The Hidden Costs Of Employee Turnover

Turnover is not something to be taken lightly. Employee turnover, or attrition, impacts profitability and often even the ability of the company to execute its business. Yet, very few companies calculate how much employee turnover costs them and use it to plan their business. Once you understand what it cost to replace an employee who leaves, you may rethink even your compensation and retention policies. The numbers are often mindboggling.

It is not a particularly well-kept secret that salary progression in most organizations is painfully slow. You get hired to a job, do great work, and keep getting your 3% yearly salary increases. Years go by. Then you meet a former schoolmate who is doing the same job, always had the same grades at school, and just joined the company you work for in the same position. You get drunk together, you talk, and to your dismay, you discover that he or she is paid significantly more than you are. Your loyalty to the company is rewarded by a lower salary than is being given to those who just joined. So you start looking around, you go to a couple of interviews, and indeed you discover that you can command a 20% higher salary than you have today. So you jump.

The problem, of course, is that increases based on percentages create bigger and bigger gaps over time. If you start with a small salary, you have no way how to catch up with someone who asked at the very beginning for more. Every manager and human resources professional in the corporate world knows that this is how things work. And yet, very few companies have in place processes that would ensure regular market correction for the people who are most loyal and are staying with them the longest.

Most of the big companies would do yearly market research. They would buy a market survey, talk to the recruitment team, and figure out how the job market, on average, moved. This would then be the percentage of the current salary budget that gets allocated on increases. Unfortunately, that completely misses the mark.

Not only has the market moved, and it needs to be covered, but also the skills of the team have increased over the year. Most companies don’t account for that. They may put in a bit of money for promotions, but that’s it. Most companies wouldn’t try to estimate the real value of the skills the employees learned over the year. Even if they “age” the market data, adjust them for expected growth, it still doesn’t account for the increased competence of the team.

The reason why so few companies do true market corrections is that most managers don’t understand what the real cost of employee turnover is. It is not something that is being calculated and tracked. It is not visible on any dashboard. The best most companies do is tracking attrition. Is it below 15%? Good. Is it more than 15%? We should probably start some engagement and retention initiatives.

This mentality would change overnight if the metrics management tracks included the real cost of turnover.

Retention report data

Work Institute published the annual Retention Report on trends and reasons behind employee turnover. The 2019 report uses data from over 250,000 employees, out of which 37,000 quit their jobs in 2018. The report lists several so-called preventable categories of reasons for leaving.

Add it together, and you find out that 76.8% of employees who left could be rescued if the managers acted. The rest left for less preventable reasons. Specifically due to relocation, retirement, and being fired.

In 2018, 27% of employees in the USA voluntarily left their jobs. And the trend seems to be accelerating as it is 8.3% more than the year before. This was mostly caused by the overheated job market. Unemployment was at historic lows, while the number of open positions keeps increasing. There is so much opportunity out there, and employees understand it.

What is striking is that inadequate facilities were quoted as a reason for leaving only by 4% of the 5.2% who left because of the environment. That means from the total number of people leaving the organization, only 0.2% left because of facilities. Yet building a fancy office is where many companies put their focus and budgets. Hopefully, this may change with the new normal after the Covid-19 pandemic that showed that remote work might actually, you know, work.

The second interesting finding that goes against what one can read in the newspapers is that turnover behavior is not so much about generations but rather about career stage. Simply said, it is not the fact that you are a Baby boomer, Generation X, or a Millennial. It is the actual stage of your career that drives your priorities. The younger you are, the more you care about career development. The older you get, the more you care about your well-being.

38.6% of leavers quit within the first year. Out of that, 43% quit within the first three months. Those who leave this early do so mainly for work-life balance, job characteristics, and career development issues. These reasons are driven by wrongly set expectations or misrepresented job during the interview process, and often also the lacking onboarding process. Something that should be easy to prevent.

Recruiting the wrong people

When you look at why people leave, the vast majority of cases can be attributed to a bad fit between the person and the job or the company, the culture, the way the work is being managed and talked about, and compensation. All those things are within the power of the organization to improve.

Most of the problems start with recruiting the wrong people for the job. In the endless war for talent, hiring managers try to get the best candidate they can find. Not necessarily the best candidate for the job. So they hire someone who certainly has the skills to do the work but is a poor fit with the team and, in fact, is not interested in doing the job in the first place. Candidates join for money, title, or because they are trying to escape their current job. No one is asking whether they will be passionate about the work or get bored in a week and disengage.

The root cause of these troubles is often in the job definition and the selection criteria that don’t match. Or even more alarming, no clear job description and objectives even being available. How can you ensure to hire the right person for the job when you don’t know what the job is, and how will you measure success?

Costs to include in the calculation

Neya Abdi lists some of the hidden costs of employee turnover you need to include in the calculation: cost of reduced productivity of an employee during the time leading up to their departure; lost productivity during the search for replacement; reduced productivity of those covering the tasks of the departed employee; overtimes of backup employees; recruitment costs including advertisements and time of the recruiters and the team doing the interviews; onboarding costs of the new employee and the trainers; and the costs of reduced productivity of the new employee until they are as productive as the person they are replacing.

Cost of disengagement

According to Gallup’s 2017 State of the Global Workplace, 85% of employees are not engaged.

The team at Gallup started with a basic definition of what “a good job” actually is. According to them, “a good job” is any full-time work for an employer. It doesn’t include various microenterprises in developing countries like small-scale farming that covers just the basic needs of the farmer without any prospect of a better future. That is all these people have and will ever have. It is not “a good job.” Globally, about 32% of people in the productive age work full-time for an employer, in the so-called good jobs. This, of course, varies widely across countries. In most of the Western countries, this number would be above 40%.

Gallup then took these employees and measured their level of engagement. Only 15% were engaged, meaning they are highly involved and enthusiastic about their work and workplace. Two-thirds are not engaged, meaning they are psychologically not attached to their work, and even though they put in the time, they don’t put in the effort. And 18% are actively disengaged, meaning they are unhappy, resentful, and undermining the work done by others.

What’s the impact of engagement on the bottom line? Gallup’s team came up with these numbers. Highly engaged businesses have 41% lower absenteeism, 17% higher productivity, and 24% to 59% lower turnover. Engaged workers also produce better quality work with 40% fewer quality issues, 70% fewer safety incidents, 10% higher customer metrics, and 20% higher sales. This all leads to a 21% higher profit in organizations with a highly engaged workforce.

From this, you can deduce that there is a lost opportunity and lost profit when having a disengaged team. The team’s engagement gets lower every time they work with a disengaged team member and see high turnover. It is difficult to put a specific number on how one particular individual’s departure impacts the rest of the team. Still, there is some impact in the range between 0% and 21% of lost profit caused by the team getting a bit more disengaged.

According to Hay Group’s Engage Employees and Boost Performance study from 2001, the highly engaged teams of consultants can generate up to 43% more revenue than the least engaged. Or the other way around, the least engaged teams are 30% less productive than the most engaged teams.

Time to optimal productivity

The most tricky part is to figure out how long it takes for a new employee to be fully productive. To find that number, you need to define what full productivity means. Is it the so-called onboarding period when the employee is in training under supervision? That could be a couple of weeks. Or is it the probationary period if one exists in your country? That could be a couple of months. Or is it the time when they get proficient enough to start to be bored? That could be a year. Or is it the time when they achieve mastery and keep pushing the quality of their work and approach to it to the new levels? That could be a couple of years. One could argue that the last one, you could call it time to optimal productivity, is the best measure. Unfortunately, not all employees achieve that level, so it is not a practical measure.

There are direct and indirect costs related to employee turnover. And then there are the loosely related and difficult to calculate costs. The impact on building a strong culture can be rather dramatic. When people are always leaving, it leads to a lack of consistency in execution. When you constantly onboard new people, you are losing productivity. The reputation of the company suffers, and that impacts both the engagement of the employees as well as the ability to hire on the job market.

Putting it all together

Using this as guidelines, you can calculate a financial loss to the company, as I have done on a hypothetical case depicted in the table below. It is an illustration of what happens when an experienced software developer leaves the company. Software development is highly skilled labor. Thus, even if you hire a reasonably capable individual, it will still take them a long time to get to know the specific product. The company has lost a lot of historical knowledge, and thus the new person is prone to make the same mistakes as already done in the past. It will take a significant amount of time before you can say the person is as productive as their predecessor. For this exercise, I choose to take a hypothetical software developer working in the US and earning 100,000 dollars a year. Don’t get too attached to the actual numbers but rather look at the final ratio as compared to the salary. You can download an Excel file here and play with the numbers a bit.

Costs of employee turnover
Example calculation of costs of employee turnover

If you wouldn’t find a person with the same skillset and settle for a less skilled person, you need to add more budget for learning and development and assume lower productivity for a longer period. When you play with the numbers, you may discover that a replacement of a skilled employee can cost you between 1.5 to 2 times their annual salary, depending on circumstances.

This should be convincing enough to show you the importance of retaining the people you’ve got. Every good person you lose has a dramatic impact on the company’s financials and the team’s ability to deliver.


What are your thoughts on the topic? What are the reasons companies don’t calculate the real cost of turnover? Do you believe that is this became a standard metric it would have a positive impact on retention?

Photo: stevepb / Pixabay.com

Follow me on Twitter: @GeekyLeader



Categories: Leadership

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