Workforce.com

It's Costly To Lose Good Employees

August 1, 1997
Can you afford to lose a million dollars? Not many companies can. But did you realize that on average, a company loses about $1,000,000 with every 10 professional and managerial employees who leave their organizations? Assuming your company has a 10 percent after-tax profit, that's a reduction of $100,000 from the bottom line.

Research at Saratoga Institute has shown that the average internal cost of turnover for exempt personnel is a minimum of one year's pay and benefits, or a maximum of two years' pay and benefits. To obtain a true picture of the cost of turnover, you also have to factor in the external effects on customer sales and retention.

The three costs of turnover.
Almost every HR professional knows the turnover rate of his or her company. However, not everyone knows the voluntary and involuntary turnover rates of his or her exempt and nonexempt staff. And, giving an annual report of turnover rates as a percentage of staff to top managers usually fails to elicit any action. It would help if a turnover report focused on the true and full cost of turnover.

The first cost is employee-based. For example: Company A employs 1,000 employees of whom 50 percent are exempt. The firm's average annual salary and benefits package equals $82,000 and voluntary turnover is 8 percent. Minimal cost of turnover = $3,444,000. (1000 x 0.50 = 500 x 0.08 = 40 x $82,000 = $3,444,000.)

The second cost is customer retention. As consumers, we all experience the annoyance of dealing with new employees at banks, stores, gas stations and other retail and service establishments. When aggravated, we take our business elsewhere. This secondary cost is easily calculated by the sales, marketing or finance departments. To calculate the average value of customers: Divide total annual sales by the average number of active customers or clients. This figure can range from a few hundred dollars to millions of dollars. Turnover in sales and service workers negatively impacts customer retention. In his book "The Loyalty Effect" (Cambridge, Massachusetts, Harvard Business School Press, (c) 1996), Frederick F. Reichheld claims that in some industries, it takes a new sales person two to three years to reach the same level of sales as the worker's predecessor.

The third turnover cost is the expenditure in marketing and sales to win a new customer. Customers must be replaced or your company loses market share. Companies that lose market share eventually fall into the doldrums of the living dead or go out of business. Here again, the marketing department knows the average cost to attract and capture a new customer. When you put the three costs together, you can see the true cost of turnover to your company: 1) Loss and replacement of an exempt employee, 2) Cost of a lost customer's purchases until a replacement is found and the new customer purchases as much as the old customer and 3) Cost of obtaining a new customer.

This equals the total potential cost. If you showed both the potential and the minimum costs to your senior managers, they might wake up and respond. To be conservative, acknowledge that the separation of every exempt employee doesn't cause the loss of a customer. To be extremely conservative, take Costs No. 2 and No. 3 out and show only Cost No. 1, the internal cost. By itself, this is still a hair-raising number.

Losing employees and finding new ones costs big time.
There are four internal sources to consider in determining the cost of separation. They are: the cost of termination, the cost of hiring and training a replacement, the vacancy cost until the job is filled and the loss of productivity with a new hire.

Termination. When an employee leaves, there are processing and interviewing costs. Typically, this cost is only a few hundred dollars of staff time and materials. Employee relations, employee records, security, payroll and other staff functions spend some time on out-processing the departing employee. In some cases, senior managers may spend more than a few hours counter-offering and trying to persuade the person to stay. These costs usually aren't excessive, but they do interfere with someone doing more value-adding work.

Hiring and Training. The average cost of exempt hires according to Saratoga Institute's 1995 "Human Resource Financial Report" (HRFR) was $8,300. In cases in which reallocations are involved, the cost is much higher. Add to that the average cost of training the new person over the first year. To simplify, you might take what your company spends annually on training as a percent of payroll and apply that. Saratoga's latest research shows an average of just over 1 percent of payroll is being spent on training. To be even more conservative, say an exempt employee's training expense is only one percent of payroll. If the person makes $65,000 in salary annually, the training expense would be $650. It's easy to see that without much effort you can spend nearly $10,000 to hire and train.

Vacancy. How long does it take to fill exempt positions in your company? The 1995 HRFR average is 75 calendar days. Take out 22 days (11 weekends) to get workdays. Divide revenue per employee (total sales divided by number of full-time equivalent employees: HRFR average = $293,000) by the number of workdays in the year. Subtract weekends and holidays to get an average of about 250 . Don't take out vacation days because they're paid. So, if your revenue per employee was the same as Company A the calculation would be: $293,000 divided by 250 days for an average of $1,172 per day. Multiply $1,172 by the number of days it takes to fill jobs, i.e., 53 (75 minus 22) for a total vacancy cost of $62,176. (Don't forget to back out pay and benefits for the 53 days that the job is open and add in any temporary employee pay you might incur.)

Of course the vacant job is covered somehow. Either you hire temporary workers, cover it with overtime pay to employees or just gut it out by working everyone harder and not paying them for the extra effort. There's always a cost. Just because you don't see it doesn't mean it isn't costing you. Sooner or later, you'll pay for it.

Productivity Loss. The new hire will take some time to reach a standard level of productivity. Without excessive computation, simply reach a consensus about the amount of time it takes the average exempt person to hit full stride. Assume it takes six months. Let's be generous and assume further that on average an exempt person is 75 percent productive during the learning period. If revenue per employee (a surrogate measure for productivity) is $293,000 per year, half would be $146,500 for six months. Taking 25 percent of that as nonproductive time, the result is a loss of $36,625.

The bottom line cost of turnover using these assumptions is $108,000 . At an average of $82,000 in pay and benefits, this is approximately the cost of 1 1/3 employees you're paying for and not getting any return out of. Lose 10 of them, and there goes your million-dollar investment. (The reason this number may seem high is that the average employee in our survey generates almost three times his or her cost.)

It's a lot to lose. But you can alleviate your vulnerability by designing a retention strategy that puts you in the driver's seat.

Workforce, August 1997, Vol. 76, No. 8, p. 32.