In the third iteration two team members were replaced. In the next iteration the team's velocity dropped and performance declined. What should the project manager do?

When team members are replaced, it disrupts the team's dynamics and necessitates a return to earlier stages of team development, as described by Tuckman's stages (forming, storming, norming, performing, adjourning). The team needs to re-formulate its purpose, roles, and responsibilities (forming) and then work through potential conflicts and differences in working styles (storming) before it can effectively re-establish norms and perform optimally. Discussing with HR or escalating to the sponsor are premature and do not address the root cause of the team's performance decline. While team-building can be helpful, simply organizing an event without addressing the underlying need to re-establish team cohesion and processes is unlikely to resolve the issue effectively.