Calculating Loss on Investment from a Bad Hire

By on September 16th, 2019

Business professionals are all too familiar with the calculation of ROI, return on investment. But how do you calculate a loss on investment? This is the kind of math you don’t want to have to do, but if you’re hiring the wrong people, it’s an equation that you need to get familiar with.

Of course, the actual cost is challenging to pin down as it varies greatly from situation to situation, but some safe assumptions can be made to help us get there. For example, founder of LinkHumans and notable former recruiter Jörgen Sundberg is cited by Forbes and Inc. for his calculation, taking into account

  • Hiring costs
  • Total compensation
  • Cost of maintaining employees
  • Disruption costs
  • Severance
  • Mistakes, failures, and missed business opportunities.

“Based on a second-level manager who earns $65K per year and has been terminated after 2.5 years,” he estimates the cost of a bad hire at an astounding $840,000. That’s a loss on investment (hiring cost + compensation + cost of maintaining an employee compared to the value of the employee’s contribution) of 298%. 

Retention Begins with a Good Hire

No matter the time crunch, shortage of resources, or pressure from leadership, no one would ever make an investment that would yield a -298% return. Turnover is costly, but many focus on what happens after a hire that might contribute to a high rate. What about what’s happening before the hire?

Technology is helping to drive innovative employee engagement efforts, but the hiring process remains as challenging yet critical to financial health and business success as ever. In its 2018 State of Recruiting Survey, Monster reported that 67% of respondents said their job had become more difficult than it was 5 years prior.

Not unrelated is that the unemployment rate has been steadily dropping since hitting a peak of 10.0% in October 2009. The U.S. Bureau of Labor Statistics reported an unemployment rate of 3.7% for August this year. The shrunken talent pool combined with the evolving criteria for what candidates are looking for in an employer, companies are facing stiff competition when it comes to snagging top talent.

It’s no longer enough to simply offer competitive pay and healthcare benefits. Candidates are looking for “permanent workplace flexibility, a commitment to health and well-being and working with a purpose,” says Alan Kohll, Forbes contributor. It makes sense that, according to the Association for Talent Development’s (ATD’s)  2018 State of the Industry report, companies are spending an average of $1,296 per employee on learning and development, continuing a 6-year run of increasing spend.

It’s ironic, then, that despite the significant money being spent on keeping employees, that companies can still end up with a candidate that’s not the right fit for the role or the culture because they were rushing to fill it. 

The Cascading Effects

The critical part of calculating the cost of hiring the wrong employee is all the cascading effects that bad hire has. In both the short term and the longer term, an under- or over-qualified candidate who is not the right fit has impacts far beyond payroll and operational inefficiency. 

Finance teams seem to be keenly aware of these impacts, though, considering SHRM reports that, in a survey of 2,100 CFOs, 39% of respondents were most concerned about degraded staff morale and 34% were concerned about a drop in productivity. Monetary costs came in third at 25%.

Of course, the financial burden is there, when you consider lost sales, lost time in extra management efforts and potentially additional costs from extra training or other support resources. 

But the truly impactful cost can hardly be calculated in dollars. Managers of these hires invest additional hours and energy into trying to correct the bad hire, causing a drain on them and potentially other team members who could have benefited from those efforts. Mariah DeLeon, Vice President of People at Glassdoor, cited the same study, saying that 35% of respondents said “a poor hire greatly influences employee morale.”

In the longer term, a poor candidate choice can have a lasting, meaningful impact on the experience of other employees and even customers. Entrepreneur.com recommends monitoring reputation closely to keep an eye on the impact the hire in question might be having. Forbes contributor Falon Fatemi echoes this sentiment, saying “Disengagement is contagious, which may be why employers can’t seem to defeat it.”

The Right Partner Keeps Your ROI Positive

The importance of hiring the right employee doesn’t make transforming hiring or retention practices easy or cheap. For example, learning and development is a key way employers are retaining their top talent, developing competencies and focusing on career growth. ATD reported that U.S. organizations spent 164.2 billion on employee training and development in 2012 (beginning 2013, per-employee expenditures were provided rather than total).

For highly skilled positions, hiring becomes even more complex. In fact, “79% of companies report that they have skills gaps that are difficult to close and most say they don’t understand how to solve this problem,” according to Sarah Fister Gale for Workforce.com. Demand for positions in highly technical industries like ICT and emerging tech is expected to continue expanding for the next decade.

McKinsey & Company’s 2017 report Jobs Lost, Jobs Gained: Workforce Transitions in a Time of Automation compares potential new jobs created to the jobs that could be lost to automation through 2030. “Overall spending on technology could increase by more than 50% between 2015 and 2030. About half would be on information-technology services. The number of people employed in these occupations is small compared to those in healthcare or construction, but they are high-wage occupations. By 2030, we estimate that this trend could create 20 million to 50 million jobs globally.”

These are reasons why especially those companies with expanding needs for these highly skilled roles in technology can benefit from outsourcing the recruitment process to a company like HNM Systems. Outsourcing makes immediately available a scalable, proven process that could take an individual company years to hone. 

What’s more, HNM relieves employers of the added cost associated with maintaining engagement with this specialized group. The standard benefits touted in regards to outsourcing recruitment end at the time of placement, but because HNM maintains their relationship with their employees, the continued cost of engagement and development is avoided as well. 

And HNM is doing engagement well. HNM Systems President and CEO Heather Moyer is proud that clients are able to retain employees at 90% or greater. This is the result of what Moyer calls “doing life” with HNM employees. In fact, a consultant/employee development committee is focused primarily on making sure employee needs are being met. 

Bad Hiring Is Solved by Better Recruitment, Not Retention

Fatemi recalled a time when a bad hire’s impact led to losing 2 key employees. “That’s an exceptionally high price to pay […] You’ll never wish you waited longer to fire someone like that.”

If a company cannot afford the exorbitantly high cost of a bad hire, it cannot wait to take the steps that will help them to avoid a $840,000 mistake. “[A] bad hire’s effect on company culture echoes beyond the employee’s tenure. Poor performers lower the bar for other employees, and bad habits spread like a virus,” says Fatemi.

But avoiding the cost of a bad hire is not to be outshined by the benefits of making a good hire. As much as the impact of a poor choice reverberates beyond the single individual, finding the right person with the right skill set with the right culture fit has its own reverberating effects. 

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