Calculating the Dollar Costs of a Bad or Weak-performing Employee

Almost every manager, when asked, readily agrees that weak employees underperform average employees by a significant amount. We certainly know from sports teams, where performance is easily measured, that there is a huge performance differential (often double or triple) between the below average, average, and top performers in the same position.

From a talent management perspective, if the “performance differential” between the average employee and the worst employee is small (less than 5 percent), it doesn’t make much sense to spend a lot of money on performance management programs. However, when weak performers produce more than 33 percent below the average, it makes clear business sense to invest in great performance management and recruiting in order to fix or replace weak performers.

And when your calculations reveal that employee actions can have a multimillion-dollar impact (in the negative direction, with the Edward Snowden NSA document leaking case, or in the positive direction, with the US Airways Sully Sullenberger safe landing on the Hudson River), you quickly realize the need to quantify the dollar impact of these bottom- and top-performing employees.

Begin Working With the King of Metrics

Before you begin putting a dollar value on below-average employees, consult with the CFO’s office (the king of metrics) with the goal of getting them to partner with you throughout the calculation process. With their help, you can not only avoid any major calculation errors but you can use their credibility in order to avoid any future criticism from finance professionals. For similar reasons, including the COO’s office is also a good idea.

Follow These Six Calculation Steps

Step I — Determine what an average employee is worth

You start with the premise that weak performers, by definition, produce below average results. So the first step is determining the results that an average employee produces. The accepted method is to use the average revenue per employee (the total corporate revenue divided by the number of employees) as a baseline and a fair indicator of the worth produced by “the average” employee over one year. Even organizations that do not produce a profit can calculate their revenue per employee. For example, at a company like Sears, the average revenue per employee is $138,200, so a 10 percent above-average-performing employee would produce an additional $13,820 in revenue each year and a weak one would produce the $13,820 less.

Step II — Determine the “weak performer differential” between an average employee and a weak employee in the same job

Your next step is to determine the percentage below that average output that a weak performer produces. This is known as the “weak performer differential percentage.” You may need to eventually calculate the weak performer differential percentage across several different jobs, but it’s best to start with a job where performance is easily quantified.

Salespeople are a good place to start in most organizations because performance (both volume and quality) are already closely measured. In the case of salespeople, you simply rank the sales for all salespeople from the very best to the worst on single a list. This list is known as the “ranked from best to worst list.” Using that ranked list for salespeople, the easiest approach is to simply identify the salesperson who appears directly in the middle of the list, and their sales number is designated as the “average sales amount.” Then simply calculate what percentage below that “average sales amount” that the bottom salesperson on the list produces. Let’s assume in this example that the weak performers sell 30 percent below average.

Step III — Quantifying the value of the “weak performer differential” percentage

If in our example, bottom performers produce 30 percent below the average, you multiply that 30 percent by the average revenue per employee that she calculated earlier (in the Sears example, it’s 30 percent X $138,200) and that gives you an estimate of the cost of keeping a bad performer, which in this case is a negative $41,460 per year.

If you’re not comfortable with just using the sales volume differential, you can do the same ranking and comparison for quality using the customer satisfaction scores of your salespeople. If for example the customer service scores also vary 30 percent below, you can be pretty sure that your original sales performance differential percentages are accurate. If they vary, you can average the two percentages.

Step IV — Determine the “weak performer differential” for other jobs

If you perform the same calculation for other jobs where on-the-job performance is already quantified (like customer service, programmers, accountants, or any revenue-generating job) you can get a better idea of what the average performance percentage difference is for a number of different jobs. On average, 40 percent of all jobs in a firm have their performance effectively quantified and reported, so as a result, those jobs alone might be enough to use as a basis for establishing a credible companywide performance differential percentage.

Jobs that require creativity, adaptiveness, and innovation have a higher performance differential. The performance differential definitely varies based on the job. The performance differential percentage between top and weak employees in “easy-to-learn routine jobs” will be much smaller than in jobs that require innovation, creativity, and continuous adaptation to new technologies and business challenges.

Step V — Adding other “weak performer costs” to the calculation

If you really want to get sophisticated, you can add some additional cost factors based on the premise that weak employees can cost more because they make serious errors (that average or top performers don’t). These additional costs are always estimates based on the documented cost of damages of a few representative weak/bad employees.

Absenteeism — bad employees are absent more often, which either slows down the work or requires expensive temps.
Less revenue — in revenue-generating jobs, weak performers will generate significantly less revenue.
Interaction with customers — in jobs where weak performers can damage customer relationships, the cost of the weak performer can multiply two or three times.
Errors — weak performers will make many more serious errors which will require expensive redoing.
Accidents — weak performers will cause or create serious accidents, which will increase your insurance costs.
Theft — some have found that bad employees break the rules more often or even routinely steal.
Reveal trade secrets — bad employees may accidentally or purposely reveal valuable company secrets.
Negative team impacts — in addition to their individual bad performance, weak team members can negatively impact team recruiting, retention, innovation, quality, rewards, and speed.
Waste their manager’s time — another cost area that you might consider is that weak performers take up an average of 17 percent of a manager’s time.
They may stay forever — because weak performers won’t easily be able to find another job, they may stay forever at your firm, multiplying the damage they are doing over decades.

If you find that weak performers can have any of these additional unique negative impacts, you should add the estimated costs of the easy-to-estimate ones to your “revenue-per-weak-employee” calculation.

Step VI — Determining whether weak performers can be improved quickly and inexpensively

Once you complete your “weak performer differential calculations,” you may also want to find out if weak performers can quickly turn around their performance after undergoing performance management, coaching, and training. This is done by waiting six and 12 months after applying an intervention, and then measuring the employee’s percentage improvement in performance. Unfortunately, the positive impact of performance management on weak performers is often small to zero. Releasing them may be the best option.

The Normal “Weak Performer Differential”

Organizations with excellent talent management have a relatively low “weak performer differential” because weak performers self-select out or are proactively managed out. The majority of firms have a “weak performer differential” (i.e. the performance percentage difference between the average and the worst employee in a job family) resembling the following pattern. I have also converted the negative impacts to a percentage of the weak employee’s annual salary.

Minimum weak employee performance differential — -33.3 percent of the average revenue per employee (- $46,060 each year in the Sears example), or three-fourths of their annual salary in dollars
Typical weak employee performance differential — -100 percent of the average revenue per employee (- $138,200 each year in the Sears example), or two and one-fourth times their annual salary
Exceptionally bad employee — -300 percent of the average revenue per employee, or six and three-quarters times their annual salary each year, until they make the single catastrophic mistake that finally gets them fired.

Final Thoughts

All organizations should know the value of their assets, whether they are well-performing or weak-performing assets. Since employees are “our most important asset” it is surprising that only a few firms have taken the time to calculate the positive performance differential that is provided by top performers and the negative performance differential that the organization suffers because it keeps weak performers. There are of course more complicated formulas to consider (such as dollars spent on labor versus dollars of profit earned each year) but the best approach is one that is customized and then found acceptable to your CFO and your executives.

I hope my basic approach gives you a head start on this essential calculation. Next week on ERE.net (1/13/14) I will provide a follow up article covering quantifying the value of top performers.