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Pre-employment Referencing Aids Your Bottom Line

February 1, 1995
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Related Topics: Retention, Featured Article
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We've all heard the horror stories. They may be unpleasant—the CFO who embezzles millions from six different employers, each of whom simply force him to quietly pay restitution, then allow him to move on and victimize another company. They may be tragic—the doctor who practices medicine without proper licensing or experience, and whose negligence leads to a patient's death. They may even be horrifying—the worker with a history of violent rages who kills a co-worker on the job. And they all have in common an underlying characteristic—they could have been prevented by pre-employment referencing.

But in this Age of Litigation, it's difficult to know how to conduct oneself during background checks. What kinds of questions can you ask a prospective employee's previous company? Conversely, what kinds of questions can you answer concerning former employees? Indeed, articles on the subject of pre-employment referencing tend to concentrate on the legal dangers and advantages of conducting background investigations on prospective employees. Attorney A will warn of the negative dangers (the risk of being sued for defamation), Attorney B will advise of the positive advantages (avoiding potential negligent hiring suits), and doubtless many confused business owners and beleaguered HR professionals will continue to allow themselves to be pressured into making the wrong decision—or worse, making no decision at all.

Pre-employment referencing should be seen as an aggressive, proactive way to reduce turnover and maintain a higher quality work force.

But few hiring managers—and certainly no lawyers—are talking about the tangible, bottom-line advantages of implementing a consistent and professionally managed referencing program, and elevating the discipline to its proper position—that of a productive management tool. One need not—should not—see pre-employment referencing as a passive, reactive means of fending off undesireables, but as an aggressive, proactive way to reduce turnover and maintain a higher quality, more productive work force. The canny HR professional should realize that reducing the turnover rate as little as 2.5 % can have dramatic effects on the bottom line, and that objective methods can be used to obtain empirical data that validates the value of referencing as a corporate investment.

Turnover exacts a heavy toll.
Like an iceberg, the vast majority of the costs associated with turnover lurk below the surface. In 1990, Personnel Journal published an article by J. Douglas Phillips ("The Price Tag on Turnover") based on case studies by the Rutgers University Graduate School of Management, in which he claims that turnover costs averaged about 1.5 times the annual salary of the position in question. Thus, an employee earning $30,000 a year would cost his or her employer $75,000 ($45,000 + $30,000) if she left the company after twelve months. But Phillips further claims most of these costs do not come from increases in the expenditures most obviously associated with turnover such as advertising, recruitment, relocation, orientation and training. He says, rather, that "hidden expenses account for 80% or more of turnover costs." And most of these hidden expenses come in the form of lost productivity.

Of all the costs pertaining to total employee turnover, four of the biggest are hidden, meaning they will not appear on any corporate balance sheet. They relate to the following inefficiency factors:

  • Inefficiency due to the position being vacant
  • Inefficiency of incoming employees
  • Inefficiency of colleagues closely associated with incoming employees
  • Inefficiency of departing employees.

Measuring the costs associated with these inefficiencies in cold, hard cash is often difficult—most jobs today do not lend themselves to objective measurement techniques. But, though efficiency may never be measured with absolute precision, it's possible to obtain reasonable and useful approximations. That's what we set out to do. Using the methodology outlined by Mr. Phillips and Rutgers' Graduate Management School, NRC co-opted the assistance of a tele-communications company, whose sales staff of 900 experienced an annual turnover rate of 35% (315), and whose sales management staff of 90 experienced an annual turnover of 20% (18). The company had no formal pre-employment referencing program.

Productivity losses cost more than you think.
The most obvious—and most expensive—productivity loss associated with turnover occurs because the position remains vacant during the search process. On average, positions remain vacant for 13 weeks, and managers have estimated that about 50% of the position's efficiency is sacrificed during the vacancy period. In the case of the telecommunications company, sales managers with an open sales rep. position in their department spent 20% of their workday covering for that position. And since sales managers make $4,200 a month, 20% of $4,200 over 10 weeks is $2,100. Other sales reps. covered the remaining 30%. Since they make $3,200 a month, 30% of their time over 10 weeks comes to $2,400. Taken together, each vacancy means a total of $4,500 in inefficiency costs—without having even paid anyone in that position a dime.

Measuring the costs associated with inefficiencies is often difficult, as most jobs do not lend themselves to objective measurement techniques.

But vacancies are not the only factor in productivity losses due to turnover. Incoming employees take a while to adjust. No matter how much orientation and training you give employees, it takes time for them to reach full productivity. The average amount of time for an incoming employee to reach 100% efficiency (the learning curve) is 11.9 months. The increases in productivity do not, however, increase in a linear fashion; the time it takes an employee to go from 0% to 25% efficiency (1.7 months) is much shorter than the time it takes him or her to go from 75% to 100% efficiency (4.8 months). The time periods between each productivity milestone on the learning curve look like this:

  • To reach 25% efficiency = 1.7 months
  • To reach 50% efficiency = 3.6 months (1.9 months)
  • To reach 75% efficiency = 7.1 months (3.5 months)
  • To reach 100% efficiency = 11.9 months (4.8 months).

We can use these numbers to help us better understand how much productivity is truly lost during the first year on the job. For example, if we assume that the average efficiency over the first 1.7 months is 12.5% (half of 25%), then 1.7 months at 12.5% efficiency is the equivalent of just 0.2 months at 100% productivity. And when we do similar calculations over the entire 11.9 month learning period, we see that during that time the employee gives us 7.5 months of full productivity, and 4.4 months of lost productivity. This is no insignificant amount of time.

That was the hard part. Now, to translate that amount of lost productivity into dollars, simply multiply the amount of time lost during the learning curve by the average salary for that time period. In the example of the telecommunications company, again, the monthly income (salary and benefits) for sales staff members was $3,200; multiplied by 4.4 months of lost productivity, this gives $14,080 in lost productivity per person. For sales managers, who make $4,200 a month, lost productivity would be $18,480.

It is important to note here that we are assuming the employee quits after exactly one year. If, however, the employee quit in the first 90/120-days, the cost of individual inefficiency would fall by one-third to one-quarter. Remember, though, that the position would again be vacant, meaning that the number of turnovers overall would increase. In the case of a district sales manager whose employment terminates (for whatever reason) in less that 3.6 months, the inefficiency cost would be approximately $7,000. Additionally, he or she would not have made a profitable contribution to corporate income.

Incoming employee inefficiency has a domino effect. Managers must realize that in addition to lesser productivity on the employee's part, they must consider the amount of productivity lost by supervisors and peers due to helping the incoming employee adjust. In the Rutgers case studies, it was found that supervisors, on average over a one year period, spent 14% of their day helping train, orient and answer questions for incoming employees. And the employees' peers similarly spent 8% of their day helping their co-workers adjust. In the case of a new sales staff member, 8% of his or her co-workers' time translates into $3,072, and 14% of his or her supervisor's time equals $7,000. Some caveats: these numbers assume that the employee stays for 12 months and makes a positive contribution to the company's revenue. Lost productivity for employees who terminate after only 3 or 6 months would cost less but, again, the total turnover rate will be higher. And in some cases, where peers depend heavily on the incoming employee's output, the 8% figure could be much higher—some companies double that rather conservative estimate.

One final source of lost productivity. Efficiency begins to rapidly decline 3 months before employees leave, with about one entire month of productivity being lost during those last 3 months. Which, for a sales representative, means $3,200 in lost salary and benefits.

Taken separately, these inefficiency costs may not seem that substantial. But, when added together, they can be overwhelming. Based on the data set out in the four models expressed above, it was determined that the average hidden costs of employee turnover for each sales representative (including salary) was $70,252. And that figure doesn't include visible recruiting costs such as agency fees, advertising, interviewing, training, relocating and other direct recruiting expenses.

As Mr. Phillips points out, avoiding turnover for only a few employees is cost-effective, "even with a considerable investment." The same is true of any program designed to reduce the average cost of turnover. He suggests that an investment of 50% of the targeted costs would pay for itself within one year. In other words, if the telecommunications company spent $35,000 per termination in an effort to keep employees at the company, the program would pay for itself within a year.

Small investments aimed at reducing turnover can reap huge dividends.
Introducing programs designed to improve employee productivity or reduce the time a position is vacant would obviously cut down on turnover costs. But these kinds of training programs take time and money to develop and implement, and outsourcing them can be even more expensive. Some outsourced resources, however, are relatively inexpensive and yet can still significantly reduce turnover. Pre-employment referencing is one of these resources.

In 1985, a Congressional Committee determined that more than 30 million men and women managed to obtain employment with the aid of a false resume. It is difficult (understandably!) to obtain data regarding how many of these employees were dismissed within a year because workers with false resumes are reluctant to come forward, and the companies that hired them are embarrassed to admit their mistake. However, we have to think about why they lied in the first place. In order to conceal a short-coming? Because of a lack of expertise or experience in a particular discipline? It is intuitively plausible that many employees, once they start working, discover that the expertise they falsely claimed on their resume is a necessary prerequisite to do the job, and end up either quitting in frustration or being fired for incompetence. And even if they're fast learners, and develop the necessary skills as they go, they still increase the learning curve and bring down productivity.

How many false resumes, or fraudulent work-histories not previously investigated, would the company have to find in order to justify the investment?

And what does this say about the employee's credibility and trustworthiness? Very few resumes contain a single lie that, once isolated and perhaps taken care of, can be forgotten. We call this the Single Cockroach Theory—the idea that the one you see on the counter is the only one in the kitchen. A false statement is usually made in order to conceal a truth, or gain unfair advantage. In both cases, the employer's knowledge is undermined, which is not only dangerous, but costly as well.

With pre-employment referencing some of these worries can be taken away, or at least lessened considerably. A company doggedly committed to a consistently-managed pre-employment referencing program, one that goes beyond a perfunctory examination of a candidates background and delves into his or her past work performance and track record, often boasts a more capable, resourceful work force that is qualified for and enjoy doing their jobs.

And this can be great for the bottom line. Assuming that the 900 employee telecommunications company sales staff had an annual turnover rate of 35%, the approximate hidden costs of turnover will amount to $22,129,380 (70,252 x 315). By reducing turnover by just 2.5% (see p. 69) the company could realize savings of $1,580,670, while the cost of running the background checks would be just $58,500 (assuming the average referencing assignment costs about $200). Similarly, a turnover reduction of 5% (to 30%) could save the company $3,161,340, while costing it only $54,000 up front. And reducing turnover by 7.5% saves $4,642,000, while costing just $49,500. It may seem counterintuitive that the cost of running background checks lessens as turnover drops and savings increase, but when there is less turnover fewer background checks are performed, as the company is filling new positions less often.

But can pre-employment referencing reduce turnover by 5%? In truth, that hypothetical estimate is a modest one. On average, our company reduces turnover anywhere from 5% to 20% depending on the industry, the salary of the positions in question and the turnover rate at the time the pre-employment referencing program is undertaken. But any reduction in turnover, no matter how slight, can mean tremendous savings for companies. If the telecommunications company's reference program could reduce turnover by only one percent, it would reap a return of over $600,000, and for an expenditure of less than 10% of that.

So the question remains, "How many false resumes, or fraudulent work-histories not previously investigated, would the company have to find in order to justify the investment?" Some would say that it's always a good idea, that with the rise in workplace violence these days, any step that can limit the possibility of violence erupting at your company should be taken. But in purely financial terms, the hidden costs of turnover are often great enough that the number of candidates turned down due to a background check can be very small and still be cost-effective. For the sales staff of 900, the program will more than pay for itself if just one bad hiring decision is averted due to pre-employment referencing.

Unplanned employee turnover is not just a statistic; it's a debilitating financial reality. As employees become more valuable in the lean and mean '90s, that the traditional "no reference" policy has passed its sell-by date should be obvious to everyone except those managers that really do have something to hide. And the debate as to the legality and cost-effectiveness of pre-employment referencing should be taken out of the lawyers' hands, and put back where it belongs; in the hands of the managers at companies that care about people and profits. But until that happens, until employers and employees alike are willing to maintain an atmosphere of open and honest collaboration, pre-employment referencing is an easy and cost-effective way to protect your company legally and on the bottom line.

Personnel Journal, February 1995, Vol. 74,, No. 2, pp. 68-75.

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