Warning Signs of a Layoff

Why layoffs happen and the early warning signs a layoff is coming.

An unfortunate reality of the tech environment over the past 2 years is that we have become desensitized to layoffs. We are constantly bombarded by LinkedIn layoffs announcements, layoff news alerts, viral layoff videos, etc.

The tech industry has clearly taken the hardest hit. Layoffs.fyi tracks all tech layoffs and while layoffs have slowed down from the peak, they are still very elevated compared to the historical norm.

Why Layoffs Happen

Layoffs almost always happen to manage costs due to slower than expected revenue growth. The beauty of high growth software is that it can be very forgiving for inefficient spend, but when revenue growth is slow that inefficient spend becomes very blatant and concerning.

Sometimes layoffs happen because of unlocked efficiency gains (i.e. generative AI) so the team size required is smaller, but if revenue is growing at a decent rate a simple hiring freeze will work to get the balance right fairly quickly.

People costs account for 70% - 80% of total costs of most software companies. Below is the average costs per employee (FTE) broken out by department (tech folks are well paid).

Source: ICONIQ

With so much of total costs directly tied to people, if a software company needs to reduce costs by any significant amount then it almost always has to reduce people. There usually isn’t enough to reduce in non-people costs (although the non-people costs should definitely be scrutinized first).

Why are layoffs celebrated by investors?

Sometimes layoffs are followed by stock price jumps and news articles like the below:

Investors like the news of layoffs when they think the company is being inefficient with its spend and they think the cost savings are better than the possibility of higher revenue growth from the headcount.

This is generally only true for larger more mature companies though with slower growth expectations. Layoffs at earlier stage companies are almost never celebrated by investors (even if needed) because revenue growth is so much more important than efficiency at those stages and a layoff almost certainly is because revenue is slow and expected to stay slow.

Signs of a layoff

1. Missing sales targets and revising down forecasts. In a recurring revenue business, unless a company grossly over hired (many did) then they should be able to freeze hiring and let revenue catch up. But if revenue targets are missed and forecasted to be low then it may take too long to get to appropriate spend levels so a layoff is needed. This is the most important indicator.

2. Hiring and spend freezes. Layoffs should be a last resort. Management will typically freeze hiring/spend and take time to investigate where else money can be saved first. They want to do their diligence to make sure they can avoid laying off as much people as possible.

3. Unit economics are bad. If sales results/targets are being missed and the company’s unit economics are bad then layoffs are definitely being considered. Understand software unit economics.

4. Projects put on hold. Similar to spend freezes, but when management plans on doing a large layoff they don’t want to commit to new projects or continue ones that won’t be finished. Things are paused or put on hold.

5. Management stops providing direction and guidance. Performing any sizable layoff is extremely time-consuming and draining for management. They also don’t want to make any big decisions when they know a layoff is coming and they don’t know how it will impact the business.

6. Increased executive turnover. Most execs have the experience to know when the ship is starting to sink or very rocky times are ahead. They are also part of the early layoff discussions so they know it is coming and may want to jump first.

7. Change in leadership behavior and working relationship. Convos become less comfortable, they micromanage more, want to know the details of what you are working on and how to run your processes. This is true for the leaders in the know about the layoff, but would also be true for a manager of an employee who is going to be part of a normal performance-based termination

There might be other signs but these are some of the most important. Each individual one may mean nothing, but when there are several of these signs then there is a strong possibility that layoffs are being considered.

NOTE: Individual performance-based terminations are normal and should be expected in fast growth companies with high expectations. However, performance-based terminations should never be a surprise. If performance-based terminations are a surprise, then the manager failed. Employees should know they are missing goals/objectives.

Performing Layoffs

Every leader will have to do either a performance-based termination and/or be involved in a broader layoff at some point in their career. There is not a perfect way for these to be handled and there are probably a few OK processes, but two things should always be true:

1. Be Honest

2. Measure twice (or more…) and cut once. Be extremely thoughtful when making these decisions - take the time to get the right data, have the right discussions, etc.

While companies should do these things for the people who are being terminated, it is also important for the people that stay. Companies need employees that are staying to trust management and stay motivated, otherwise it can create a downward death spiral for the company.

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