Contents

1. What’s the deal with companies making record profits and then laying people off?
2. Firstly, how do companies even make big planning decisions?
3. Record industry profits alone don’t mean much
4. Cost squeezing is a thing, but not for the reasons you think it is
5. Okay so not all layoffs are raw moustache-twirling greed but some are driven by bad decision making, right?

1. What’s the deal with companies making record profits and then laying people off?

So you pick up the newspaper¹ and you see that yet another company has announced layoffs.

Despite a booming U.S. economy and significant advancements in the tech sector, including a robust performance by companies like Nvidia Corp. and a thriving artificial intelligence (AI) industry, tech companies have continued to lay off workers at an alarming rate in 2024.

[…]

In 2024, the tech sector has already seen layoffs outpace those of the previous year, with over 42,324 tech employees laid off, averaging more than 780 layoffs each day.
Yahoo Finance: Despite Booming Economy And Record Profits Google, Amazon, Microsoft And More Lay Off Over 42,000 So Far In 2024 (Caleb Naysmith, 2024)

And you think to yourself: “What in the scooby is going on? Aren’t these companies just tripping over how much money they make? This seems wrong.”

One of the reasons people like to give is greed:

The causes of this recent industry contraction include studio consolidation, tightened margins after an early Covid-era boom, and good old fashioned corporate greed.
PC Gamer: The impact of 16,000 games industry layoffs, in one chart (Ted Litchfield, Wes Fenlon 2024)

Koul slammed the layoffs as “unnecessary and counterproductive” in a statement to CNN on Friday that blasted “corporate greed.”
CNN: The tech sector is pouring billions of dollars into AI. But it keeps laying off humans (Catherine Thorbecke, 2024)

Simply blaming greed is an overly simplistic and reductive argument that ignores how companies actually make decisions.

So let’s explore this briefly. I want to discuss:

How can record industry profits be irrelevant for specific company decision making?
How do companies make labour decisions?
How do budgets and corporate management principles influence labour decisions?

Ultimately, what I would like to teach is that sometimes it’s not greed that drives layoff decisions.

Even the most virtuous and well-meaning company that follows normal and sensible business practices can end up laying people off in ways that appear greedy if you don’t understand business.

2. Firstly, how do companies even make big planning decisions?

Business typically conduct an exercise every year to determine what resources, assets, and capabilities they need to execute their future business plan.

This activity can take many different names such as the:

Annual Business Plan;
Long Range Plan;
Annual Planning Cycle;
etc.

But it’s all fundamentally looking to answer very similar things ²:

What are the strategic goals for the company?
- e.g. Grow 2x above market growth rates, become #1 in market share, etc.
How will these strategic goals be achieved?
- e.g. Launch a new product or service, improve customer NPS scores, expand into a new country, etc.
What resources are needed to execute on the business plan?
- e.g. +150 hires in engineering for APAC, +50M in marketing spend in traditional media channels, etc.
Who is responsible for the business plan executions?
- e.g. Head of America is responsible for LatAm expansion, Head of Sales is responsible for +500M pipeline generation, etc.

Typically these decisions will be made in large committees or working groups.

For large companies, one of the Finance / Operations / Strategy Departments will typically own primary responsibility for the business planning cycle.

The other business units will then all contribute to a singular business plan. Behind the scenes politicking may also take place between executives to fight over limited resources or determine responsibility.

2a. Labour demand forecasting is one component of business planning

Labour demand forecasting is the part of business planning that asks the question: How many people do we need to do all the stuff we want to do?

This part of the business planning cycle is one of the primary drivers of determining headcount.

Depending on the industry you work in, the method and granularity of forecasting may vary. For example:

In the Retail industry labour forecasting can be incredibly granular to the point of planning the exact hours in a person’s shift.
In contrast, the Technology industry might only care about the total number of employees in a department and not bother looking any deeper.

However, nearly all companies will have some type of labour demand forecasting process.

2b. Profit and headcount aren’t 100% correlated

Labour demand forecasting is a future-looking activity. You need to judge what your future labour needs are, and shape your workforce today to meet the capacity and capabilities you expect you need.

Profit is what you earned today and in the past. But this is a historic number. It’s not necessarily reflective of what you will achieve in the future.

While they can be related (e.g. making more profit is good and lets you afford more things), that doesn’t mean it must affect labour demand forecasting.

So what drives labour planning activities?

2c. Your labour planning is driven by your business objectives and operational plan

Let’s see what EA said about why they were laying people off in 2024.

“We are also sunsetting games and moving away from development of future licensed IP that we do not believe will be successful in our changing industry.” (CEO Andrew Wilson)
CNBC: EA to lay off 5% of workforce, or about 670 employees (Alex Koller, 2024)

So EA is saying that it is going to focus on doing less stuff.

They’ve been spending money and hiring people to work on projects that were unprofitable and ultimately won’t be successful.
They don’t have anything else they can do with all these people

This… is a pretty generic and boring business plan that makes sense?

I want to be clear. It obviously really sucks for the people who are getting laid off. I sympathize with their plight. Being laid off is a terrible experience.

But this isn’t a scene from a movie where the CEO twirls their moustache and cackles like a Disney villain as they decide to lay off 670 people.

This is a business decision that EA has made by:

Evaluating their current operations;
Identifying there are areas of the business that just do not make sense to keep doing anymore; and
Choosing to stop doing that stuff.

This is what I mean about labour demand forecasting being future looking and not historic looking.

If your company is no longer doing [X] activity next year, it doesn’t matter how much money you made this year. You’re just not doing [X] next year.

2d. In general, we want businesses to adjust their workforce in response to changes in plans

Let’s say a country decides it wants to move to cleaner methods of electricity generation.

Coal is one of the dirtiest methods for generating electricity. So let’s say the government decides it is going to restrict the maximum energy coal power plants can generate.

If you run a coal power plant company, this is pretty bad news. Your business in the future is going to tank. So you need to downsize.

Your coal power plant company can be as profitable or successful as you want. It doesn’t really matter how profitable this company is. Make up any fictional profit number you want to. This is still a coal power plant company that is being forced to downsize.

So, naturally, the company will lay off workers it no longer needs to reflect the reduced demand for its business.

Is this the evil Coal Power Plant CEOs stealing from society by exploiting its workers and viciously firing them? No, not really.

Should we keep hiring coal power plant workers just to prevent people losing jobs if we’re just, you know, not going to operate coal power plants anymore? Also no, not really.

The same theories and ideas that make this true for the coal power plant industry are true for every other industry. Just replace the words “coal power plant” / “because of regulation” / “coal power plant workers” with your choice of [Industry] / [Reason] / [Type of Worker].

The alternative is either banning businesses from ever laying workers off, or trying to create a legal system where we try to define “good” versus “bad” layoffs and try to ban the “bad” layoffs.

Both of these would be highly impractical to actually implement³.

2e. But layoffs still have a significant impact on people even if the layoffs have a clear business rationale!

Yes, I agree.

This however is now a separate discussion about a broader set of issues:

How should society deal with changes that cause people to be unemployed?
Who is responsible for reintegrating people back into the workforce?
Should workers have a safety net of some sort (e.g. unemployment assistance, universal basic income, etc.) to minimize the impact of unemployment?
What minimum standards and protections should workers have when layoffs occur? (e.g. notice periods, paid leave, etc.)
etc.

3. Record industry profits alone don’t mean much

Your personal company’s situation and the industry’s situation can be very different.

Let’s use a real world example. I’ll choose Take Two Interactive (TTWO) since they’re still publicly listed and are a pure gaming companies⁴. Take Two also announced it was laying off 5% of its workforce earlier this year.

Video game publishing giant Take-Two Interactive is laying off 5% of its workforce, approximately 600 employees, and canceling several projects currently in development
Variety: ‘Grand Theft Auto’ Publisher Take-Two Interactive to Lay Off 5% of Workforce, Scrap Several Games (Jennifer Maas, 2024)

What do we see when we look at the numbers⁵?

TTWO	TTWO2023 vs 2024 YoY
Revenue	+52.6%
Operating expense	+117.9%
Net Income	-369.0%
Net Profit Margin	-276.2%
Cash held	-60.3%

Source: Google Finance, July 2024

So what can we see from this data?

Just because the industry has record profits doesn’t mean anything if your specific company is losing money;
It doesn’t matter if your revenue is going up if your costs are going up even faster;
It doesn’t matter if you’re profitable if you run out of actual cash and become insolvent⁶. So you need to make sure you take action if your cash falls too low and cut expenses.

4. Cost squeezing is a thing, but not for the reasons you think it is

A theory I sometimes see people write about is the idea that layoffs occur because businesses just want to cut costs due to greed.

I won’t say that this never happens. However, there are also many benign reasons why businesses may do this.

4a. The cost envelope approach to budgets

Most businesses have a long-run sustainable cost structure.

What this means is that:

There is some level of costs the business can safely sustain without becoming loss making;
In the long-run, businesses want to have a set of internal operations that stays within this safety limit;
If businesses drift out of the envelope, then the business needs to develop business plans that reduce costs until it is back within its safety limits⁷;
The cost limits that a business can have is dynamic and can change over time⁸;
Because this is a moving target, a business should constantly reevaluate its cost limits and keep updating its business plans to reflect changes on an annual basis.

So even if a business is doing well, it may choose to still make cuts in order to achieve a desired long-term cost profile.

Note that estimating your cost profile is once again a future-looking activity.

4b. I understand that loss making businesses need to cut costs. But why do profitable businesses also cut costs?

The common answer is greed. If a business makes money, it needs to make more money so just cut the costs!

This is not always true. After all, you need some level of costs to support your business operations.

Cut the costs too much and you devour your own operational capacity within the business. That in turn makes it harder to make money in the future (due to smaller operations) and is ultimately self-defeating.

And if this was true, we wouldn’t see companies making large spending commitments. For example:

In its earnings report on Thursday, Microsoft said capital expenditures jumped 79% from a year earlier to $14 billion. The company is spending much faster than it’s increasing revenue — sales climbed 17% in the period.
CNBC: Microsoft says cloud AI demand is exceeding supply even after 79% surge in capital spending (Jordan Novet, 2024)

So the answer of “But Wall Street / Hedge Funds / greed” doesn’t quite work here.

Companies are absolutely allowed to aggressively spend if there is a clear and justifiable rationale for it.

So what are some real business reasons why companies may choose to aggressively cut costs other than blaming “greed”?

4bi. Margin of safety

Profit and revenue can be volatile in some industries. Therefore companies may choose to maintain a “margin of safety” for extra security rather than just target the maximum cost limit.

I wrote in my previous essay on corporate decision making:

There seems to be a weird belief online that just because a company has money, it’s obligated to spend it. (And preferably on what you personally feel is most important right now.)

This is just… not true?

[…]

Businesses don’t like running out of money. The more volatile your industry, the more safety you want. The more stable your industry, the more risks you can afford to take.

Gaming is a terrible industry to be in. Consumers are fickle, trends can suddenly and dramatically change, and competition is fierce.

Hoarding a giant pile of cash is a good thing if you want to feel safe. It lets you wait out downturns in the economy, it means you don’t have to resort to layoffs just to stay alive, and it means you can fund new projects cheaper (since profit is “free” but loans have interest costs).

You want to avoid dipping into your “safety money” if you can avoid it. So even if a company has a good idea, it may still choose not to spend because the fear of things going wrong is too important.

4bii. Reallocation of costs

This is a big factor in the technology industry right now and one I do not see discussed much.

There are several factors behind the churn. AI is at the forefront. Companies need to free up cash to invest in the chips and servers that power the AI models behind these new technologies. There’s also the stock market effect. Companies that conducted layoffs haven’t been punished, either by investors or on their bottom lines. In fact, they’ve been rewarded with rising stock prices.
CNBC: Why widespread tech layoffs keep happening despite a strong U.S. economy (Jeff Morganteen, Anuz Thapa, 2024)

CNBC bungles the analysis here. It’s very surface level and assumes that the “stock market effect” is somehow a unique and separate reason.

Let’s say you genuinely believe that AI is the future in Tech⁹. If so, you should be immediately prioritizing investment into AI technology.

But where do you get the cash to make these investments? Well, you cut costs in parts of your business that are less critical. You then reallocate the cash you freed up into the higher priority areas.

This is not dissimilar to how you might review your household budget. You might cancel some unnecessary subscriptions to streaming services and eat out less in order to afford something more important to you such as the mortgage.

This is just businesses taking the exact same approach to allocating their cash.

The difference is that when you cancel a streaming service to reallocate spending, no one in your family gets fired¹⁰. When a company cuts costs to reallocate spending, someone might actually get fired.

Your spouse might reward you for being more efficient with allocating the household budget by saying thanks. Investors might reward a company for being more efficient with allocating the corporate budget by buying the stock, and driving share prices up.

This is why I argue that the “stock market effect” isn’t a unique and separate reason. The “stock market effect” is the market giving their opinion on whether it believes the capital and budget allocation decisions of a company make sense or not. The layoffs and reallocation towards AI investment are the same thing.

4c. And so we get to bad writing and bad reactions

It never has anything to do with “efficiency.” It’s always about goosing dividends.

I don’t blame people for having these reactions. It is very understandable why people react the way they do if they have never learnt about cost limits and budget allocations.

Let’s apply what we just learnt however to see if we come to a different conclusion though.

Spotify has been consistently loss making for a long time¹¹.

	2019	2020	2021	2022	2023
Net Income (Loss)	(186)	(581)	(34)	(430)	(532)

Source: Google Finance, July 2024

We know that companies operating beyond their cost limits need to find a way to get back within those limits. So we expect Spotify to find ways to cut costs to return within those limits.

Spotify also wanted to free up cash to invest in AI to create a better product¹².

So knowing these two goals for the business, layoffs are a natural business decision that has nothing to do with raw moustache-twirling greed¹³.

5. Okay so not all layoffs are raw moustache-twirling greed but some are driven by bad decision making, right?

Sure.

What drives businesses to make bad decisions however is a separate topic that is much broader than just labour demand and budget planning.

Afterall, no company executive wakes up in the morning and exclaims: “Today I am going to make bad decisions!”

They can make bad decisions of course. But normally they don’t actually believe those decisions were bad.

Tune in next time¹⁴ when I write about how businesses make bad decisions due to bad data, bad incentives, and bad management structures.

1
If you’re an old fuddy-duddy like me who enjoys reading physical things
2
This exercise can also be performed more frequently (e.g. every quarter of half year) but practically every company does it at least once every fiscal year.
3
Not least because courts are extremely reluctant to second guess judgement made by company management. See my prior essay on fiduciary duty.
4
e.g. Sony has stuff like music and films, Microsoft has Cloud + Software, etc.
5
If you wish to pull the data to do your own calculations, you can do so on Google Finance.
6
The currently cash burn is likely due to the development costs for their new game GTA VI, which currently isn’t making them money. So until then, the expenses needs to be managed.
7
Because if you’re constantly loss-making in the long-run, the business will go bankrupt and shut down
8
For example, the invention of automated machinery changed the cost profile for manufacturing companies by changing the balance between capital and labour
9
I’m not here to litigate if AI is overhyped or not. As far as investors and tech executives are concerned right now, it is real. So it’s good enough for me to use this as a real-world example for how business decision making works.
10
Hopefully.
11
If you wish to pull the data to do your own calculations, you can do so on Google Finance.
12
Well, at least according to Spotify it would improve the product.
13
You might disagree that this was the correct solution and that there are alternative possible solutions. That’s a fair argument! But greed and incompetence are not how I would describe this decision. And if you disagree, the onus is on your to show that an alternative path was possible.
14
Soon™

MoonBear Musings

What factors influence layoff decisions?