making their sales forecasts because demand kept weakening. However, despite lower sales in 2008–2009, the company stayed highly profitable and held its segment margin rates, which is very hard to exercise in a recession.

During the 4th quarter of 2009 our sales forecasts stopped going down, and by January of 2010 my team and I were starting to talk nearly a recovery. As orders began to pick up, it was clear that we were well prepared in comparison with our competitors: Our inventory and delivery times were better, and considering we had held on to our people, we plant it easier to win new business concern.

Founded: 1885
Headquarters: Morristown, New Jersey
Employees: 132,000


Source: Honeywell

We watched our turnover very carefully every bit the economy rallied. The rap on furloughs is that they penalize top performers and cause them to leave. Just in fact our "regrettable turnover" (the number of employees we'd like to retain who nevertheless choose to get out) decreased significantly. That makes sense to me. Generally speaking, non everything is about money: People aren't mercenary, and they desire to be function of something successful that is bigger than themselves. We'd had a practiced track record since 2002, we had a lot of employees who believed in what we were doing, and we communicated it clearly. People could see that things wouldn't stay atrocious forever, so they hung in.

Withal, I believe that we made two mistakes in implementing our furlough plan. The first was how nosotros let employees know about the sacrifices I would be making. Very early in the recession I decided that I would not take a bonus for 2009. At the time, my almanac bonus was around $4 million, then that was significant. When employees asked me in boondocks hall meetings how the recession would impact my bounty, I e'er gave the politic corporate governance response: "That's not my decision—it's up to the board." Everyone would have been meliorate served if I'd just said that I'd already decided to forgo my bonus.

The second fault was that when we decided to let individual units determine how many weeks of furlough they needed, we should have made information technology clear that we didn't want them imposing standardized furloughs across their businesses. For case, some of our units furloughed workers in Cathay, where revenue was still growing. Employees in emerging markets have a lot of opportunities, and ordering furloughs in a fast-growing market created some Hr problems and organizational malaise that we could have avoided.

Still, I believe that our decision to use furloughs instead of layoffs was the right ane and that we managed to become about ninety% of the implementation right. I hope we never accept to do it once again—but if we practise, I'll make sure we hit 100%.

A version of this article appeared in the June 2013 outcome of Harvard Business Review.