For businesses to thrive in today’s economy, finding and retaining the best employees is important. This is especially true for small businesses competing with larger businesses, and larger budgets, for top talent.
When you’re a small business on a tight budget, it is vital to know the true cost of replacing an employee as it could have a serious impact on the company’s cash flow.
However, without the right staff, this kind of progression poses a real challenge.
Existing studies on the cost of replacing an employee
Some studies, such as the Society for Human Resource Management (SHRM), predict that every time a business replaces a salaried employee, it costs 6 to 9 months’ salary on average. For a manager making £40,000 a year, that's £20,000 to £30,000 in recruiting and training expenses.
But others predict the cost is even more—that losing a salaried employee can cost as much as twice their annual salary, especially for a high-earner or executive-level employee.
Turnover seems to vary by wage and role of employee. For example, a Centre for American Progress (CAP) study found average costs to replace an employee are:
16% of annual salary for high-turnover, low-paying jobs (earning under £30,000 a year). For example, the cost to replace a £10/hour retail employee would be £3,328.
20% of annual salary for midrange positions (earning £30,000 to £50,000 a year). For example, the cost to replace a £40k manager would be £8,000.
Up to 213% of annual salary for highly educated executive positions. For example, the cost to replace a £100k CEO is £213,000.
What makes it so hard to predict the true cost of employee turnover is there are many intangible, and often untracked, associated costs.
My initial thoughts are that the above study has underestimated the cost of hiring the average-salaried employee, perhaps overlooking the costs associated with hiring a recruiter or failing to account for the value of a business owner’s time throughout the recruitment process.
What is the true cost of replacing an employee?
The truth is, there are a wide array of factors a business should consider in calculating the true cost of losing an employee.
To crack the case I've deployed some of my own mathematics to get to the bottom of things.
Obviously, the first big cost you have to consider is the salary. While it very much depends on what sort of experience you’re looking for, what level you’re hiring at and the contract specifics, you can assume it’ll be in the tens of thousands of pounds. The most recent government figures put the average UK salary at £27,721 per year.
The next thing to consider is how you want to recruit your new employee. Do you go through a recruiter, or use up your time? One misconception is that using your own time is the more affordable, but if you value your own time at £100 per hour, the cost to your business of having the owner recruit new staff can get racked up pretty quickly.
Based on the average salary above, a recruiter would usually charge between 20% and 30% to source talent for this position, which overall would cost the business over £5,500. Additionally, if you spent 42.5 hours to find your new recruit, you’re looking at a cost of £4,000 (based on a valuation of your time at £100/hour).
Here’s a breakdown of the costs:
Crafting the job spec
From my experience, the job spec is a vital component of the recruitment process and its value can often be overlooked, particularly by small business owners taking recruitment into their own hands.
A solid job spec can create efficiency as potential candidates can easily identify whether or not they fit the bill, and therefore if they should apply. It sounds simplistic, but it's vital to the overall process.
If the employer is too vague in what they are looking for then they are only encouraging unnecessary applicants, which is a waste of time for all involved.
Overall, when hiring for the average-salaried employee, producing the right job spec would take up two hours of a business owner’s time. Based on our above valuation of time, that’s £200.
According to Collingwood, 118 people apply for a given job on average. This number does vary from industry to industry, but overall, 118 applicants to screen equate to a lot of hours.
From my perspective, the average salaried job takes up roughly 24 hours in screening, or £2,400 if you’re to put a cost on it.
Collingwood claims that the average screening call takes an average of 30 minutes, despite the fact that many managers claim they know within 90 seconds if they would hire the candidate or not.
If 20% of the applicants get an interview, you’re talking about 24 candidates and 12 hours of work, which totals a cost of £1,200 to the business.
Assuming a quarter of the candidates contacted for an initial call make it through to an interview, you’re left with six potential employees.
With the average face-to-face interview lasting about 45 minutes, this is represented by four-and-a-half man-hours and an overall cost of £450.
The final hurdle in the recruitment process is staff onboarding. Onboarding equips new employees with the requisite information, knowledge, tools and resources to understand an organisation’s culture, people, processes and practices. All of which takes time.
For the average-salaried employee, onboarding generally requires less time than if you were hiring a senior or director level employee.
Generally, I’ve found this process to take four hours, equating to £400 as a cost to the business.
While handover can generally be an extensive process in more senior roles, or particular industries, by-and-large the handover process generally takes about a day for employees on the average salary.
That being said, employers will be liable to pay double wages on that day, given the existing employee and their replacement will be working together to transfer work from one hand to the other.
Based on the average salary this is a cost of £76 to the business.
Most companies offer either in-house training or funding towards external training. Either way, this comes at a cost. It’s a vital cost as training can help improve employee retention rates. The average UK company spends £1,068 per employee according to a report by Bersin.
It doesn’t end there. There is an array of other costs to consider such as the HR costs to deal with new starters, holiday cover, cover for maternity leave, sick days, company cars, software licences and more, depending on your industry.
Overall, based on the figures generated above, the cost to replace the an employee earning the average UK salary of £27,721 could be up to £11,000, assuming you're using a combination of using a recruiter to source the talent and the hours an owner would spend hiring the right candidate - a huge hidden cost for any small business to front, especially if they are in an industry with a high staff turnover.
While I chose the average-salaried employee based on the interest of smaller businesses, it is worth noting that for more senior employees, the costs incurred in recruitment can become much more tricky, and overall, a lot more costly to the business. I estimate that candidates filling a £60,000-salaried role could cost at least £20,000 while replacing the likes of a director could easily break into costs in the hundreds of thousands.