What is the true cost of an employee?

The true cost of an employee? Well, there’s salary, payroll taxes, benefits, and workers’s compensation. But to fully understand that question, one should speak to an experienced HR professional, which is exactly what I did.  Karen Alary, SPHR, Human Resources Consultant (karen.alary@gmail.com) explains it as follows: “The true cost of an employee starts long before they even set foot in the company’s front door.  Identifying the need to create or fill a position, defining the position, recruiting, and the time it takes to fill the vacant position make up some of the initial costs that many employers don’t necessarily even recognize as hard costs.  But remember that these activities all take time, that time is money, and that money equates to the true cost.  And then there are the recognized costs associated with the pre-employment phase such background checks, referral bonuses, agency fees, relocation costs, etc. Studies show that a formal onboarding process results in significantly higher worker productivity year-over-year, but in the meantime new hire training and the time it takes a new employee to “get up to speed” means the company isn’t receiving the full benefit of the employee’s potential contribution.”

Maybe we should be more concerned with the productivity and value that the employee brings to the organization, which sometimes is not so easily measured, and then compare to cost.  Karen Alary continues: “An employee’s intrinsic motivation speaks directly to the level of engagement and productivity.  If an employee lacks motivation he is not contributing his maximum potential.  And low productivity directly impacts a company’s bottom line, adding to the true cost of an employee.  This is probably the most difficult aspect to measure yet one of the most important ones in which to take heed.”

But should we also consider the opposite side of the coin, namely what is the true cost of replacing an employee?

What is the cost of replacing an employee? Studies indicate that the true cost of employee turnover is 25% of that employee’s annual salary for low level employees and up to 500% for “C” level positions. So let’s just say that in Northern California, the average wage is $50,000, the turnover rate is 25% (the national average), and your company has 40 employees. The turnover cost would be $125,000 per year.

Certainly, a strong consideration should be made to keep existing employees if at all possible, considering the high cost of replacement, as well as the organizational distraction that turnover creates. Granted, some employees go so far wrong that termination and replacement is the only option. We are all familiar with that aspect and probably have experienced it first-hand. But at least some of the time, the reason that an employee has underperformed is because the employer has failed to communicate expectations, need for improvement, etc.

How many of your employees get annual reviews? How much thought, time and effort goes into the annual reviews that do get done? How timely are the reviews? Are managers trained to perform annual reviews, or are they left to “wing it”? Over my thirty years of business experience, I have rarely seen companies handle this process even remotely well. Annual reviews are in my view a bad idea to begin with, but are often the only feedback that employees receive.

Why not do frequent employee coaching/mentoring sessions instead. These sessions are very short discussions with your direct reports. They are informal and designed to communicate praises for work well done, as well as to address problem areas quickly and efficiently. Without such a mechanism, poor performance issues tend to fester and result in frustration on the part of you the employer and the employee. Then the high cost of employee attrition can kick in.

Most, but not all employees want to do a good job, and want to know if they are meeting your expectations. The more frequent the coaching they receive from you, the more quickly they can figure out how to perform optimally, and the more responsibilities you can comfortably delegate to them. You are right if you think I am recommending that you again read The One Minute Manager by Kenneth Blanchard and Spencer Johnson, which you probably have not blown the dust off since reading shortly after its publishing in 1982. 

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