Dip’s Hits

In technology we’ve gone through cycles of boom and bust. One of the latest trends is to ‘outsource’. This usually means taking an existing product and sending maintenance or future development of it to Asia. This sounds good on paper, because designers in those countries are typically paid 1/3rd of the costs for employees in North America.

But is it really? What are the true costs associated with this?

It’s an easy sell to executives, who get the best talent available overseas paraded around and show a quick understanding of complex systems, programming languages and design concepts. These guys are easily the equivalent to designers here- well spoken, high-tech, experienced. The assumption, of course, is that the other designers on the team are at a similar level. And also that these same designers who learn the product will be working on the product.

Sadly, this is demonstrably false. As anywhere, there’s no guarantee that an employee will stay with a company. However, in these outsourcing firm’s case- it is worse. These ‘hot shot’ employees are their absolute best employees and are used to sell the outsourcing firm to each company, not for working on the project. Furthermore, the turnover for the rank and file employees is often above 50% annually. The end result of this is that no experience is left and the next ‘batch’ of employees has no history of the product, nor training to maintain it. The employees learn ‘on the job’ and continue to benefit themselves, but product after product faces serious delays, bugs, features being broken, and a hastened demise of the product.

The problem is that even though this is known, executives are on a short cycle; they typically only stay in a position for two years. A failed technology product takes three to five years before it can be judged that the cost benefit was a failure and the product ends up more expensive than had the outsourcing not taken place.

This desire to cut costs is always prevalent in modern business decisions. But to do it immediately to skilled employees has certainly gained momentum because of the alleged success (and delayed failure) of outsourcing.

So, some bright guys at Circuit City tried the same thing.

In a ruthless move to slash worker compensation costs, electronics retailer Circuit City announced March 28 that 3,400 in-store employees, 9 percent of the company’s workforce, would be fired. The company is specifically targeting experienced workers because after years on the job they had accumulated relatively higher wages. According to the Washington Post those affected were notified Wednesday morning and immediately escorted out of the stores by management.

According to a Bloomberg report, average pay for Circuit City store employees is a modest $10 to $11 an hour.

The retailer, which operates 640 outlets in the US, is cutting $775 million in costs over the next seven years by replacing its better-paid store clerks and outsourcing its information technology department. Stocks rose by 2 percent on news of the firings, to $19.23 a share.

Well, that is impressive- an immediate 2% increase in the share price. And 3400 experienced workers laid off because.. they were experienced. Well, these people are just cogs, and can be replaced at will- lots of people are looking for work and all Generation Xers are technologically savvy.

In theory anyway. Or perhaps because of it. If you know more about a product (because you’re technologically savvy) than the guy trying to upsell you on something, you will simply ignore him. On the other hand, if this guy really knows the product, you’ll listen to his advice.

Let’s do some basic math. Let’s say you can replace those ‘over market’ employees with someone making $8 an hour. That’s an immediate 20% savings. But not really, because the true cost of employees is far above their salary (benefits and such). But, let’s go with that. For one year, you’d save $15 million! That’s pretty good- get rid of those overpriced employees and replace them with some kids who just want some extra money.

There’s a cost to decisions like these, you’ve got to pay the big guys who make the tough calls.

According to Forbes.com, president and chief executive Philip Schoonover received $4,514,975 in compensation and an additional $5,459,409 in stock options in 2006. Executive vice-president George Clark drew $1,949,733 in compensation and $4,083,013 in stock options last year.

If my calculations are correct- the two top execs got.. $15 million. But, the stock did go up, so the important thing to the investors- the actual owners of the company- are making money.

Retail operates much faster than technology. People buy things constantly, not in waterfalls. The impact of losing employees is bound to have an effect, but promotion and marketing should be able to compensate. But what of the employees left? Their senior people have been let go- what is their future like? What of the people coming onboard, knowing they are not hired for their abilities, but rather for accepting low pay. What kind of performance can you expect? Will this uncertain attitude show through?

The layoffs were in March 2007. This is the end of the third quarter for reporting. What is the result- did the cost savings offset potential loss of productivity?

The No. 2 U.S. electronics chain also said it may post an unexpected fourth-quarter loss. Fourth quarter is usually when many retailers, including electronics chains, reaped their biggest profit for the year.

It appears that it was a horrible miscalculation. Instead of that 2% surge in share price by those in charge- the investors have lost 75% of their value. Seventy-Five percent in less than a year. I don’t even want to calculate the market value loss of this. The investors should be livid. If you’re going to do something radical, try it in a few stores, before risking the company.This is what happens when you outsource- when you go cheap. The short term gain is never worth the impact to the company.What of the executives- those captains of industry who themselves made what they saved by getting rid of the 3400 experienced employees? The chickens came home to roost in force! The stock is decimated, morale is abysmal, per-store sales are down, profit margins are down, and the impact is going to be felt even in the fourth quarter, which is what stores depend on for much of their profit due to exploitation of ‘holiday’.

“We are very dissatisfied with our third-quarter results,” said Chief Executive Philip Schoonover in a statement. The company’s problems “are primarily self-induced and are within our control to improve.”

The CEO admits they (he) screwed up. Perhaps he’ll resign? The shareholders are probably going to revolt and demand his head. Even so, they’ll find some comfort in knowing that his performance-based options will be null, and that he’ll simply have to suffer through his multi-million-dollar salary.

Circuit City said in a regulatory filing Wednesday that its board approved a special cash retention award program for its top executives including Chief Financial Officer Bruce Besanko and a long-term incentive plan for CEO Schoonover and other top executives.

This is beyond belief. The theory was that executives never have to face the music for bad outsourcing decisions. Yet, somehow they’ve managed to spin this into a cash bonus and long-term incentive plan?

“It seems like the top executives are paid more for poor performance,” Merrill Lynch analyst Danielle Fox posed the question for management on the call. She asked what kind of incentive plans the company had for its rank and file employees instead.

Reference: Marketwatch

Update:   The brilliant CEO, who took home $5 million in pay last year just quit.  The stock target is now $1.75.  Was justice served?  Maybe not, but all the reports I read said that the ‘fire experienced employees’ was the beginning of the end, so I doubt others will go that route.

Update2: 10November2008.  Circuit City has filed bankruptcy.

This entry was posted on Sunday, December 23rd, 2007 at 10:52 am and is filed under Rants. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.