L&D In Tough Times

by External12 Nov 2013

With key indicators pointing to an economic slowdown, Melbourne Business School associate professor Catherine de Fontenay examines the pros and cons of continuing to invest in employee skills

“A downturn presents the perfect downtime to enhance the skills your people really need to excel” 
Harvard Business Review (HBR), Dec 2008
In a slowdown, companies look for ways to cut their costs; and “companies are known to target HR investments first when cutting budgets” (HBR, Dec 2012). But is it a good idea to cut training expenses? Many experts think not. This article reviews the rationale for training, and how the rationale changes in a time of slowdown.
Economists divide training into two broad categories: general and specific. General training provides workers with skills that are of value in the general marketplace: Excel spreadsheet skills, machine repair skills, etc. In contrast, specific training provides workers with skills that are only valuable to a specific company: for example, knowing how to use an HR computer program that was designed specifically for the company.
In practice, firms require skills that range from very specific to very general: for example, training in proton therapy would be useful if a doctor from the Royal Melbourne Hospital moved to another of the world’s five cancer research hospitals, so it is fairly specific; while training in reading CAT scans would be useful in most hospitals, so it is more general.
Providing general skills to workers is risky, because those skills have value on the marketplace. Once an apprentice is trained, he may be hired by another company at a higher salary, or he may bargain for a higher salary based on competing job offers. The training gives him bargaining power.
The more general the training, the more risky it is for the firm, so perhaps workers should study part-time and pay for it themselves, if they want general skills. But we have ample evidence that companies choose to provide valuable general training. For example, conservative estimates of the cost to one firm of training an apprentice in Germany put the cost at over $4,000p.a., even after accounting for the value of the apprentice’s work (Acemoglu and Pischke 1998). So why would it still be worthwhile to train?
Employment is an ongoing relationship, and employees are more likely to stay if they feel that the firm is investing in them. Studies have shown that employees who receive training are more likely to believe the firm supports their development, to be more satisfied with their jobs, to be more willing to work hard and less likely to leave the firm (Koster et al. 2011).
Employers may be paying more for the person with more skills, but they receive large benefits in terms of productivity and reduced turnover. For example, studies of US apprenticeship programs (which are largely unsubsidised by the government) estimate “that employers get a 38% return on their investment in the form of lower recruitment costs and a reduced need for expensive contractors” (HBR, Dec 2013). Companies such as Accenture,
Le Pain Quotidien, and Enterprise Car Rentals say they reap the benefits of ongoing training: “trained employees don’t quit as quickly,” says Katherine LaVelle of Accenture; “we feel that if we put time and money into developing our people, they’ll last with us and grow with us,” says Leah Rucinski of Le Pain Quotidien (CNN Money, 5 May 2013).
“Many firms fear that if they invest in training on their own, competitors that don’t make similar investments will lure away their workers”
Harvard Business Review, Dec 2012
The consensus among economists is that it is valuable to provide general skills if there are frictions in the labour market. Frictions are anything that makes it difficult for the worker to walk down the street and get a job that pays him better for the new skills. The more frictions in the market, the less he will be able to bargain for higher wages based on the new skills. There are three categories of frictions, as described below:
Understanding the role of frictions can help a company determine what kinds of training to invest in.
If the job offers that the worker will receive are in another location, the worker may not be able or willing to move. This is a very important factor in more isolated locations: the fact that a worker has chosen to remain in Swan Hill rather than migrate to Melbourne suggests that they have strong attachments to Swan Hill. If there is no other employer who values those skills in Swan Hill, the skills don’t give that worker bargaining power. And if there is a skill that is mainly valuable in the WA mining sector, we can expect that some workers will be lured away to the mines, but not everyone will be willing to move to remote WA.
If the training puts the worker into a higher-skill category, and there is a relatively small market for those skills, it can still pay to train. Jobs in that field may only open up occasionally, so the worker would be taking a risk leaving a steady job for a shorter-term assignment elsewhere; his bargaining power is limited. The other consideration is that undertraining has large risks, in these environments: if the company does not train any apprentices in that field, they may be so scarce that the company cannot find any to poach from others. The company is benefiting other companies by training, but also benefiting itself.
A firm with a well-established excellent reputation has a very strong bargaining position. It is difficult for workers, particularly older workers, to credibly threaten to move to another company whose record is less well known; so they have little bargaining power. Many of their competitors may not be as long-lived or as well known. Some industries have a close-knit community, and information flows freely, but information about a young company is not always available. Do they invest in safety? Will they make every effort to cut as few jobs as possible, in tough times?
Understanding the role of frictions can help a company determine what kinds of training to invest in. For example, it is not always profitable to pay for a general management course for an HR person based in Melbourne, because general HR is not specialised and not geographically restricted: that HR person could get a job in thousands of other Melbourne firms. There are not enough frictions. The firm may still want to invest in some training, as part of its relationship with the worker, but in less training than for other workers. It does make sense for the firm to invest in rural workers, for example workers who have been settled in that region for years, because there are large frictions.
Finally, the firm does not need to worry about these considerations when thinking about giving a worker a small amount of training (a week-long course, for example): the training will not make enough of a difference to his employment prospects, so it won’t change his bargaining power; but it may improve his productivity.
“‘Are you kidding?’ you might ask. ‘When times are tough, professional development is a luxury’. Not so. Often that is precisely when there is enough breathing room in the daily work flow to give your people the chance to better themselves. Employees at all levels can be sent for training … which pays off when economic normalcy returns”
Harvard Business Review, Dec 2008
The cost of training falls dramatically in a recession. That is because the main cost of training is ‘opportunity cost’: if I attend a three-day training course, the fee is one part of the cost; but the main cost is that I am not available for three days of billable work. If the staff in my department have idle time because of the slowdown, there is no longer an opportunity cost; my department will complete the same work in the same time, even with the training.
It’s critical to realise that this idea of opportunity cost can be missed, if we focus too much on internal accounting. Depending on how we charge different departments for training, a department could still improve its balance sheet by cutting training; and the department will be feeling pressure in a recession. But if the company makes an overall training plan, understanding that there will be recession times and boom times, it needs to recognise that the company will save a lot of money by training in a recession.
You should also encourage your business partners to consider training opportunities during slowdowns, to improve their performance in working with you. More generally, education tends to be countercyclical (that is, the sector is larger in recessions and smaller in booms) because people have more time and fewer opportunities in a recession. Some firms will not train in a slowdown because of financial stress: there is too much chance that they will go bankrupt and will not be around to capitalise on the training later. But if your company has been around for more than 10 years, it’s unlikely that the slowdown is the end of the game for the business; however, you may need to find a bank willing to support you financially in making longterm investments. This will reduce any short-term financial stress.
Generally speaking, frictions get much stronger during a recession, and weaker during booms. So workers are much less likely to voluntarily change jobs in a recession. This is one risk of actively training in a recession: some workers will leave for greener pastures when the economy gets better. And then the firm will have the cost of training them, without the benefit.
Many firms understand the cyclical nature of their business, and try to retain workers during a slowdown. It makes sound business sense: spending money to retain workers reduces hiring costs later on, and strengthens the reputation of the firm as a company that takes care of its workers. In the long term, the firm will reap the benefits of this investment, because in good times workers will be less inclined to move to other firms that are less dependable, even for more pay. The firm will not have to raise salaries as much to retain workers. 
In economic terms, this is the information/ reputation friction described above. The stronger that friction, the more the firm will reap the full benefit of any training it provides. Thus, investing in saving jobs and investing in training are complementary investments that yield stronger rewards when they are done at the same time.