Employee Replacement Costs
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What Are Employee Replacement Costs?
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.
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.
Specific Costs to Replacing an Employee Who Leaves
Here are some specific costs related to replacing an employee at your company.
Cost 1: Administrative Costs
It takes time for your HR department and other managers to terminate and hire employees. This includes time and resources related to offboarding, exit interviews, administering unemployment, recruiting, onboarding, and training new employees.
Cost 2: PTO Payout
If this is applicable for your company and state, the departing employee will receive a payout of all unused PTO for the year.
Cost 3: Unemployment Claims and Taxes
If your departing employee files a claim for unemployment, you may have to make a payout to them. Additionally, you may see an increase in the unemployment tax rates for your company.
Cost 4: 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. While this loss may be a cost of its own, 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.
Cost 5: New Employee Finding, Hiring and, Training
Hiring a new employee can be very pricey, and these costs can go up because of a variety of factors, including the role being hired for, the labor market, and the experience required of the employee being hired. If you outsource recruiting, these costs will go up as well.
Cost 6: Legal Costs
For messier situations, the cost of legal counsel may rear its ugly head. Depending on the situation, these costs can be fairly significant.
How to Calculate the Cost of Replacing an Employee
Here is a step-by-step guide on calculating the cost of replacing an employee. It references portions of the Turnover Cost Calculation Spreadsheet produced by The Society For Human Resources Management.
Step 1: Acquire the Labor Cost of All Involved Personnel
To properly calculate the administrative costs of replacing an employee, you’ll need to know the hourly rate of each individual involved with the process. (If the person is paid a salary, divide that annual salary by 2,080: the average work hours per calendar year.) These include:
- HR/payroll/recruiting personnel
- Managers or supervisors
- Departing employee
- Regular and overtime rate for current employees working extra hours and shifts
- Temporary employee rate
Step 2: Calculate the Hard Separation Costs
These are the hard (or direct) costs of separation for your company.
- Exit interview: Staff administration time (Hours*Rate=Staff Wages)
- Exit interview: Departing employee time (Hours*Rate=Employee Wages)
- PTO or related payout (Hours*Rate=Payout total)
- Unemployment benefits and/or severance pay .
Step 3: Calculate the Hard Vacancy Costs
These are the direct costs of having an employee vacancy at your company.
- Regular time: Added work for current employees (Hours*Rate=Employee Wages)
- Overtime: Added overtime work for current employees ([1.5*Rate]*Hours=Overtime Pay)
- Temporary hire: The rate for the temporary employee (Hours*Rate=Temporary hire pay)
Step 4: Calculate New Employee Hiring Hard Costs
These are the direct costs associated with hiring a new employee to replace the departing one.
- 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)
Step 5: Calculating Soft Costs
Calculating soft costs is more subjective than calculating the hard costs. You’ll need to exercise judgment and be content with estimations as you determine these costs. Think of these costs as “indirect” costs or the lost potential of the departing employee.
Here are some of the soft costs to consider, as well as some real-world examples to go with them.
- 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 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.
Step 6: Calculating Your Employment Replacement Cost
Now that you have calculated your soft and hard costs, simply add the two totals to arrive at the employee replacement cost of one employee.
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.
Armed with these employee replacement numbers, you can start interpreting the costs and use them strategically. While the average employee replacement cost varies per 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 employee replacement cost 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.
Using the Total Employee Replacement Cost Strategically
Your employment replacement cost can be very useful for you as you make decisions related to employee retention and turnover. Here are some ways that you can use your employee replacement cost numbers strategically.
Refining the Turnover Process at Your Company
Take a look at your employee replacement costs. Are they too high for your company? This is something that you might want to discuss with your company’s accountant or financial analyst, if you have one. They will have more experience with strategic financial management and may offer some insights. If your company does not have a dedicated financial team yet and you are unsure about what these costs should be, don’t stress. There are often more cost-effective ways to do things, and reducing costs is very helpful, even if you aren’t sure about the financial strategy behind it.
Look at doing a review of your turnover and employee replacement processes to see where you could make things more efficient. Perhaps you can streamline HR processes related to the termination or improve the training process for new employees to make the transition easier.
Refining these and other processes can lead to not only saving money for your company, but they can make it a more effective organization.
Prioritizing Employee Retention
With your employee replacement costs estimated and outlined, you can begin to consider policies you can implement at your company to improve retention.
If the replacement or “turnover” costs are high for your industry or employee role, then you may want to invest in more robust employee retention practices to avoid frequent turnover.
For example, an education technology (ed-tech) company might have higher turnover costs to replace a sales rep than a local fast-food chain would replace an entry-level worker. This is because it often takes months for an ed-tech sales representative to become trained at the job, while it takes less than two weeks to train fast-food workers.
Therefore, focusing on improving retention is more necessary for the ed-tech company, because the cost to replace a sales rep is very high. For the fast-food company, it may not be as strategic for them to focus on employee retention.
Think about your company, industry, and employees. You may find that there are different replacement costs for different job positions. Knowing these costs will help you and the executive team create better, more efficient retention programs for the employees who need it most.
A Final Word on Turnover
After looking at all of these costs, it’s fair to say that employee turnover and replacement can be an expensive endeavor. That being said, it’s important to look at many factors when considering terminating an employee.
On the other hand, it’s even more important to look at ways that you can retain your top talent so that you can avoid these costs. Consider reading this Eddy Encyclopedia entry on Employee Retention to find some ideas for your HR department.
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Questions You’ve Asked Us About Employee Replacement Costs
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.
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