How to Calculate the Real Cost of Turnover

What do your employee recruitment selection mistakes cost your business? In the course of my business, I have frequently asked this question of managers about specific positions for which they were hiring; for example, sales. Given the wide variety of jobs and industries, the considerable variance in the answers I have received regarding the costs associated with such hiring mistakes has not been surprising. What has been the real eye-opener, however, is my realization that the responses are most always conjecture!

Virtually everyone admits that turnover costs are exceptionally high, but the reactions I see tend to be more blasé and reflect little if any shock. In fact, I get the impression from many managers that they accept this as a cost of doing business and would rather not know just how expensive their turnover has become.

There are the simple cost guesstimates of which we have all heard; for instance, that turnover costs one times an employee’s annual salary, or something approximate. The DOL, obviously averaging all jobs, has said that it costs one-third of an employee’s annual salary or wages. Others make the claim that turnover costs 25 percent of the combined annual salary and benefits.

These estimates are probably not even close to the truth. Depending upon a number of variables, we can generalize for some jobs that turnover costs vary between 100 percent and 150 percent of the annual salary. From a slightly different perspective, an HR publication noted a while back that a major technology company calculated a minimum cost of $600,000 when an upper-level manager died, a number that would be many times higher today considering current compensation levels. The point I want to emphasize is that, although we can catalog some of the obvious line items, what is far more consequential is that turnover is a significant constraint on organizational performance, and merits priority attention.

If you really want to drill down and lay bare all your costs associated with turnover in your business, take into account this surprisingly long list of the cost factors.

You have costs associated with an employee departing or being terminated.

These include:

  • Temporary replacement costs, which may involve employing temporary personnel, or enlisting present employees to perform tasks of the vacant job as well as their own, and which may include overtime (less the salary and benefits that would have been paid to the departing employee).
  • Lost opportunities and lost productivity, as a result of either replacement personnel, or if the job remains vacant for more than a short period of time. This might vary from a 50-percent loss, with fill-ins to 100 percent for a vacant position. For sales territories that are vacant, multiply the quota gross margin by the number of weeks the job remains unfilled.
  • Administrative costs, including the costs of conducting an exit interview and terminating payroll, benefit deductions, benefit enrollments, handling government and legal compliance notifications and administration, and simply processing the paperwork for a resigning employee.
  • Additional management costs associated with the necessary work-arounds.
  • The cost of the training and education and even certifications, which are lost along with the departing employee.
  • The impact of the event on the entire department’s performance and productivity. A lot of wasted time and downtime often accompanies terminations and unexpected departures (this is very difficult to measure but is particularly expensive in more senior roles).
  • Severance costs and the continuation of benefits provided to employees who remain eligible for coverage under these programs.
  • The substantial costs of lost knowledge and skill sets. This might be the most significant cost of all, considering the impact on the company’s operations if there is no immediate way to fill this void.
  • The costs of unemployment insurance – a rise in premiums and/or time spent preparing for an unemployment hearing, or the costs paid to others who may handle the unemployment claim process on your behalf.
  • The costs associated with losing customers or clients that the employee may take with him or her, or the extra costs you will have to assume to retain those customers (another significant cost consideration that needs to be taken into account, yet one that you may only be able to estimate).

Then you have recruiting expenses…

  • Direct costs such as agency fees (15 to 30 percent of the annual salary), advertising, referral fees, job-board costs, and the like.
  • Pro-rated costs for the recruiting process, including the recruiter, clerical assistance, management and supervision in the department, which might require from one to two weeks per hire, given all the tasks associated with the process. Also include the time needed for résumé review and processing along with possible candidate travel expenses.
  • Costs related to interviewing internal candidates, along with the fiscal and opportunity costs associated with preparing for those internal candidate interviews.
  • The costs of conducting background checks, drug screens, reference checks, and employment testing for the short-listed 2, 3, or 5 candidates.

And now you have to train your new hires again…

These costs include:

  • All orientation expenses.
  • All training and certification costs, including time off the job, and associated costs, materials, programs, any related travel expenses, and instructor expenses. These costs generally run much higher in sales organizations and contact-management centers.
  • Take into account an expense factor for instructional equipment and materials needed, including company or product manuals, computers, or other equipment used in the delivery of training.
  • Supervisory or management costs linked to training, learning, review, etc. This can add up to the better part of a full day every week for the manager, for a number of weeks.

Of course, with new employees you will always have ramp-up costs, which include:

The new employee learning the job, the company policies and practices, etc.; the new employee is, as a consequence, not fully productive. Use the following guidelines to calculate the cost of this lost productivity:

  • Low productivity – the new employee is performing at maybe 25 percent for several weeks or a month, so the cost is 75 percent of the new employee’s full salary for that period.
  • For month two and possibly month three the employee is performing at a 50-percent productivity level. The cost is calculated at 50 percent of the full salary for that time.
  • During months four and five the employee is contributing at a 75-percent productivity level, resulting in a cost of 25 percent of the full salary.
  • The cost of coworkers’ and supervisors’ lost productivity due to their time spent on bringing the new employee up to speed.
  • The cost of mistakes the new employee makes during this elongated indoctrination period.
  • The cost, if relevant, of lost department productivity caused by a departing manager who is no longer available to guide and direct the remaining staff.
  • The cost impact, if relevant, associated with the completion or delivery of a critical project in which the departing employee was a key participant.
  • The cost of reduced productivity during a transition period for a manager or director who loses a key staff member or an assistant.

Don’t forget to account for your physical and materials costs too…

These can include:

  • the cost of putting the new employee on the payroll
  • establishing computer and security passwords
  • issuing identification cards and business cards
  • releasing internal and external publicity announcements
  • establishing voice and email accounts
  • other costs such as credit card accounts
  • leasing other equipment such as automobiles, cell phones, and pagers

Small wonder many managers don’t want to to know what employee turnover is costing their business! The costs generally add up to a lot more than what simple estimation methods suggest, and when revealed, would likely warrant moving the issue to the front burner, where there are already so many problems competing for management attention.

Turnover is most often expressed as an expense factor; for example, “It adds this percentage to our costs…” But what is a more dramatic statement of the costs of turnover and a real attention-getter is to express turnover costs as a percentage of profits. When it’s understood just how much of the bottom line turnover chews up, there’s a lot more incentive to address the problem.

If you want to reduce some of the calculation work, or even play around with the numbers, to estimate what your costs might be, we can help you. On our website, one of the tools we offer is a turnover calculator.

Go to http://2oms.com/2011/12/how-much-does-turnover-cost-your-organization/

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For more than forty years, Frank Gump has been helping corporations become more productive and profitable by helping management teams identify and hire top performers and manage them most effectively. Developed and refined through extensive experience in more than 1200 organizations in the United States, Canada, England, and Australia, ADGI’s Organizational Management System (OMS) is a finely calibrated, technologically advanced decision-making process offering the potential for enormous payback. Contact ADGI for more insight and connect with Frank on LinkedIn. Follow ADGI on Twitter @ADGIGroup. Like ADGI on Facebook and follow us on Google+.