Workforce Planning during COVID crisis

The current global market conditions have left many businesses wondering what to do. Is the timing right to scale down my operations? Will the previous market conditions ever return or will I need to adapt now instead of waiting?

Economics and mathematics may help with the answer. As you can see on our mathematical proofs there are 4 optimal options:

1) Indefinitely reduce production, employees and capital investment;

2) Reducing production scale to the current demand and plan to increase afterwards;

3) Keep the same workforce but leave employees idle;

4) Close the business

Having to choose one of the options can be very difficult. It’s one thing to make a decision if you know how long the crisis is going to last but it’s quite another if you don’t. We prepared a google sheets doc that can be downloaded for businesses to run their simulations and have some idea. We used a very simple model to try to help as many businesses as possible.

In this article I’ll show why these are the four possible solutions and which solution is best depending on the economic situation the company is in as well as discuss the example in the google sheets shared.

The hypothesis

We’re considering situations where business are impacted by the current crisis have experienced reduced demand and face severance costs associated with firing employees as well as hiring costs associated with increasing their workforce.

We’re also considering “fixed proportions production functions” - meaning each unit of product needs a fixed number of people and capital to be produced. In our example each unit of product needs 5 people and 1000 dollars.

Product prices, wages, productivity, hiring and severance costs, during normal and crisis demand cycles, and interest rates are all considered fixed and known. We’re trying to keep it simple and applicable to the majority of business operations.

Evaluating the options

We assume companies want to maximize profits and to do so we need to analyze our previous options in two different market states: crisis and no crisis. We drop the “Close the business” solution as it not an interesting option to consider. This multiple period problem is the one on the google sheet provided.

The first main evaluation is the “Present Value of capital needs”, i.e. how much money the business is going to need to pay for extraordinary costs and losses during the crisis. If the business does not have this much credit or reserve then the given option is not feasible unless short term profits can pay for them.

The second main evaluation is “Present value of all profits”, this is the amount of all future profits brought to the present considering the base scenario, in our example a 4 months crisis. It’s a good evaluation for how much a company is worth and if we knew with certainty how long the crisis would take it would be the best way to consider which choice to make.

Unfortunately we’re not sure how long the crisis will last and if we don’t even know the probabilities of each possibility we might turn to decision theory instead. It has many ways to consider a choice, the two I like the most is picking the best worst case scenario and minimizing the maximum regret.

Picking the best worst case scenario means that given a choice made and the possibilities of what can happen, evaluate what is the worst it can happen. From each of the worst case scenarios pick the best one.

In our example Option 1’s worst case scenario involves a profit of 254k and a 45k capital requirement. Option 2 provides 1.113k profit and 52k capital requirement. Finally Option 3 provides 1033k profit and 123k capital requirement. This means that Option 2 would be the best choice if you can afford the 52k capital need.

On the other hand minimizing maximum regret is a little more complex and interesting. Let us begin by talking about the idea of regret, it’s measured by the amount of profit foregone due to a suboptimal decision. For example, if the crisis has a long duration and you picked choice 3 on our example then you missed out on 80k extra profits if you had picked option 2 instead.

The idea is that nature is going to evaluate your choice and make you regret choosing it as much as possible, that is the “Maximum regret - Profits” value. To make you regret your choice nature is going to pick a scenario where you are either overreacting or underreacting.

If you picked options 1 or 2 you would be most prepared for a long crisis and so nature can make you regret it by making it a short crisis. The opposite would be true for option 3. This is the result shown in the “Maximum regret - Duration” value.

Finally, “Maximum regret - Choice” is what would be the best option given the maximum regret nature is trying to inflict to you. Notice it’s always a different choice in our example, that is because nature is doing exactly what you don’t hope it to do and therefore making a different option being optimal.

In our example considering regret the best option would be option 2, the one that leads to the least regret. Notice that many economists dismiss the regret minimization rationale since it’s considered irrational, still I think people are irrational and to me this is actually the evaluation rule that makes the most sense as it doesn’t look only at worst case scenarios but involves all scenarios meaning decision makers wouldn’t be looking only at the worst things that can happen but would also consider possible good scenarios being unexplored.

The four possible options

1 - Reduce company scale permanently

    Although it would be hard to find any business person willing to have a smaller company indefinitely this solution is probably the safest one. And even though it has a scary “permanently” it’s pretty much a overstatement since we’re just considering a very simplified model.

    The rationale is based on the fact that reducing the workforce to meet the crisis demand leads to savings in terms of wages and not rehiring means saving on hiring costs. As you can see in our example this solution does not depend on the duration of the crisis so at least it leads to a high degree of certainty.

    The company only would have to pay for the severance of the extra workers it’s shedding but afterwards it’s good to go. Another added benefit is that it leaves open the chance to pivot to option 2, i.e., the company can still change it’s mind and rehire people after the crisis.

    In our example this option had the lowest capital needs but still the fact that normal profits are so much higher it does not make it a compelling option. It shows a classic safety versus reward trade-off.

    This option also leads to a massive regret in our example which would be attained if the crisis were actually very short meaning that it would have been better to just keep everyone on payroll normally.

2 - Adapt the Scale to the Demand

This option involves reducing production to meet the exact demand during the crisis and then raising production back to normal afterwards. This means firing and rehiring people as well as reducing purchases of inputs and then increasing it after rehiring everyone. The losses will come from paying severances and incurring rehiring costs.

One appealing characteristic of this solution is that the costs are distributed through time. The company will take an initial hit and then will only have to think about rehiring costs after things go back to normal. It also keeps option 1 open depending on how the market evolves and hiring costs develops.

This solution will be better then keeping the same workforce idle if salaries are higher than the cost of firing and rehiring people. It will be better than reducing the workforce permanently if the profit margin is larger than the hiring cost, so hiring back people makes sense.

In our example this option had similar capital needs to option 1, the difference being the hiring costs that would only have to be paid in the future. Another interesting result is that the duration of the crisis has a small effect on capital needs and profits (in our example).

As a matter of fact the longer the crisis the smaller the capital needs as rehiring costs would have to take longer to be paid. In terms of profits this choice still would rather have a short crisis then a long one.

Finally notice that this option has the best worst case scenario and gives the least regret, meaning it’s actually the most balanced option across all possible scenarios, i.e., the crisis may be long or short this option does not lead to missing out on much.

3 - Keep the same workforce but leave (some) employees idle

    This certainly would be the most decent option but unfortunately not every company can afford it. The good news is that it can also be the best option since it precludes from paying severances and hiring costs. If employees even agree to work on reduced salaries then this option becomes even more appealing to businesses.

    The problem is that this is probably the riskiest option. If the crisis lingers too long or if demand is hit too strongly the money to pay for those idle workers might end up being gone and the company may go bankrupt. On the other hand this option makes companies the most ready for retaking opportunities after things go back to normal so it’s definitely a high stakes option.

    We already compared this solution to the previous one, compared to the option of permanently reducing the scale of production this option is better if the extra profits of operating at a larger scale once things get back to normal covers the extra loss of paying for idle workers instead of firing them.

    The interesting thing about this option in our example is that although it had no extraordinary costs in terms of severance and hiring it leads to a monthly loss as long as the crisis lasts due to payroll.

In our base scenario of a 4 months crisis this option would be the one leading to the highest capital needs. It’s also the one that varies more wildly depending on how long the crisis may last. This option also can lead to a rather large regret if the crisis ends up being long meaning that option 2 would have been the best choice.

Conclusion

The Coronavirus is a huge threat to humanity, not only a health threat but also an economic threat. So many people are at a loss in terms of how to protect themselves from the virus and many businesses are also confused about what to.

In this article we used a very simple model to devise possible strategies and which would be the best depending on the company situation. It’s obvious that such a simple model has limitations and it also requires forecasts and risk analysis due to uncertainty but hopefully it’s a useful starting point for discussion.

In a crisis there may also arise huge opportunities. Technology can help soften the blow and even bring huge rewards once normalcy returns. Businesses that get ahead now may not be caught up by their competitors in the future.

We’re hoping to contribute by offering a massive discount on our AIs to help businesses go through these somber times, contact us if you think we can help. What did you think of this post? And how is your company doing? What strategy is it following? Let me know on the comments.