Tech Companies Must Cut, but How Deeply?

Given anemic sales, there remains only one other option for techcompanies bent on raising earnings: cut costs. That means there are likelyto be more layoffs, coming on top of those recently announced by thelikes of Intel ( INTC), Sun ( SUNW), and Applied Micro ( AMCC). Consider it the final nail in thecoffin of the once-anticipated second-half rebound.

Aside from the obvious human toll, the specter of staff cuts presents adilemma from a business planning standpoint. It forces tough strategicdecisions on managements that remain largely clueless about the demandoutlook.

Firings are bound to slam morale among remaining workers, dragging downproductivity. Worse, consider the consequences of cutting into the rankstoo deeply. "If they make a bet to cut staff and now they have aplateau and demand resumes again, a lot of guys will be caught short," saysThomas Weisel analyst Kevin Vassily.

Case in point: Applied Materials ( AMAT), which pushed through layoffs in thelast downturn shortly before business picked up. As a result, it ran intoproblems meeting demand when the economy turned. "They probably lost someof their business, on the margin. In a cyclical business, that's aproblem," says Vassily.

Do It Now

On the other hand, if a company waits too long to reduce costs, itsprofits will shrink relative to competitors. Indeed, despite the Applied Materials example, analysts have been speculating that semiconductor capital-equipment companies are overdue for staff cuts.

"Although many cost cuts at chip-equipment companies were made inlate 2001/early 2002, we sense that it was not enough" given the weakprognosis for business, wrote Deutsche Bank analyst Timothy Arcuri in arecent research note. At the recent Semicon trade show in San Francisco,executives at equipment suppliers suggested more cost cuts are on the wayby fall, including headcount reductions, he said.

Unfortunately, typical staffing dilemmas become even more complicatedin arcane tech industries like chip equipment. Because it's tough to find an engineer schooled in the intricacies of semiconductor equipment, companies are understandably reluctant to fire them. When demand picks up again, they don't want to risk being understaffed, because it's so difficult for them to hire trained workers.

But amid a worsening revenue outlook, some companies conclude they havelittle choice but to lay off workers -- even though they've already enduredpainful job cuts. In its July conference call, Lam Research ( LRCX) admitted that200 employees left the company in the most recent quarter, reducing headcount to 2,500. As recently as 2001, the company had a staff of 3,150.

Of course, the same challenges that apply to semiconductor equipmenthold true for computer hardware companies with proprietary technologies.For example, Apple ( AAPL) must retain a large staff of engineers familiar with itsMac operating system and power PC chips, while Sun has to do the same forits Solaris and Sparc products. Hewlett-Packard ( HPQ)picked up additional legacy productswhen it merged with Compaq, which had, in turn, inherited products fromDigital and Tandem.

By comparison, Dell ( DELL) doesn't need to employ armies of specializedengineers because it uses Microsoft's operating system and Intel's chips. Its in-house needs remain relatively simple.

But for companies with proprietary goods, deciding on the size andnature of layoffs is complicated and often risky. "If you're a computersystems company, those are the decisions that can make or break the placein the long term," says Barry Jaruzelski, a managing partner in the globaltechnology practice at Booz Allen Hamilton.

Take Apple, which in retrospect made some smart decisions in itsdarkest hours. When the company's business tanked in the mid-'90s, it tookthe drastic step of halving its product line under development.

Meanwhile, management was careful to retain the company's talented corps of industrial engineers and designers. "Steve Jobs and Fred Anderson, the CFO, made sure that all those irreplaceable resources were protected, even invery difficult times. They retained all those people who later brought the iMac and eMac and new flat panel screens," says Jaruzelski. "They knew they would be the key to the company coming back. And in two years, Apple was much smaller but profitable at half the size."

The Job Outlook Now

After a round of layoffs at the beginning of the downturn, techcompanies had eased up on job cuts. But now, amid worries about adeteriorating revenue outlook, managements are again growing highlyconscious of pressure to slash costs. In June, the number of announcedlayoffs in the computer industry surged to over 25,000, up from around8,000 the month before, according to Challenger, Gray & Christmas.

The same month, H-P said it would speed up previously announced job cutsof 15,000, while warning that it expected its revenue to fall in thesecond half of the year.

Technology Job Cuts, 2002
Month Computer Industry
January 6,583
February 4,822
March 1,807
April 8,428
May 8,366
June 25,392
Total 55,398
Source: Challenger, Gray & Christmas.

But aside from H-P -- which was planning to lay off workers anyway,following its merger with Compaq -- a couple of leading tech companies have laid off fewer workers than expected.

On its earnings conference call in mid-July -- the same call in which headmitted the company would slip back into the red next quarter -- SunMicrosystems CEO Scott McNealy sounded downright defensive in justifyinghis decision to cut only 1,000 employees out of a staff of nearly 40,000.

"I'm sensitive to the fact that many of you think we could take theinfrastructure down," he told investors and analysts. But he said Sun istaking a "calculated gamble" by holding the line on deeper job cuts, sayingthe strategy should work, "assuming the economy doesn't do anything morescrewy to us growing forward."

In similar fashion, last month Intel announced layoffs of 4,000 peopleout of its 85,000-strong staff. That's a sizable cut, to be sure, butconsiderably less than the 10,000 or so that some rumors had suggested.

Both companies benefit from deep pockets, with respective cash holdingsof $2.8 billion and just under $9 billion. By holding the line on layoffs,they may be better-positioned to take advantage of growth when the economypicks up -- after their rivals have downsized.

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