When Rightsizing Makes Sense...And How to Do It

Given where the economy is currently heading, David offers a framework that can help principals of creative firms make those tough staffing decisions in a timely and considerate manner.

Transcript

Blair Enns: David, we tend to avoid timely issues, and before you insert your joke--

David C. Baker: We're trying to not be super relevant or what's the goal here?

Blair: The opposite of timely is not irrelevant. It is timeless.

David: Okay. You scared me for a minute. I'm on board now. Keep going.

Blair: Okay. We're recording this on Friday, March 13th. Friday the 13th 2020, at a time when the coronavirus, or COVID-19, is sweeping the planet. We're just starting to get a sense of how big it is here in North America. We didn't want to do a podcast on the coronavirus, but there is an issue coming out of this pandemic that is timeless. We're calling it rightsizing. When rightsizing makes sense and how to do it. Rightsizing is a euphemism for downsizing, correct?

David: Right. I don't know. It probably still feels the same if you get dismissed, whether you were rightsized or downsized. But, I think it's a little bit friendlier term, supposedly.

Blair: This isn't a friendly topic. As you point out, this is why you the listener, or the owner for the firm, this is why you make the big bucks. These decisions that David's going to give you a framework to help you make. These are the decisions where you earn your pay and all the status and glory of being the person at the top of the firm.

David: Right. Before you cut your pay, before you dismiss people.

Blair: Cutting your pay does not absolve you of the responsibility to make the decision. Now, before we get into this, the principles and frameworks around rightsizing and when it makes sense to do so, and how to do it, recently, you hosted your own webinar on how to respond to COVID-19. What was the response like to that?

David: Well, it blew me away. I have a Zoom account. I used to use GoToWebinar. I have a Zoom account that's automatically provisioned for 100 people. I thought, "We'll probably get more than that." I raised it to 500 and then it just blew right through that in less than one business day. We ended up having 852 principles of firms. They were obviously very interested in that topic. One of the things that I just touched on was the idea of how and when do you rightsize staff. You and I both thought, "This is a topic we could dig in pretty deep here."

At the moment, obviously, a lot of firms are considering it. But, this is something that comes up in every firm's life at some point and, hopefully, we'll be able to put together an episode that we can just point to and that would be helpful to people as I think about it.

Blair: Your first point is, probably, it would be great if you had made some decisions in advance when you weren't in the heat of the battle, when you weren't feeling the stress of the moment. Is that correct?

David: Right. There's too many things that are just pulling on you if you just wait until that very moment. What you would do- and this could be caused by a downturn in your industry, or by losing a big client, or maybe losing your sales person, or maybe it's more of an industry right thing, which has happened to us several times in the past, 2001, 2008, apparently, 2020. The idea is to have a plan A. We need just a minor correction here, just a little bit. Maybe 10, 15, 20%, something like that and then a plan B which is much deeper.

The idea is you just pull that out of the folder and dust it off and it's easier to make changes rather than come up with something in the emotion of that moment. When I talk with people that have gone through this- I went through this myself one time, running an agency. It was one of the most painful moments I had. I remember crying during parts of it. You don't know. You're looking ahead and you can't see when the right time is. That is mainly the most painful part of it, I would guess.

Then, you talk to people afterwards and say, "Hey. What was the timing like? Did you do it at the right time?" Sometimes, people will say, "Yes. I really did it at the right time." Other people will say, "No. I waited too long." I have never had anybody tell me, "No. I did it too early." It's something we're thinking about. Even if you're not facing that situation right now, maybe you will in the future.

Blair: I think a lot of agency principles and entrepreneurs, in general, tend to be pretty optimistic, right? The reason behind that would be, "We're optimistic that things are going to turn around," and then we wait a little bit too long. This idea of having a plan in advance, a plan that you've made during the light of day. We can talk about what would trigger certain things. Is it certain drop in revenue or a number of clients, etcetera? Let's move on to the signs. What are the signs that it might be time to enact this plan?

David: This is the most difficult. When is it serious enough? I need to go to the ER. That's how you're thinking if it's from a personal health standpoint. Here, for the business, let me just give you a couple guidelines that might help our listeners. One is if multiple clients, two or three significant clients, begin delaying projects. That, to me, is the most worthwhile sign because most firms don't have a client concentration issue.

If you do have a client that represents a fair bit of your business, your billings, then that would also be another sign, if there's some blip in that relationship. Usually, the blip isn't terribly serious. It's just simply a delay because they're not quite ready to pull the plug yet, but they value the relationship they have with you. They also need to explain why they're not getting you what they need, or a payment is delayed. They just explain this to you. That's probably the safest way to look at this.

Another sign might be just not seeing as far ahead as you normally do in terms of workload. This varies by firm, for sure. Digital firms that are building big projects can usually see three, four months out in front of them. Other firms that are on a really pure project to project basis, they're not going to see more than eight weeks ahead of time. Just know whatever that is, when you think about managing your own capacity, and when that starts to drop, then that could be a sign. Then, the most important one is when you at your projections, your fee projections.

Let's say it's a $1.1 million firm and 100,000 of that would be outside costs like freelancers or media buys or something like that. Then, you would subtract that from the 1.1 and you're left with a $1 million in terms of fee. You could not, on a usual basis, safely spend more than 45% of that on unburdened comp. Unburdened means it doesn't include taxes, benefits, or bonuses. If Tom makes 60 and Luis makes 60, then your unburdened comp between the two of them is a 120.

You have to include yourself in here. When you look at what your fee projections are, you shouldn't be spending more than 45% of those on unburdened comp. As your fees drop, but your unburdened comp stays the same, you know that when those lines begin to cross, they get closer together, then, maybe it's time to think about what to do here. At the beginning, you put the plans together, plan A, plan B. If it's later in the process, and you pull one of those out of the folder and you say, "All right. Time to do something here."

Blair: This is almost imagining a dashboard or, at least, a checklist. The first sign is multiple clients start delaying. Second is a blip in a gorilla client relationship. Not everybody's going to have a gorilla client, but most firms do. Then, you lose visibility beyond eight to ten weeks out. This really vital metric, and I've heard you say this before, but it just hit me how vital this is in this moment, you keep an eye on that unburdened compensation ratio. Once it creeps above 45% of AGI, that's when the warning sign should start to flash. Is that correct?

David: Right. You can creep up to maybe 50%. Above that, every percentage point you're paying people is coming out of profit. In a really difficult situation, you might say, "Alright. I'm okay doing this without making any profit for a short period of time, three months, six months, whatever." Then, you might creep up to 55% or something like that. Anything above that and the red light should be screaming in your head. I know red lights can't scream. I'll just correct that before you can jump on that for me. It's time to be pretty nervous.

While it's true that a lot of firms don't have gorilla clients, any client concentration problem, the ones who do have usually been growing really quickly. You will see a connection there. Any firm that's been growing really quickly almost certainly has been growing quickly on the back of one client. That puts them at particular risk because they don't have their eggs in multiple baskets.

Blair: When you look at why businesses go out of business, it's usually a combination of two things. One is prevalent, perhaps, low lying stress. Then, the second thing is a shock. You're under stress already, and this is how human beings get sick too, and then there's this shock. What's happening right now at the time of this recording is essentially a global shock. Those firms that were under stress are most vulnerable, so you want to pay attention. I imagine, just going back to that 45% of unburdened comp as a percentage of AGI, if some firm principles are doing the math now, they're going, "Well, I've always been above 45%. I've always been at 50 or 52%." Is that appropriate to say? That might be the sign of an existing stress already. Something's fundamentally but slightly amiss about the business?

David: In the language of health, we might say they have a suppressed immuno. There's something wrong there already. They're old, they're infirmed, they have some complication, right? They don't have the ability to bounce back like other firms do. If you think about a really healthy firm that doesn't have some sort of a deficiency in their immunization system, or however you want to think about that, they've got cash on hand, they have clients that are all relatively the right size. They have a marketing plan spinning up, they have a good culture. That's what drives my business. It's this hope that I can slowly help people make strong business decisions so that when shocks like this hit them, it doesn't take them out. They may miss a couple of beats, but they're not out for good.

Blair: When the shock does hit, you actually have a bunch of levers that you can throw. How do you decide which one to use? Use it as an example. My wife is my business partner and we've been talking through this. Basically, this conversation. Not so much on downsizing, but that does come up, "Are we going to get to that?" There are a lot of levers we will throw before then. We hatched a plan. I said, "Okay, well, we've got lots of credit. It's just not as cheap credit as I'd like to have. As a plan to prepare for a worst-case scenario, I'm going to see if I can get access to cheaper credit." That's one example. There's also payables, et cetera. What are the things that we might choose from and how do we choose?

David: Yes. Some of them are ones that you'd only want to live with temporarily and others that you'd want to live with long-term. One of them, like you said, is stretching out payables. I'm a little nervous about that. In many cases, borrowing money, you might even stray outside of your positioning if you need to and you probably would just assume that this is temporary, that it's not going to work long-term. You don't want to tell too many people about the fact that your straying from your public positioning. When it comes to making decisions around the people that you might dismiss, I can give our listeners some very specific tips here. One of those is that last in first out that you would find in a union setting absolutely does not apply.

You should, as much as possible, just strip your mind of that. You shouldn't be trying to protect the people that have worked there the longest or somebody just bought a house. You just got to be careful about that stuff. That's the first one.

Blair: Hold on a second. I know we only have so much time, but can I just push back on that? I'm just unclear. Why is the most recent hire not the obvious one to let go first?

David: Because what does the business need moving forward? You've hired somebody because your business is trending in a direction. I was just talking with somebody right before you and I got on the phone. They're adding this new service offering that the marketplace is demanding from them and this new person is going to do it as an example. That would mean that they're going to step back and keep doing the old things if they just keep the people that have been there the longest. I just don't think it's relevant at all.

Blair: Yes, good answer. Okay.

David: The second thing, this is not intuitive, you want to protect the role players and then flex with the skill players. I'm using football, American football, terminology here. The role players are the AMs and the PMs, account managers, project managers. Those are the people that you need to protect. Those are the ones that are more relevant to keeping clients and keeping them happy. They're also very difficult, much more difficult to use on a freelance basis. You would keep those people, protect those, and then you would flex, as in maybe dismiss or cut the hours, of the skill players. The coders, the writers, the designers, and so on, whatever your firm does. That would be the second and third ideas.

The fourth idea is to not neglect the middle layer and this is what can happen if you don't think about it. You're starting to build your firm. You've got five, six people, you're running it, that's not more than you can handle mentally. You decide that as you add more people, you need a middle management layer. Now, you're managing as the leader, you're managing the middle layer, and the middle layer is managing the rest of the people. Well, you will get closer emotionally to the middle layer because those are the people that you interact with every day. Those are also the people who have made it easier for you to dismiss some of the things that you just don't enjoy doing anymore.

They've helped free you up. It's natural to lay off the lower people who don't seem as important. Just like you built this pyramid up, or you slowly added a middle layer, you do need to think about peeling off some of that middle layer as well. Otherwise, if you don't do that, you'll end up with a very top-heavy organization. With you, a pretty big middle layer, and then a whole lot of chiefs and not a lot of Indians. It's just something else to think about.

Blair: You politely say don't neglect the middle layer, you mean when considering layoffs?

David: Right.

Blair: Another way to say it would be, you might start by looking at the middle layer, is that correct?

David: Yes, you might. Of course, the downside of that is that you are probably going to have to get your hands dirty again. It's all hands on deck. You're going to be operating like you were before some of these people came on board and that's just one of the sacrifices that's necessary. There's a tough question that comes up when you think about who to include in this rightsizing and that's all the personal issues that come up. Here's an example. I just hired Tom and Tom was looking for a job. Tom didn't have one and I gave him one. If I dismiss Tom and he's basically just looking for a job again, he didn't quit a job to come work for me. Linda quit a job and she might've even taken a pay cut to come work for me.

I feel worse about laying Linda off because she quit a job to come work for me. Or, you think about, "Susie bought a home with that new promotion I just gave her that gave her the confidence to buy a house." These are the issues that as a leader you do have to be aware of, but you almost have to ignore them. You've got to be sensitive to people and do whatever you can, but your job is primarily to do what's in the best interest of the firm, no matter how difficult that is. Does that make sense?

Blair: Yes, it makes perfect sense. I can just imagine how difficult some of those decisions are. The way to think about it is if the firm does not survive, how many people are you creating hardship for as opposed to that one difficult conversation or that one difficult situation? Plus, as much as we know our teammates, we don't truly know about other opportunities that they may or may not have, or their ability to recover, whether they've got family support, or somebody's been trying to hire them for quite a while, or whatever. We're just unaware of that and I don't think we should take on the responsibility of having to make those guesses, or decisions, or do that math. Do what's right for the firm is what you're saying.

David: Yes. When you look back over your career, and I do the same over mine, when I lost those jobs. I fired myself at one job. I was a middle manager and I just realized there's just no way I can lay off these other people and not cut my own job. They were the best things that happened to me. I don't want to pretend that that's always the case because some people are unemployed for quite a while, or it's very disruptive for them, so it's not always true. I would say, most of the time, it's a catalyst for a great change in somebody's life. That doesn't ease the pain, but it does mean that it's not quite as catastrophic as it feels like it might be.

The other thing to think about is that you are presumably hiring really smart, really capable people that fit your culture. Those are the people that will struggle less to find new jobs. If you've done a really poor job hiring people, then dismissing those folks, yes, they're going to struggle to find another job too, but that's why you shouldn't hire them.

Blair: Okay, we're talking about how to think about and make sense of rightsizing and then how to do it. We've just been talking about how to make some of the decisions. Once you make the decisions, let's get into some of the specific tactics of how you go about these things.

David: First one to think about is don't cut one person this week, and then two people two weeks from now, and then another one three weeks later. When you do that, people come to work and they just don't know when the next shoe will drop. I describe that crudely as don't chop somebody's leg off one inch at a time, "Okay, I don't know how far the infection will get, so I'll just take two inches off. If that's not enough, then, next week, we'll take another inch off." That's just not the way to do it. Just cut as deep as you think you'll need to. Trying to think ahead at least two months. If another round of cuts is necessary at that point, then they are. That's just part of life.

You don't want to leave people wondering every day if something bad is going to happen. That's the first tip. The other is, don't ever do it on a Friday. Don't ever do it in the afternoon. You want to be around so that the folks that are still on the team have a chance to talk with each other at work and they have a chance to talk with you if they want to. Otherwise, they'll be texting between themselves after work, or on the weekend, and they might get unnecessarily riled up, and there may be some misunderstanding because you can't step in and clarify things. You always want to do this in the morning. People have more emotional ability to adapt to things in the morning, when they're not as tired. Always do it in the morning and don't do it on a Friday as well. Be respectful. I can't imagine a situation that would justify you escorting somebody to the door, I still see that happening sometimes. Now, if you're dismissing somebody for cause, then maybe that makes sense, but not in a situation like this. Just treat people with complete respect as much as you can.

They're hurting anyway. Just let them hang around but say, "Listen, hang around for a couple of hours, if you need to, I want to make sure you have a chance to talk to anybody that you're close to here. If you need to come back tomorrow, that's fine, if you need to use the equipment." Just give them that respect, treat them as if you would want to be treated.

Blair: Yes, and tied up with respect is be empathic too, is what I'm hearing you say?

David: Right.

Blair: Okay. What about everybody taking a pay cut instead of having to layoff an individual or two?

David: This question comes up quite often. I think it's something that can work if the culture is really good. The problem with it is that a lot of folks that work for you don't have that flexibility in their budget. In other words, they don't have 10% or 15% or 20% extra every month, and if you cut that, they'll still be able to make it. What you might be doing is creating a hardship for everybody. It's possible, especially, if you just dip into a cut with the middle layer and yourself. It is possible. Usually, it makes more sense to make a tough call, especially, if the culture can't withstand it. Usually, if that's a good idea, the staff will come to you and suggest it.

Blair: I heard a stat this morning on a podcast that I was listening to. I'm not going to remember the bulk of it, but it was a significant percentage of American families do not have the capacity to take a $400 financial hit. The idea that, say, you're paying somebody well and let's say it's 100,000, which I think is still good money today, and you ask everybody to take a 10% pay cut. I think the reality is there are some people out there who are in that age, or in that income bracket, that might not be able to withstand, without a significant hardship, with a 10% pay cut.

There is something to think about because you as the owner can withstand a 10% cut in your income, or in your salary, doesn't mean that your people can. I can see how you have to think deeply about that.

David: Yes. When we get more money, our needs and our wants tend to expand to take up that money, right?

Blair: You've made these decisions on who you're going to lay off and you have got some guidance, some parameters, on how to do it, when to do it, et cetera. Are there some things that you can do to lessen the impact of the fall as these people are walking out of the door? You've already alluded to some of them like, "Hey, feel free to stick around and use the equipment, et cetera." Are there other things that we should be thinking about that we might do to help these people?

David: Yes, for sure. Of course, severance is going to come to people's mind immediately. How much severance, I hear people talk about rules of thumb. The problem is that I hear very different rules of thumb. I hear one month for every five years, sometimes I hear one week for every year. That's probably more typical one week for every year. If the firm is suffering, then you don't usually have a whole lot of severance to dribble out. I've encouraged people to use this mental trick. Let's say that things are getting fairly bad but you're not ready to pull the trigger yet. What you do is, say, pick this date in your mind, say, it's six weeks out.

You could dismiss somebody right now and give them six weeks severance or you could wait two more weeks and give them four weeks severance. Just use that mental trick in your mind so that whatever it adds up to, the number of weeks they're still with you plus the severance, should equal the same thing. Every week you keep them longer is one less week of severance. When you think about it that way, it's more humane to do it quicker rather than later because they know that they're now looking for work and they have this thicker cushion. That's one thing that I would definitely say.

Blair: I really like that idea. I think that's a great, as you call it, mental trick, in all but the situations where severance is spelled out in the contract. Those situations aside, is severance at all a legal issue or is it entirely at the discretion of the owner of the firm?

David: It depends on where our listeners are. In North America, it's a discretionary issue. In many countries, pretty much over all of Latin America and a fair bit of Europe, it is mandated. From what I remember, it's at least a month and then it goes up from there. You really don't have any choice. The sooner you make that call, the less time they'll be on payroll, but you'll still be on the hook for the severance.

Blair: Severance is one way we can lessen the impact. What about offering follow on work, freelance work, something like that? Does that make sense?

David: For sure. Often, you may not need all of their efforts, but you might need some of them. As a goodwill gesture, you could say, "All right. I'm converting you now to freelancer, but I also want to give you some work. I'm going to guarantee you 30 hours the first week, 20 hours the second week, 10 hours a third week." It's going to slowly fade out, but it lessens the impact. That's one thing you could do. If there's a client, your structure is such that you can't serve them profitably, but maybe a freelancer working from home could make money on them, especially, if this person is connected to them closely already, it often makes perfect sense to let them take a client with you. It's a great solution for you, great solution for this person, and a great solution for the client.

Blair: I've got to let you go, but feel free to choose any of one of our clients on your way out the door?

David: [crosstalk] Laptop, maybe. Any equipment that they're using that you don't need because you have a smaller staff, that's often a kind thing to do. They probably have a personal laptop, but it's probably not capable of doing the high-level freelance work that maybe they're moving into. Health insurance, depending on the country again. Talking more about the US, where a lot of our listeners are. That's a huge concern for them, especially, if they're not married to somebody and they're on that person's health insurance, that's a big issue. You could continue paying for that.

Blair: This is almost uniquely a US issue. It is a big issue and I think many outside of the US do not appreciate how significant an issue this is. The cost of private health insurance is significant.

David: Yes, I think it hurts entrepreneurship significantly. There are a lot more people that would have been entrepreneurs if they could solve the health insurance issue for themselves. At the moment, still an issue in the US. Let them use your facility. I'd be careful with this one because it's not really great long-term to have them hanging around. You can help find work for them, definitely write them a glowing letter of recommendation. There are all kinds of things that you can do. I think beyond these things that we're talking about, being an empathetic human and just communicating that, being vulnerable, being helpful, struggling with them, I don't even know how to measure that, but it's certainly significant.

Blair: I would add to that, just based on what you've already said. At the top of the list, be prepared, be as prepared as you can and you might be listening to this at a time when it's like, "Okay, well, the moment for preparedness is passed." The more of these decisions you can make in advance, and I particularly like your mental trick of saying, "Okay, six weeks out, so I can lay them off now and give them six week severance or I can wait two weeks," et cetera. That kind of preparation about telling yourself, and maybe even writing down, when you're going to make what decisions. I think that's a big part of being empathic and aiding your people as best as you can. Let's talk about the last person or issue on the list is you, the principle. You could lay yourself off. Well, you can't lay yourself off, what can you do? What hits can you take personally and what are the things do you need to be thinking about?

David: If you've always wanted to buy this new car and you're ready to do it, maybe you still need to, but don't park it in the front. I remember I was working for somebody who was laying people off. He drove to work that day and parked his red Corvette in the front. It was just bad optics. Just all the little things. Just look at things through their eyes, through your team's eyes, that's important. I do think it makes a lot of sense to cut your own pay. I don't think it makes sense to cut it deeper than what the highest non-principal, in other words, the highest-paid employee would make.

I just don't think it makes sense. It relieves the pressure and you should not relieve the pressure for the smart business decisions you need to make. That's another reason why it's not a good idea to leave a lot of money in your business because then when something like this hits, you feel like you have all the time in the world and you don't react quickly enough. That's an important one. I'd also just introduced the idea that open-book management is something that people tend to warm up to when things are tougher at their firm.

Don't do that just when things are tough. You might be more open-bookish about your firm struggles, but are you willing to maintain that when things get great again. I just think a little bit carefully about that. I want to go back to something you said at the beginning, it's so important, is this notion because it seems like as an industry, we're really poor at planning for these kinds of things. We don't want to plan for contingencies and I don't know why it is. Is it because we're so incredibly hopeful and positive and think that we can sell our way out of things? I don't know what it is, but I just don't see many firms who are doing contingency planning like firms in other segments of the business world. I don't know why.

Blair: Might be a combination of optimism, creativity. Optimism is a big part of creativity. An aversion to planning, which also goes with creativity. The high autonomy score, an ability to think on your feet. You might have that ability to think on your feet, and you might have that ability to think rationally on your feet, but it sure feels better when you make the plan when the chips aren't all on the table. Then, you can reference the plan. You still might deviate a bit from the plan as you're in the ring and you have got to box.

You have got to make real-life decisions in that moment. It sure would be helpful in moments like this if you had thought about it ahead of time and you could pull out this list of things that you will and will not do or in what order and at what point. You can look at the list and say, "Here's what rational me thought at the time. Here's what irrational, or maybe just emotional, me is thinking right now. Let's at least find something that makes both of these people happy or less unhappy."

David: I think what you just said about the creativity and thinking on our feet, that might have something to do with it, too. When you go through this, I went through this once when I owned an agency and I remember the terror of it. That terror has never left me. It's really useful to remember that terror so that we don't get too far ahead of ourselves here. Remember, that other side of growing too fast, or the other side of spending too much money, or not having a thick enough cushion, or allowing too big a client. Let's remember the flip side of risks sometimes and at least be aware that it might hit us that we're not immune to that.

Blair: I'll just say a final word to our younger listeners who are just a few years into managing their firm. I'm 53 now, and I've been saying recently, I feel like the benefits of aging. I feel like I've seen everything twice, maybe three times. As we're going through this economic downturn, and the market's still continuing to crash, I'm looking at it and thinking, "Now, I've seen this before. I know how it ends." It's just a sense of calming that the world isn't ending. I don't remember feeling that in 2009. 2009, I had bravado in my business. It was essentially just me back then too.

I launched my business in early 2002, another down economic time. There are opportunities in volatility but when you have to make these decisions, they're really difficult. If your business survives, you'll go through this again. You'll take more seriously the idea of the importance of planning, you'll learn some lessons, and then you'll go through it again. Maybe by the time, the third time you go through it, you'll realize, "Okay, stay calm. Work the plan. Everybody's going to be okay." One of my favorite lines is everything always works out in the end. If it hasn't worked out, it isn't the end.

David: That's a good reminder. The folks who weren't running a firm in 2008, 2009 are probably having a slightly different perspective of this than those that went through that. 

Blair: Well, David, this is a good topic. On behalf of all of the creative industry, I know over the last couple of weeks, and over the next few weeks, you're spending a lot of your time talking to large audiences remotely, like you did through your webinar, and you're addressing audiences of various industry associations. Just trying to give them a sense of assurance and the tools like this on what to do when you have to do something. Thank you for all your good work and thanks for a great conversation today.

David: Yes, thank you, Blair.