Morale Matters: Some Do’s and Don’ts of Cost Cutting

Let’s get straight to the point: you don’t need to see that jobless claims for the week ending March 28 skyrocketed to 6.6M claims (after rising to 3.3M the previous week) to know that startups are scrambling to cut costs and extend cash runways. With much of the nation under shelter in place orders, the economy has largely ground to a halt. And while the record $2.2 trillion stimulus package offers some hope, it remains to be seen whether venture-backed startups will be able to access loans and other programs offered by the SBA.

Tech startups need to think creatively about how to hunker down, weather the storm, and survive to fight another day. And do so in ways that prevent self-inflicted morale damage that outlasts the downturn itself.

As anyone who has been through an economic down cycle knows, there are very few cost-cutting options available to company leaders that don’t carry collateral costs. That’s especially true for decisions that impact employees directly, like bonuses, salaries, perks, and benefits. At a typical early-stage startup, compensation expense is one of the largest single OpEx line items. So when it’s time to cut costs, it’s the first place to start looking.

These decisions are tough because they impact people. And making the wrong moves can mean heavy hits to morale that linger well past the downturn itself. Company leaders need to act decisively but not before considering the consequences and potential side effects. It’s a case of not letting the cure be worse than the disease.

Here’s how I would think about reducing your cost structure while maintaining employee morale.

1. Reduce or eliminate discretionary expenses: The first step is to review and reduce the discretionary components of every OpEx line item. Typically this includes reducing or delaying program expenses, minimizing or eliminating T&E, and delaying hiring. I’d group employee perks into this category, but beware of inadvertently cutting high-value but low-cost items with high impact on culture. Weight those highly. Lastly, while you don’t want to open up the cost cutting planning process too broadly, it can be helpful to enlist the input of functional leadership. Their buy-in can be valuable for selling the expense reductions internally. Scale partner Rory O’Driscoll shared advice on the scenario planning process and COVID-related financial impact assumptions.

2. Delay or eliminate bonuses: During periods of growth, bonuses should be set to cascade and support the success of the business. During a downturn, performance is of course going to be down, and performance-based bonuses will be impacted because the company is likely to miss targets, however defined. Base salary should stay intact as should sales commissions as they are individual performance based.

3. Reduce executive compensation: This one is tough. In larger organizations, it’s common for executives to reduce their salary to $0 for a period of time. That being said, they are often richly rewarded in other ways including stock and other compensation. Founders and other startup leaders are often stuck in the middle where cash compensation is below market while the equity component has no immediate liquidity. Nonetheless, compensation has to come down. How much? Enough to signal to employees that management is feeling the same pain they are and especially in the case of layoffs.

4. Manage out bottom performers: Managing out bottom performers is a common practice in all companies, and doubly so at startups where every position is key. This can provide a shield against morale hits when you accelerate that process during a downturn. Most employees will mentally place eliminating low performers in a different category from across-the-board downsizing. This may provide meaningful burn reduction for your company but see my note below about healthcare.

5. Reduction in force (RIF): Lastly, you’ll want to consider a reduction in force. Sometimes, even after taking every other step to reduce your cost structure, the only way to survive is to let people go. When doing so, focus on retaining those that will be difficult to replace when the recovery does come. Also, make sure that you’ve cut deep enough to avoid a second RIF because you didn’t eliminate enough costs the first time around.

Note that I haven’t included a broad salary cut as one of the burn reduction strategies. It often sounds like a reasonable option, yet it is never as easy as it sounds. The morale impact can be quite high, sometimes even worse than an RIF. This is because of two factors:

• Blanket cuts have a material impact on some more than others — see the idea of a flat tax vs. a progressive tax structure.

• While it’s nice to believe that everyone will be altruistic during this difficult time, some employees will inevitably view their salary reduction as subsidizing underperformers.

Special note: Think long-term about healthcare 

Pay extra attention to how you treat former employees with regards to healthcare. Yes, healthcare is a big item on your P&L and seems an obvious place to start cutting. But I’d advise trying to figure out a way to help with healthcare beyond the requirement to provide COBRA insurance. Picture your Glassdoor reviews one year from now: letting employees go during a healthcare crisis without a medical safety net won’t help you recruit during the recovery. It’s a case where brand considerations and doing right by former employees are one and the same.