I find it surprising when investors, particularly Wall Street, cheer a company for reducing head count because it is usually not a good business decision. I am not making a moral statement; it is about the underlying business reasons. While reducing head count does immediately reduce the cost side of your business (outside of redundancy expenses), it usually has a greater impact over time on revenue.
People create revenue
Your team is how your company creates revenue. They build the products customers pay money to purchase. They provide support so customers return and continue spending with your company. They market the product so people learn about the product and buy it. At the root of business, companies employ people because they make money for the company. The logical extension of this argument is that if you reduce the number of people, you will have less people generating revenue.
Julian Simon trumps Malthus
Malthus and Julian Simon were two economists of different eras but more importantly different philosophies, and history has proven Simon correct. Malthus lived in a time when people had a short life span and had to spend most of their time on difficult work. He theorized that as the population grew, the situation would get worse as there would be less food, more disease and overall fewer resources to go around.
Julian Simon, conversely, argued that people were incredibly resourceful and always came up with more efficient ways to use resources. Thus, as the population grows, there would actually be more to go around and people would live better. When people argued that oil would run out or we would not have enough food to feed ourselves, he argued that these would not be problem’s due to human intellect.
Simon famously bet Robert Ehrlich, a Malthusian economist, to pick any five metals and Simon argued the price would decrease over time. Simon won the bet.
The same holds true in the business world. The output and revenue of your company is not a fixed pie. People develop ways to grow both revenue and profitability. Having a growing team leads to a growing company just as a growing population leads to a larger population (and one of the reasons the anti-immigration arguments are fundamentally flawed, but I try to keep politics out of my blog).
Network effect
Output is not linear, and reducing headcount by five percent can often reduce revenue by more than five percent. People build off the ideas and efforts of their co-workers. I was once in a situation where I was one of four business development people. One member of our team left and we decided not to replace him. He was not an exceptional performer; his output was comparable to other sales people on the team. When he left though, sales dipped much more than 25 percent. This happened because he sometimes found deals that complemented accounts that other sales people were working on. He may have found a product we could sell to someone one of our other team members was working with. When that product was no longer known to us, there was less to sell to our other customers.
This same phenomenon holds in other aspects of business. Designers build off of each other’s ideas and will often integrate parts of other people’s features or games into their designs. Marketers learn from what is working and not working in other areas of the marketing department. Engineers learn how to overcome challenges and bugs based on experiences their colleagues have had. As you start unwinding from these networks, output suffers.
Always be diligent
There is a scenario when it is beneficial to reduce headcount, when the reduction is not meant to reduce costs but to lower bureaucracy and inefficiency. The key is that you should always be striving the eliminate inefficiencies the reduction should be with that goal rather than reducing expenses just by lowering headcount.
When people are used to create bureaucracy, they do not drive output. Simon was far from a socialist and understood it was a combination of capitalism and people that created growth. If your company has added people who do not clearly contribute to its profitability, then you should strive to reduce those people or teams should. That should always be part of your business processes.
Also, if teams or groups are over-staffed without people having clear purpose, that is also a reason to reduce team size, as sometimes less is actually more. I have been at companies that had ten people doing the work of what two people could do. This was not only a waste, but it actually created less output than comparably companies that had two people doing the same work. The high staff count meant that nobody had the opportunity to make decisions and most of the time was spent in meetings or creating PowerPoints for each other.
The key is creating an efficient organization where everyone is contributing to growing the company. Once you have achieved this goal, reductions in head count just negatively impact long-term profits.
Key takeaways
- Reducing headcount may help profitability in the short term but overall it will have a greater impact on revenue than on expenses.
- People create value and by extension less people will create less value.
- One caveat is that companies should always strive to reduce bureaucracy. The goal, however, should not be to reduce costs by eliminating headcount but should be to reduce the inefficiencies.
The Business of Social Games and Casino 
Thanks for posting Lloyd!
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