Employee Replacement Costs
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What Is Employee Replacement Cost?
Whether an employee resigned or was terminated, replacing them comes with a cost, and you may be surprised at how high it is. These costs include administrative and training costs, costs related to PTO or other payouts, and costs related to a decrease in production while a new employee is being hired and trained.
Employee Replacement Cost (ERC) is the true price of replacing an experienced employee with a new one.
The Average Cost to Replace an Employee in the U.S.
Employee replacement costs vary widely depending on the position and the industry. More entry-level jobs requiring less experience have smaller replacement costs. On the other side of the spectrum, executive roles can cost hundreds of thousands of dollars to replace.
One study conducted by the Society for Human Resource Management (SHRM) tells us that replacement costs can equal six to nine months of the employee’s salary; others say to double a year’s salary for an approximation.
Other research by the Center for American Progress shows that replacement costs for hourly employees can be 16% of salaries for non-exempt workers or as high as 213% of salaries for exempt employees.
The numbers are all over the place, but one thing is clear: ERC is expensive. Let’s break down employee replacement costs and find out just what comes into play.
Why It’s Important to Understand Employee Replacement Costs
Here are some of the top reasons why it is important to understand employee replacement costs at your company.
- Releasing an employee is expensive. Terminating or firing an employee isn’t as simple as removing them from payroll. From holding exit interviews to administering continued health benefits, issuing PTO payouts, and managing decreased company production, losing an employee can cost your company a lot. No one likes expensive surprises.
- Replacing an employee is time-consuming. As an HR professional, you will be heavily involved with the replacement of an employee. You will spend time offboarding and terminating the current employee, as well as searching for, hiring, onboarding, and training the new employee. Time is money, so it will cost a lot to your department.
- Knowing replacement costs can help you act strategically. Knowing the costs associated with replacing employees can help HR and managers be strategic as they consider terminating or replacing employees. One example of this may be to avoid replacing employees who are critical to production during high production times so as to reduce the amount of production that is lost.
What You’re Really Paying When an Employee Leaves
Here are the main factors that come into play when an experienced employee is replaced.
Hiring and Firing Costs
Costs to terminate employees and recruit new ones include payroll for the time it takes for employees to advertise, screen, interview, hire, and onboard new workers; offboard, exit interviews, and administer unemployment for terminated employees; and hard costs such as advertising jobs.
In addition, the departing employee may be eligible for a payout of unused paid time off. If your departing employee files a claim for unemployment, you may have to make a payout to them. You may see an increase in the unemployment tax rates for your company.
For messier situations, the cost of legal counsel may rear its ugly head. These costs can be fairly significant.
Vacancy Costs and Reduced Production
Because you are losing an employee, there is now a shortage of staff at your company, which may reduce productivity significantly. Additionally, you may have to pay overtime for current employees working extra, hire a temporary employee to cover for the departed employee, or even increase employee coaching if current employees are less experienced.
Work Errors and Inefficiency
Reduced production continues as the new hire becomes familiar with their duties and team members and performs basic training and onboarding requirements. New employees make mistakes and are still learning the best ways of doing things. Their customer service skills may not be up to par. They slowly figure out how to be effective and efficient. They could drop the ball with a big client due to unfamiliarity with the project. Errors and inefficiencies can cost lots of money in the long run.
Coworker Engagement and Culture Deterioration
High turnover causes employees’ confidence in the organization to dwindle, resulting in a deteriorating company culture and productivity. They may lose friends when people leave. Additionally, coworkers must pick up the slack while the position is unfilled or a new hire is training, adding to low morale and burnout.
How to Calculate Replacement Cost
Let’s look at how you figure out the ERC of a specific job. Pick one job position at your company and make the following calculations to find out how much an employee replacement for that role will cost.
Step 1: Calculate Vacant Position Coverage Cost
The vacant position coverage cost tells you how much money you’re losing with the position remaining empty. When an employee leaves the company, their work (which provides monetary value) either goes undone or is picked up by their coworkers, who have to put off their own regular duties.
You can calculate vacant position coverage cost simply by finding out how much the position is paid every day and multiplying the daily rate by the number of days the job remains vacant. To find the role’s daily compensation rate, divide their yearly total compensation (salary + benefits) by the number of working days that year. (The number of working days in a year varies from year to year.)
You want to calculate the vacant position coverage cost for a marketing specialist role at your company. The average total compensation for the position is $50,000 per year. To find the job’s daily compensation, you divide $50,000 by 261 (there were 261 working days in 2021) to get $191.57. You then multiply the daily comp by the days you expect the job to be vacant, which is 30 days.
|VACANT POSITION COVERAGE COST|
|New job role total compensation (yearly)||$50,000.00|
|New job role total compensation (daily)||$191.57|
|Days job is vacant||30|
|Vacant position coverage cost||$5,747.13|
The vacant position coverage cost is $5,747.13. This is the amount your company is losing by leaving the position vacant for 30 days.
Step 2: Calculate Hiring Costs
These are the direct costs associated with hiring a new employee to replace the departing one. They include:
- Job postings (cost of job ads, etc.)
- Recruiter (Rate*Hours=Recruiter Wage)
- Interviewing time (Rate*Hours=Interviewer/HR Wage)
- Reference, background checks and drug testing (vendor cost and administrative time)
- Offer and rejection letter administration time (Rate*Hours=HR Wages)
- HR onboarding time for the new hire (Rate*Hours=HR Wages)
- Job training by the supervisor (Rate*Hours=Supervisor Wages)
- Job training for the new hire (Rate*Hours=New Hire Wages)
Some of these costs (recruiters’ payroll, advertising, interviewing, etc.) are usually paid in lump sums to cover multiple open positions needing new hires, which means you’ll probably need to divide them down to the individual position.
For instance, find out how many hours a recruiter and hiring manager need to dedicate to hiring someone new, and multiply those hours by their total daily compensation rate. Don’t forget to calculate the costs of job advertising, background checks, and candidate assessments for the individual role as well.
To hire a new marketing specialist, you know that a recruiter spends several hours writing a job posting, communicating with applicants, scheduling interviews, and assisting in interviews. You also know that a hiring manager spends some time interviewing and vetting job candidates. In addition, job postings cost money to advertise online through your company’s applicant tracking system.
You convert the recruiter’s and hiring manager’s total compensation to hourly rates by dividing yearly compensation by 2,088 (there were 2,088 working hours in 2021) and multiply them by the number of hours you expect each of them to spend on hiring a new marketing specialist.
Your applicant tracking system charges the company $30 per day for each individual live job posting. You believe the marketing specialist job posting only needs to be live for 20 days, so you multiply that by the $30 charge.
|Recruiter total compensation (yearly)||$60,000.00|
|Recruiter total compensation (hourly)||$28.74|
|Recruiter hours spent||20|
|Total recruiter costs||$574.71|
|Hiring manager total compensation (yearly)||$90,000.00|
|Hiring manager total compensation (hourly)||$43.10|
|Hiring manager hours spent||10|
|Total hiring manager costs||$431.03|
|Job advertising cost per day posted||$30.00|
|Days job posted||20|
|Total job advertising cost||$600.00|
|Total hiring cost||$1,605.75|
You add the recruiter cost, hiring manager cost, and the job advertisement cost for a total hiring cost of $1,605.75.
Step 3: Calculate Onboarding and Orientation Costs
As in Step 2, add all the onboarding and orientation costs for the open position. These costs include training and getting the new hire up to speed. How many hours are used by managers, trainers and mentors to train new employees on their responsibilities? What do each of these employees get paid per hour? Account for all the hours that are spent by other employees training a single new hire and multiply those hours by each worker’s hourly rate of pay.
Does your company pay for any training programs for new employees? Most of these programs are paid by the company on a monthly or yearly basis. Either way, you can divide the monthly/yearly cost by the average number of hires you get in a month/year to find out how expensive the training program is for an individual employee.
Other costs are unique to your organization. Check for costs like welcome gifts, equipment for accommodations, and others.
After a new marketing specialist is hired, onboarding and training takes place. The new employee will have a peer trainer (a coworker to show them the ropes, answer questions, and introduce them to the team), a corporate trainer (a member of HR to share HR policies and other company procedures), and an HR administrator (to collect and file payroll, I-9, and other new hire paperwork). Lastly, the new hire will participate in the company’s online training platform to get familiarized with their department’s software and processes.
For each team member who spends time onboarding the new employee, break down their yearly total compensation again into hourly rates and add the costs of onboarding the employee, similar to steps 1 and 2.
The company’s online training program is paid by the year, and most departments require their new hires to spend the same amount of hours using it. You know the company hires about 21 employees each year on average, so you divide the yearly program cost by 21 to find how much the program costs per new hire.
|Peer trainer total compensation (yearly)||$55,000.00|
|Peer trainer total compensation (hourly)||$26.34|
|Peer trainer hours spent||15|
|Total peer trainer costs||$395.11|
|Corporate trainer total compensation (yearly)||$60,000.00|
|Corporate trainer total compensation (hourly)||$28.74|
|Corporate trainer hours spent||10|
|Total corporate trainer costs||$287.36|
|HR administrator total compensation (yearly)||$50,000.00|
|HR administrator total compensation (hourly)||$23.95|
|HR administrator hours spent||1|
|Total HR administrator cost||$23.95|
|Training program yearly cost||$600.00|
|Average number of hires per year||21|
|Training program cost per employee||$28.57|
|Total onboarding costs||$734.99|
You add up the costs of the peer trainer, corporate trainer, HR administrator, and training program for the new hire for a total onboarding cost of $734.99.
Step 4: Calculate Productivity Ramp-Up Cost
New employees won’t produce as much as the departed, experienced employee. As the new employee is “ramping up” and figuring things out, there is a temporary loss of productivity and therefore a cost to the company. Here are a few examples:
- Loss of productivity due to the old employee’s departure and new employee’s training.
- In one week, the departing employee at a fast food restaurant would have assisted 250 customers, with each customer spending about $20 each.
- Considering that they only took orders and did not prepare the food, it’s safe to say that they did half of the work to make the sale. Therefore, they lost $2,500 in productivity (250 customers*$20/2=$2,500 revenue lost).
- Loss of productivity due to the departing employee’s coworkers (i.e., decrease in morale, continued discussion of the departure).
- Because the employee was very helpful to their coworkers, their departure had a ripple effect on morale. Workers spent more time talking about the departure, which led to 50 fewer orders being fulfilled before the end of the day.
- With each order valued at $20, that is a potential loss of $1,000 (50 orders*$20=$1,000 revenue lost).
- Loss of productivity due to the old employee’s departure and new employee’s training.
- Loss of productivity of the supervisor during the termination and training processes.
- The manager at the fast food restaurant helps with difficult transactions to help keep the cashiers taking orders quickly. Because they are helping terminate and train employees, they are unable to help cashiers process those difficult transactions, so the average time to take and complete an order increases by 10 minutes.
- Daily orders decrease from 2,000 to 1,500 for the week. With each order averaging $20, the fast food restaurant would lose around $10,000 in revenue.
Ramp-up costs can also be calculated by estimating how a new hire’s productivity improves over time. In days 1-10, they may be 10% productive; days 10-20, they may be 40% productive, and so on. Create a step ladder up to 100% productivity (which could be by day 30, 90, or 120, depending on the job). The manager of the position may know this best. Match these productivity percentages with their daily total compensation rate to find out how much money you’re losing at each level until they’re 100% productive.
You meet with your people analytics specialist and learn how productive new hires in the marketing department are as they ramp up. On day one, they’re 0% productive, by day 20 they’re 40% productive, and so on until they’re 100% productive after day 60. Multiplying the productivity rates by the role’s daily total compensation, you can estimate how much money they’re producing for the company day after day as they ramp-up. When you subtract these production amounts by their daily total compensation, you see how much money the company is losing until the new marketing specialist is 100% productive.
|Working days||% Productivity||Production||Ramp-up cost|
|Total ramp up cost (60 days)||$747.13|
You run the numbers and see that the company loses a total of $747.13 in productivity ramp-up costs.
Step 5: Add Everything Up
Adding these numbers gives you a general idea of how much it costs to replace that particular position.
You may want to consider calculating the employment replacement cost for different positions at your company, as different positions require different resources and amounts of time to replace.
This formula accounts for all the costs of employee replacement except co-worker engagement and culture deterioration. This more qualitative variable may be harder to measure; however, it is still crucial to acknowledge when replacing employees. The monetary costs are easier to calculate and prioritize, but you shouldn’t forget the more subtle, long-term consequences of turnover that can harm company culture and employee engagement.
You’ve calculated as many costs as you could think of related to replacing a marketing specialist. You add together the vacant position coverage cost, hiring costs, onboarding costs, and ramp-up costs for a grand total of $8,834.99.
|EMPLOYEE REPLACEMENT COST|
|Vacant position coverage cost||$5,747.13|
|Total employee replacement cost||$8,834.99|
Beyond this, you recognize that there are likely to be more hidden costs in the form of lost productivity and morale from employees in the small marketing department each time a team member leaves and a new one arrives. Though this number would be much more complicated to calculate, you can easily assume it could add thousands of more dollars to the marketing specialist ERC.
6. Using the Total Employee Replacement Cost Strategically
Armed with these employee replacement numbers, you can start interpreting the costs and use them strategically. While the average ERC varies widely depending on role and industry, the Society for Human Resources Management cites that for hourly workers, the average employee replacement cost is about $1,500 (as of 2019). For salaried roles, SHRM suggests that replacement costs roughly six to nine months of the salary of the departing employee.
At the end of the day, interpreting your ERC has to do with your company’s financial position and the industry and roles in question. For example, if you are a small start-up with limited resources, employee replacement costs can be detrimental to your organization, while a much larger, more established organization may have the resources to deal with higher turnover and replacement costs more easily.
Regardless, once you’ve finished these calculations for the different roles in your organization, you have a mass of information. How do you use it?
- Conduct a cost analysis. Analyze the costs of each of your hiring processes. What are the most expensive parts of hiring a new employee, and why? Do any costs surprise you?
- Identify redundancies. Sometimes there are steps in hiring processes that aren’t worth the money you’re paying for them; they may be useless or redundant. Compare each cost with its actual returns and determine which practices are worth keeping and which may be worth throwing out.
- Recommend changes. After conducting a thorough cost analysis and assessment, put together some recommendations for changes to your company’s hiring process. Find ways to reduce costs without hurting the new hire experience. Bring these recommendations to your supervisor or other business leaders.
- Consider a retention program. Realizing all of the costs that go into replacing employees may help you and other business leaders realize how important employee retention is. Use these numbers to justify a retention program—even one that seems expensive at first. Retention programs are almost always less expensive than replacing employees.
You’re surprised to find that replacing a marketing specialist—one of the company’s lower-paying jobs—can cost around $9,000, around 18% of the position’s yearly total compensation. More critical jobs would be more expensive to replace.
Due to all this data collection and analysis, you’re confident you can make turnover less costly. You share this information with your business leaders and are tasked with assessing the marketing department’s hiring process and implementing changes to increase efficiency and save money.
From the data, it’s clear that the vacant position coverage cost is by far the most expensive, so you work with the marketing department hiring manager and recruiter to find ways to reduce the time it takes to replace new employees. In time, new procedures are set in place to post jobs more quickly, filter applicants more efficiently, and get new team members through your doors in a much more timely manner.
Tips for Keeping More Employees from Leaving
By now you better understand how expensive employee turnover can be for a business. Here are some tips to keep your employees from leaving the company.
- Provide value. Provide an employee value proposition adapted to your unique group of workers. Some people strongly value internal growth opportunities; others, good health insurance; others, a healthy work/life balance. Go out of your way to learn and give your employees what they want, and they’ll stick around as long as you do so better than other companies.
- Compensate competitively. Compensation is just one part of a company’s employee value proposition, but it is an important part. Pay attention to what other companies offer in terms of salary and benefits, and make sure you know where you stand.
- Compensate strategically. Perhaps more important than compensating competitively is to compensate strategically. If you don’t pay as much as other companies, provide more value elsewhere so employees still have a reason to stay.
- Actively listen. In order to know the most influential reasons your employees choose to stay with your company, you need to ask them. Don’t wait until they have an offer from another company. Have regular conversations with employees about how they’re feeling about working in the organization and if there’s anything you can do to keep them longer. People analytics and employee surveys can help with this.
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Brandon is currently a People & Capabilities Advisor at Thiess where he helps implement HR strategies in Salt Lake City and Colorado. He recently graduated with his MHR and MBA at Utah State University, where he also received his bachelor’s degree in Communication Studies with minors in HR, business management, and technical sales management. He has filled professional roles as an HR business partner, an HR generalist, and a senior recruiter; and has exceptional experience in people analytics, compensation, and talent development. Brandon is a strong advocate for HR strategy and helping business leaders understand the true power of maximizing employee potential.
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Chris is an HR entrepreneur. Having worked with small businesses and start-ups throughout his career, Chris is passionate about pioneering HR departments in companies where they don’t currently exist. He currently works at Skill Struck, a local Utah tech company and is striving to be an expert in all things related to small business HR departments.