Redundancy: crunching the numbers

Analysis

Redundancy: crunching the numbers

Deciding you need to make redundancies is one thing, the next step is to decide how many and where. This article sets out some basic guidelines for making those decisions.

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Deciding you need to make redundancies is one thing, the next step is to decide how many and where. This article sets out some basic guidelines for making those decisions.

Two choices: cost-based or function-based
 
The decision to make redundancies can be based mainly on either of two criteria:
  • cost-based — achieving a particular cost-saving; or
  • function-based — looking at the current and future work requirements of the business and making the jobs that are least important, or those that can be managed some other way, redundant.
Various factors will influence that decision:
  • size and type of the business
  • how urgent the 'crisis' actually is
  • prospects and likely time frame of business recovery
  • reasons for change, eg result of merger/takeover, technological change, withdrawal from markets, discontinuing old products and services
  • future plans for the business
 
Cost-based decisions
 
The following steps are required:
  • Set a dollar target amount for cost savings. This can be either a fixed amount or (better) a percentage of the total payroll cost. Whichever you choose, include both direct and indirect labour costs. The latter include payroll tax, workers compensation premiums, superannuation contributions and the value of all other employee benefits (including FBT where it applies).
  • In larger businesses, it may be worth having separate cost-saving goals for each section or department.
  • Calculate total average remuneration per employee for each section to be affected. It is probably better to make separate calculations for salaried versus wage-remunerated employees.
  • Calculate the total and average amounts of severance/redundancy pay that will apply to each section.
  • Calculate an amount per employee for the cost of the redundancy transaction. This will include the cost of outplacement assistance, plus administrative costs such as conducting interviews, preparing letters/statements and preparing references.
  • Then calculate the cost saving for each employee as follows:
Total remuneration of employee
 
Minus total amount of redundancy severance pay
 
Minus cost per employee of the redundancy transaction as described above
 
Equals cost saving of making the employee redundant
  • Finally, divide the cost-saving target amount by the cost saving per employee. The result is the number of employees you need to retrench to achieve the target.
 
Cost-based method: for and against
 
The advantage of the cost-based method is its simplicity, plus its logic is fairly easy to justify to employees, and perhaps other stakeholders such as unions or shareholders.
 
On the other hand, in its most basic form it does not take account of legislation, award or agreement provisions that may apply. Most of these factors can be incorporated into the model (if they can be expressed as a cost), but they will make it more complicated.
 
More seriously, it overlooks the issues of merit and relevance to future needs, which the function-based method addresses to some degree. So it may provide an answer to a short-term crisis, but may not produce the best long-term result.
 
Function-based method
 
The function-based method concentrates on particular jobs only, and attempts to identify which ones are the most appropriate to be made redundant. It too ignores the attributes of the employees who are in those jobs.
 
This method uses the following steps:
  • Identify and list all the major job functions performed at the workplace, and the number of employee working hours per week required to complete each one. For example, five people full-time on a single function is 190 hours per week.
  • Look at possible alternatives such as reassigning part of the workload to employees performing other jobs, reducing the number of full-time employees but increasing the workload of the remaining ones, and redesigning jobs to reduce overlaps.
  • List the possible risks or consequences of taking such actions as reduced quality control, loss of business through being unable to meet orders, more customer complaints, and employee turnover risks.
  • Assess the gravity and potential costs of these risks and consequences, and look for other ways to avert them.
  • If the potential risks are acceptable, factor them in and calculate the number of employee hours that can be saved by making the changes.
  • Convert these saved hours into remuneration costs (following similar lines as for the cost-based method above) and calculate the number of employees this is equivalent to, which provides the number to be retrenched.
  • Then decide which are the most appropriate jobs to eliminate.
 
Function-based method: for and against
 
The obvious advantage of this method is that it focuses more on the actual work done, and can also consider ways to have that work done more efficiently. It enables you to look at the longer-term relevance of each work function as well, and obviously those that aren’t likely to remain important can start to be phased out or combined into other jobs.
 
However, it still doesn’t take individual employee attributes into account and, being more complicated, might be harder to justify to employees and other stakeholders.
 
Other factors
 
It may also transpire, particularly with the function-based method, that the target you set for cost-cutting is unsuitable. For example, you can’t achieve it and still retain sufficient people to perform all of the essential work tasks. In that case, you will need to either revise the target and repeat the calculation processes or, else, look for alternatives such as outsourcing the work — if doing so actually produces a cost saving, which is not always the case.
 
Also, as pointed out in other articles on redundancy topics, it is important during any business downturn to ensure the business will be able to take advantage of opportunities that arise when the economic situation begins to recover. This means, for instance, trying to keep the employees that you think will be most valuable to you in the future and, where you have a choice, selecting for retrenchment those whose skills, knowledge, experience or potential may not be so valuable in the longer term.
 
Returning to the issue of costing, when you have decided via one of the above method how many employees to retrench, and which ones they will be, it is advisable to calculate the precise cost savings from retrenching those particular employees, and again compare the result to your target.
 
 
Source: Mike Toten, HR writer.
 
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