Layoffs cost more than you think

(Fortune Magazine) -- As Warren Buffett likes to say, "It's better to be approximately right than precisely wrong." Every CEO should remember those words when confronting the powerful temptation to lay people off.

When you're desperate to save money, calculating the savings from firing staff is easy. But figuring the costs - the real costs - is hard. In fact, you can't do it precisely. So a lot of managers, rather than trying to get the costs approximately right, just assume that they equal the severance costs. That's being precisely wrong, as Buffett would say, and it can get a company in trouble.

Sometimes, of course, layoffs are unavoidable. But before you pull the trigger, consider their true price:

Hundreds of companies now state an explicit goal of being an "employer of choice" in their industry or locale. That's a worthy goal in an economy where the war for talent is a long-term fact of life. How badly will a layoff damage your company's brand as an employer - and its ability to attract the best talent?

Top law firms compete ferociously for the best new lawyers, yet many of those firms are laying people off. New York-based Simpson Thacher & Bartlett figured this was the moment to offer associates a chance to take a year off to work on a public service project and get paid $60,000 plus benefits - less than half their normal pay but a lot better than nothing. And it makes the firm much more attractive to the next crop of law school graduates.

Layoffs greatly increase the chance that you're firing a future company leader. You may never know whom, but the effect is still real. The banking and electric-utility businesses went through severe cutbacks in the 1980s, and executives in both industries have told me that they paid a heavy price 20 years later when they needed experienced, knowledgeable leaders and found only a broad empty space in the ranks.

Even the survivors pay a price. They "will certainly experience some grief. They also fear the loss of their own job," says leadership consultant Wally Bock. Sometimes the effects are worse. Workers who remain after a layoff file dramatically more medical claims, reports a study by Cigna and the American Management Association.

Don't count on a layoff announcement to make your stock go up. It might, if you're laying off people because you're combining two companies in a merger, says Bain & Co. But if you're laying off employees strictly as a cost-cutting measure, Wall Street may see the move as a sign of trouble - and send your stock down.

The day will come when the economy turns up, and when it does, you'll face the costs and delays of hiring and training new employees. Companies that have held on to their workers will be able to respond far more quickly. Northwest Airlines learned that lesson when it fired hundreds of pilots during tough times in 2007. When business picked up later that year, it had to cancel hundreds of flights because it didn't have enough pilots. The airline scheduled its remaining pilots too aggressively, and at the end of each month many of them had used up their permissible flight hours. The company had to speed up its recall and retraining of laid-off pilots.

Not many companies will avoid layoffs in a recession as bad as this one. Yet some manage. What do they do instead? Toyota (TM) continues to pay people but uses the time for training, education, and public service projects. The city of Atlanta recently cut hours and pay by 10%. FedEx (FDX, Fortune 500) has imposed graduated pay cuts - less for front-line workers, more for managers.

Then there's Aflac (AFL, Fortune 500), which has never had a layoff in its 54 years of existence. Janet Baker, senior VP of corporate learning, told me how that record fuels a virtuous circle: "Everyone understands that we've never had a layoff and is a good steward of our resources to make sure we don't have one."

How much is that worth? How much do layoffs really cost? Just remember that it's a lot - even if you never know precisely.