Dealing with demotions can be unpleasant for employers and employees, but there are benefits from demotions that aren't always immediately obvious. How the employee reacts to the demotion often depends on how the company presents its reasons.
A demotion could be the best option for keeping an employee who has potential but needs more training and experience. Sometimes companies grow faster than anticipated, and employees get pushed into roles that they don't want or aren't ready to handle. An employee who you think has the potential to excel at your company may respond more favorably to a demotion if you explain the situation and provide an opportunity for additional job training. After all, the employee may realize he's in over his head and unfit for his current position.
Sometimes a company's structure changes, and demotions are necessary because departments are phased out and fewer high-level positions are needed. Such changes can be an opportunity for improvement for all involved as people assume new responsibilities to take the company in a different direction. Some people won't view the changes or demotions as an opportunity and they'll quit. Yet the people who remain may be a more motivated bunch who are excited about the company's new direction.
An employee who has an attitude or performance problem has a negative impact on the workplace, especially if that person is in a management position. Not demoting a poorly performing manager will likely sink employee morale and hamper productivity. A demotion will make it clear that poor performance and bad attitudes won't be tolerated by the company. Always be prepared to take further actions because a demotion can spark more bad behavior from an uncooperative employee, and you ultimately may have to fire the person.
A demotion can be significantly less expensive than firing or laying off an employee because an employee you keep on is not eligible for severance pay or unemployment. However, it can be a mistake to enforce a demotion when it would be better for an employee to leave the company. Some people's egos are strongly connected to their jobs and rank, and they would become disgruntled over a demotion. In such cases, it may be better to offer an employee a way to make a graceful exit from the company.