Table of Contents
- Why is this cost calculation important?
- Monetary costs of replacing an employee
- Example calculated cost of replacing an employee
- What is your cost of replacing an employee?
Losing an employee is painful. They have amassed immense knowledge about your business that needs to be replaced. They likely play a critical role on their team. And if they’re in a client-facing role, you now have a relationship emergency to manage. Certainly there are other reasons to focus on employee retention. When calculating the cost of replacing an employee, consider the impact it has on other team members, morale, and workload. All of these things directly impact employee engagement.
However, for this article, we’ll mostly focus on the monetary cost of losing an employee. In my opinion, the qualitative impact of losing an employee is greater than the financial cost to lose an employee. But the financial cost is a more straightforward way to justify investment in employee engagement, satisfaction, and retention.
Why is this cost calculation important?
The cost of replacing an employee can have a significant impact on how you view employee retention efforts. If your cost of replacing an employee is high, you will rightly justify the cost of retaining an employee. For example, pretend it costs you $50,000 to replace a key employee. It then seems like an incredible deal to invest a mere $10,000 in retaining them. Once you perform this cost calculation, you will likely approach raise negotiations differently with key employees.
Conversely, if you find that the cost of replacing an employee is negligible—say, $5,000—you may not view retention as something worth investing in. Unfortunately, this is often the case when companies only need low-skilled workers or are in an industry where the supply of job candidates far exceeds the demand of employers. Beyond the financial cost of replacing an employee, though, there are other factors worth considering. The job satisfaction of retained employees can go down when their coworkers leave, potentially resulting in decreased engagement and decreased performance. Again, though, these are topics for another day; let’s get back to monetary costs for now.
Monetary costs of replacing an employee
There are some costs of losing an employee that apply across all industries. Replacing that valuable employee requires investment in a few areas. You will need to recruit new job candidates, spend time interviewing and hiring the right person, spend time and potentially other resources onboarding the new employee, and possibly purchase replacement equipment if the departing employee’s equipment will not work for the new employee.
Regardless of how you recruit new job candidates, it will require some type of expenditure. Be it money for ads, time you spend searching LinkedIn, or time from the rest of your team reaching out to their network, there is a recruiting expense.
Reviewing resumes, screening candidates, and conducting interviews all take time and effort from your team. In most cases, this time displaces other valuable work. Hiring managers typically already have a full schedule, which is why they need to hire in the first place. Carving out time for hours of screening and interview activity every week is difficult. While the search for an appropriate hire continues, the hiring manager’s typical work is likely going to suffer.
At a minimum, you have a set hourly rate you are paying your hiring manager. Consider every hour spent recruiting as an investment that could have been spent elsewhere: increasing business value in your product, investing in professional development of team members, and so on.
Hopefully, whatever tools and equipment your departing employee used can be used by their replacement. Unfortunately, this is not always the case. For example, if a previous employee’s chair has significant wear and tear, you will not want to seat a new employee in it. It sends a negative signal to the new employee (“we will not make a $X00 investment in a nice chair you will use eight-plus hours per day). Similarly, software developers who are given used computer equipment may infer that the company is not willing to invest in the best tools for them to do their job.
This isn’t to say you must purchase brand new equipment for every employee. But if the equipment you have on-hand looks like it’s seen better days, replacing it with new equipment sends positive signals to your new employee. “We are investing a lot in you because we value you as a person.”
Compensation delta costs
Chances are, you will not find an equally qualified replacement for the same salary as you paid the departing employee. Likely, you’ll pay more: people who switch jobs are more likely to receive higher compensation than those who remain in the same job for a long period of time. Therefore, the simple nature of negotiating salary in a high-demand industry will result in some cost.
Onboarding and training costs
There will be some time devoted to onboarding and training in any employee’s first days. Completing HR paperwork, going through cultural training, learning about the systems used at the company, or otherwise helping new hires understand the projects they’ll be working on can take significant time. It’s really a double-whammy: your new hire is not yet performing revenue-generating work, and neither are the team members who are assisting with training and onboarding.
Certainly, this is an investment worth making. You need team members who have the skills and context necessary to do a great job. However, the short-term costs can quickly add up.
Lost opportunity costs
Between the time you lose an employee and bring their replacement in, you may be losing revenue from the vacant seat. This is especially true in professional services, where most clients are paying by the hour for your team’s expertise. In a lot of cases, the opportunity is not technically lost. The services are still needed by your client, and they will pay whenever your new hire is up to speed. However, at a minimum, we are talking about a delay in realizing revenue, which can have a detrimental impact on company cash flow.
Your company may have other financial costs associated with replacing an employee. For example, government contracts often have requirements to maintain certain team sizes, mixtures of skills, or even retention of specific people. If losing an employee means violating those contract terms, you may find yourself delaying work until the contract can be renegotiated, seeking exceptions to be approved by the contracting office, or losing the contract entirely.
In the hospitality industry, running with a skeleton crew may translate into decreased customer satisfaction. This decreased satisfaction can be amplified by social media and online review sites, leading to fewer new customers until the situation can be over-corrected to the point that customers are leaving rave reviews that counteract the negative ones.
Regardless of industry, there are likely additional costs of replacing an employee that are worth contemplating.
Example calculated cost of replacing an employee
Example lost opportunity costs
Let’s run a quick back-of-the-napkin calculation for the cost of replacing an employee. Let’s say I have an employee working on client contracts at a $100/hour rate. As soon as that employee walks out the door, I’m losing $4,000 per week until I can get a replacement hire in to service the contract. Considering most professionals give the courtesy of two weeks’ notice, and recruiting and interviewing can take a couple of weeks, we can estimate that we’re losing roughly 4 weeks of work. That in itself—which, in my experience, is a very conservative estimate—translates into $16,000 of lost opportunity costs.
Additionally, consider the time spent by existing employees in finding the right hire. Using the two-week estimate above for recruiting and interviewing, let’s say we’re devoting an average of 1 person’s time for two weeks. That will increase or decrease depending on the recruiting pipeline. Sometimes you may have 2 people in a room interviewing a candidate. Other times you may have no one working on it because they’re waiting for candidates to respond to emails. Assuming the employees helping with recruiting and interviewing are also billing out on $100/hour contracts, there goes another $8,000 of lost opportunity.
Also consider the cost of onboarding and training. Let’s assume you have a qualified, highly-skilled hire on your hands. Let’s be incredibly optimistic and say that their time plus the time of trainers only results in 1 person-week of lost opportunity. Goodbye, $4,000.
Example miscellaneous costs
And don’t forget the job ads! If you’re hiring a software developer, Stack Overflow Jobs is a great place to post, but a single ad may cost you $1,500. (Remember to make the best of your investment by starting job posts with your company’s purpose!)
Let’s assume that the new hire will be able to use all of the same equipment that was used by the replaced employee. Therefore, the cost for new equipment is $0. Whew. That’s good, at least. Let’s also say you lucked out and found someone willing to accept the exact same compensation as the replaced employee. Boy, are we lucky!
And the grand total is...
These costs bring us to a total of $29,500 to replace a single employee. Again, this is a rather optimistic number. The earlier example of $50,000 is closer to average for a highly-skilled employee with several years of industry experience. A key employee that serves in higher-level roles can easily creep into replacement costs in the six-figure range.
I hope this example scenario helps drive home the true cost of replacing an employee. When business leaders say “people are our most valuable resource,” they’re right. It may sound cliché, but even if you’re only looking at money, the math certainly works out.
What is your cost of replacing an employee?
Once again, the focus of this article was the monetary cost of replacing an employee. There are other costs to consider that are more difficult to measure. What impact does losing an employee have on other team members? Are the departing employee’s client relationships going to survive? What about your company’s reputation? Quantitative and qualitative costs to your company are significant, and understanding the true cost is important to the sustainability of your business.
Use this exercise to consider what you should be doing differently. Are you devoting enough resources to employee retention efforts? Can you measure employee satisfaction? Do you have a way to promote employee engagement?
These can be difficult questions to answer, but we’re here to help. Contact us to start a discussion about improving employee retention and reducing your cost of replacing an employee.