In earlier articles in this series, I made the contention that the average talent level of most companies hasn’t increased in the past 10 years. I contend that this is largely due to a follow-the-crowd or “blame some bureaucratic rule” excuse.
Here are two of the articles in this ongoing series, for those who want to catch up with the bandwagon.
Part 1: The Financial Impact of Not Hiring the Least Best
Part 2: Should the Recruiting Department Be Charged With Financial Malfeasance
The root cause of the problem seems to be the lack of a CEO-driven talent strategy, combined with some CFO-like financial rigor. Most companies have talent-related mission statements, but these rarely convert to a strategy. If they did, cost per hire would be tossed out, replaced by some quality of hire metric.
For some reason converting the “talent is #1” mission statement into a real strategy with real tactics seems all but impossible unless a big employer brand is driving it. That’s why the CFO needs to get involved by looking at the financial impact of bad hiring decisions. Gallup is doing a lot of work in a related area, by directly examining the huge financial impact of worker satisfaction and engagement on earnings. Something similar should be done on the hiring front, since this is where the problem originates.
Every hiring decision has a direct financial impact. The best people save money and produce more. To calculate this profit impact at the hiring decision level all you need to do is to compare the profit contribution of a well-above average target employee to the person being hired. I suggest using the top third of your current employee base as the target, and compare all future hires to this level. The difference represents the opportunity lost in dollars. Calculating this is not hard to do.
In Part 1 of this article series, I presented a model that involved multiplying revenue per employee by some reasonable estimate of variable contribution margin. This results in average variable profit per employee, or APE. Since all employees are not created equal, it’s reasonable to estimate that the top third of the people you hire generate 20% more APE than the average, and the bottom third generates 20% less. This 20% difference is D in the model. Some might argue that D is greater than 20%. Few would argue it’s less. For calculating the financial impact of not hiring a top-third person, it’s a reasonable floor.
For example, Amazon’s APE is approximately $140,000 per employee. (Send me your stock ticker symbol if you’d like to see your company’s calculation or go to my blog to see how to calculate this.) With D equal to 20%, it means that each person in the top third generates $168,000 in APE and each person in the bottom third generates $112,000. This is a difference of $56,000 per person. The simple math equation is “Lost profit=2D*APE.”
For most companies the profit lost by hiring someone who winds up in the bottom third instead of the top third ranges from $50,000 to $100,000 per person. (This is valid for typical staff-level positions, with a multiplying factor on top of this depending on management level and position importance.) If you do this 100 times a year, this turns out to be a lot of money — a loss of $5 million in per tax profit using the $50,000 impact.
Now for the big picture strategy and financial impact part. Instead of multiplying the lost profit by 100, substitute one third of the people you expect to hire in the next 12 months. The reason: one third of the people you hire in the next 12 months will wind up being in the bottom third of your workforce. And for most of you, this number is a lot bigger than 100.
Of course, no one goes out of their way to hire someone who’s going to wind up in the bottom third, but somehow it happens anyway. Usually this is due to weak systems, the pressure to fill positions, ineffective sourcing, weak technology, incomplete assessments, overburdened recruiters, and/or hiring managers who can’t assess or attract strong people. A hiring strategy designed to measure the financial ROI of each hiring decision would have minimized the impact of these mistakes, especially if someone on the CFO team was involved in the pre-hire calculation.
This all starts by thinking about each hiring decision as part of a bigger, “raising the talent bar” hiring strategy. If you’ll be hiring 1,000 people over the next 12 months it’s obvious that 333 people will wind up being in the bottom-third. Shifting just 100 people into the top third will earn your company at least $5 million in additional pre-tax profit, and your average talent level will increase. If it costs you less than $500,000 per year to pull this off, it becomes a pretty big ROI, so making the business case is pretty easy.
I’ll present the actual calculation to measure new hire ROI in the next article in this series, but for now I’d like to suggest there are some things you need to consider first. Here’s my short list:
Last question: should the recruiting department’s performance be measured by some productivity and cost metrics, or by how well it helped raise the company’s talent bar? Obviously, a lot of things would have to change to excel at both, but maybe that’s a good place to start.