The Business Cost And Impact Of Employee Turnover

Feb 27, 2000

One of the most critical components of success for the business owner, regardless of size, is the ability to keep the cost of doing business at a minimum. Obviously, every owner wants to ensure the best possible profit margin for the sustained growth and success of a business. What many businesspeople fail to realize is that employee turnover can represent a very substantial cost and lead to erosion of the bottom line.

Would it surprise you to learn that it will cost at least 150% of a person’s base salary to replace him or her? Actually, the more you pay a person, the higher that percentage will be – because the more you pay this person, obviously, the more you value their contribution to the growth and success of your business. Most businesses will probably pay their top salesperson triple (or more) what they pay a bookkeeper. The business values the contributions of the salesperson at a higher level, at least in strictly monetary terms, over those of the bookkeeper, although both perform valuable roles.

Let’s say you have an employee with an annual salary of $50,000 who leaves a company. (The reasons for leaving are not important in this case: if the plan is to replace them, the costs will be the same.) It will cost a company a minimum of $75,000 to replace that person. This cost includes the savings realized because the person has left! And, all of that cost is taken away from the bottom line. We have developed a Turnover Cost Projection Model that identifies and calculates all the costs incurred. The model indicates that the business costs and impact of employee turnover can be grouped into four major categories:

    1. Costs due to a person leaving
    2. Hiring costs
    3. Training costs
    4. Lost productivity costs

For purposes of illustration, I’m going to use an example of a Financial Analyst in a mid-sized company. This person is paid an annual base salary of $52,000, which works out to an hourly rate of $25, assuming a 40-hour work week.

Costs Due to a Person Leaving

When this Financial Analyst announces that s/he is leaving, (to avoid awkwardness, allow me to use the preposition “he” for now on) he has immediately begun to transition out of the company. Even though he has given you two or three weeks notice, his mind and full attention are not on this business anymore; this is simply human nature. At this point, costs include the following: employees who must fill in for the person who leaves before a replacement is found; the lost productivity of the employee while he is still in his position but not fully concentrating on his job; the cost of a manager or other executive having an exit interview with the employee to determine what work remains, how to do the work, why he is leaving, etc.; the cost of training the company has provided this departing employee; the cost of lost knowledge, skills and contacts of the departing employee; the increased cost of unemployment insurance; and the possible cost of lost customers the departing employee is taking with him (or that leave because service is negatively impacted). The sum total of these costs can be as much as 85% of this position’s base salary or $45,000.00.

Hiring Costs

Unless there is someone to promote or the perfect person just happens to come along at the right time, there will be some costs associated with identifying and hiring a replacement for the Financial Analyst position. These costs will include items like advertising, an employment agency, employee referral award, internet posting and other forms of announcing the availability of the position. More money may well have to be offered to attract the right candidates.

At the next stage, interviews conducted by management and/or hiring department staff will cost money in terms of the time they spend arranging for interviews, conducting the interviews, calling references, having discussions about the people they met, and time spent notifying candidates who did not get the job. The time spent on these activities will also cost money in terms of lost productivity, because, with rare exceptions, these people are not employed to be full-time interviewers. Also included here are any skills, personality or assessment testing your company may utilize. Finally, there is the cost of conducting pre-employment checks such as past employment histories, drug screening, educational, verifications and (possibly) criminal background checks. And don’t forget, these assessments and reference checks may be conducted on more than one candidate for this opening. The sum total of these costs will be from 15% of this position’s base salary or approximately $8,000.00. This will increase to about 38% of the position’s base salary or $20,000.00 if an employment agency is used.

Training Costs

Now that the person is hired for the Financial Analyst position, they can’t be expected to know absolutely everything on his first day, can they? Costs to factor in for training include any new employee orientation that explains benefits, basic policies, company history, etc.; specific training for the person to do his job, such as computer training, product knowledge, industry knowledge, and the day-to-day duties to get the job done. Even though this may be informal or on-the-job training, the time it takes for various people to impart this knowledge is costing money – especially since people who are knowledgeable enough to train others are probably also highly valuable the company. Set the sum total of these costs at approximately 13% of the position’s base salary or $7,000.00

Lost Productivity Costs

Because the newly hired employee does not come fully trained, it will take some time before he is fully productive in his new position. This is true even if someone has been promoted from within the company. The following formula can be used: the employee is only 25% productive for the first four weeks; 50% productive for weeks 5 – 8; 75% productive for weeks 9 – 12; and will finally reach full productivity after week twelve. Since this person is being paid at the full rate of pay during this period, there are still more lost productivity costs. Naturally, for more senior-level positions, or those requiring longer periods of time to develop full productivity, the costs will be higher.

During this time of lost productivity, the person’s supervisor is also spending more time instructing, reviewing work and possibly correcting mistakes. (There will be some mistakes that are not caught right away and will cost money to correct down the line such as with a customer who receives an incorrect price, invoice or actual shipment due to the new person’s error.) Put the sum total of these costs at approximately 32% of the position’s base salary or $17,000.00.

Adding the subtotals of each major category discussed above gives a total of $77,000.00 if an employment agency is not used and $89,000.00 if one is used. The first figure is just about 150% of the original $52,000.00 base salary we used in this example. (And remember the additional costs of employee benefits and company paid taxes on top of that, which can range from 20 to 30 percent of the base salary.)

If we were looking at a sales position, the costs would be significantly higher due to the value of lost sales or customers. To calculate this cost, take the costs listed above and add the average revenue per sales representative divided by the number of weeks the position is vacant. This total will be well above 200% of the sales persons annual compensation. The employee as resource, rather than expenditure For a company with $5 million in revenue and $250,000.00 in net income, they have just spent between $75,000.00 and $90,000.00 of that profit to replace someone!

You may say that these are just “the costs of doing business” and to a certain extent, that’s true. However, would you rather spend $75,000.00 on purchasing a new piece of equipment that can increase your manufacturing or service capacity, or use it just to maintain the status quo? Many managers have focused only on the cash cost of employee turnover. They do not realize the entire cost and impact of turnover. The point is that the cost of time and lost productivity are no less important or real than the costs associated with paying cash to vendors for services such as advertising. This is something often overlooked or underestimated by employers; yet in today’s tight job market, with companies competing for skilled workers, these costs are becoming more and more significant.

This is not to say that all employee turnover can or should be eliminated. But given the high costs involved and the impact on productivity and customer service, a well thought-out program designed to retain employees can easily pay for itself in a very short period of time. Unless you are prepared to beat all of your competition on wages all of the time, it is a good idea to start taking a hard look at your benefits, your policies and the “intangibles?” that make your company a desirable place to work.

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