As Talk of a Recession Looms, Here's Why You Should Think Twice Before Laying People Off to Cut Costs
While the initial response is to cut costs quickly, businesses that haven't done so amidst similar past crises have managed to come out stronger in the end.
During the last couple of weeks, we have heard about several big companies announcing significant layoffs; Cameo and Robinhood, among others. Similarly, Meta announced a hiring freeze, and Uber's CEO mentioned that from now on, hiring is going to be a "privilege."
The main driver here is the sense of a recession in the air. From the significant drop in the valuation of recently IPO'd tech firms to the urgency in the Fed's actions, the general sense is that the euphoria of private firms' valuations and $100 million seed rounds are a thing of the past.
Over the last few years, most startups have invested heavily in growth but are still far from being profitable, so most will soon see a need to raise additional funds. Since the previous funding rounds were most likely raised on inflated valuations, raising additional funds will probably require taking a "down round," impacting current investors and further diluting the founders.
So the question that every founder and operator should be asking is, "Should I also start laying people off to cut costs?" Unfortunately, the answer to this question is not all that simple, and I would like to highlight both sides of this debate.
While the initial response is to cut costs quickly, firms that haven't done so amidst similar past crises have managed to come out stronger in the end.
During the 2008 recession, for example, computer networking company Arista Networks saw its demand shrink and its cash reserves dwindle. While most other firms fired their R&D people to preserve cash, all while maintaining their salespeople to create bigger cash cushions, Arista did the opposite and doubled down, keeping its developers and even hiring a few more, thus strengthening its competitive advantage and moat.
Arista Networks wasn't alone in using this strategy. A few years ago, I welcomed tech executive and investor Keith Rabois as a speaker in my scaling class. Among his accomplishments, he was an executive vice president at PayPal. When asked what allowed PayPal to be so dominant and have its core team subsequently start so many other successful firms, such as SpaceX and LinkedIn, he responded that due to recessionary pressure when the firm started, it had easy access to a dense pool of talent that ultimately catapulted them to success.
These stories may seem anecdotal, but there is a lesson here. In my opinion, over the next few years, we are going to see more investors favoring business models that can become more profitable. But that doesn't mean that firms should stop hiring, and it doesn't mean they should start firing people, either. In fact, I would argue that firms need to answer three simple questions when thinking about scaling:
1. How can you remain differentiated?
Keeping the firm as technologically viable and as ready as possible to retain this competitive advantage until the economic situation changes and the economy starts growing again, is crucial. A firm that has a great product or service at that moment will be prepared to jump on that growth wave.
2. How can you create a clear path to profitability?
As I mentioned, investors are more likely to support and provide a cash infusion to firms that have a path to profitability. So, find out what the firm can do in the near term to demonstrate such a path. What are the main levers you can pull that will bring you closer to sustainable growth?
3. What is your real constraint?
In regular times, I usually ask managers what constrains their ability to grow aggressively. In uncertain times, firms still need to grow, but we need to ask a slightly different question. It's no longer about what is limiting your ability to grow fast but rather, what is limiting your ability to survive or maintain yourself while surviving?
Growth is not the goal anymore, survival is.
In reality, if the goal is to survive, the easiest way to achieve that is to stop spending cash. But then you undermine your reason to exist and may end up with nothing. So surviving while maintaining a competitive advantage may actually mean hiring those who others are firing, and ensuring that your firm will have high-quality employees in critical areas.
So don't ask what the minimum you can do to survive another day is. Focus on the minimum you need to do to make sure you maintain your competitive advantage while also maintaining your survivability.
Hiring is clearly going to be a privilege over the next few months. But those who have that privilege will be better equipped when the recovery period begins.