Mita,
When one talks about downsizing, one always thinks about an increase in productivity. There is another dimension. If a company loses business (on a more permanent nature), it could then downsize or "rightsize" to keep the same productivity norms. Let me try and answer your questions:
1. Both. Normally, it is the managerial levels that are first trimmed until a point where there is just about enough experience and leadership. Then the direct force is looked at.
2. Most definitely yes.
3. Separation pay is totally voluntary. As per my understanding, there are no "benefits" like tax, etc., which a company gets (can someone please check and confirm this either way). It is only the reduction in the future cost of operation.
4. Talk straight. Let the employee know the true picture. Do not link it to anything else (mostly performance) ... this will keep the morale of the employee up when the job hunt starts. Answer all the questions as candidly as possible. Give them access to talk to senior management if required. Put their F&F processing on a speed course. Volunteer to give a good reference check. Respect the person ... that is the least one can do. In a nutshell, a) keep the person's morale high b) clarity of communication c) offer any other help required.
5. Both are means to reduce the workforce. Early retirement is generally offered when you are looking at trimming people in the 45-55 years range (that's where your highest salaries are). They, being close to retirement, will opt for VRS as their post-retirement benefits would not get affected, i.e., pension, or they would be given a one-time payment which would be good for them but less than what the company would have to bear if they would have to serve out the remaining years. Layoffs are done when people are in their junior to mid-range. They can get another job.
Rana