Sep 26, 2019
How to really calculate the true cost to hire
What the in-depth research* for our cost to hire calculator taught me about how you should really evaluate an employee’s or contractor’s value. (It certainly shocked me).
Most employers and managers are evaluating the cost of hire (and the value of an employee or contractor) all wrong.
Here’s why (and the formula you should use to calculate the value).
(For more on why I was looking into the real value of an employee, head here.)
The Pareto Principle beats the standard Bell Curve
It’s common practice to view the performance of workers along a normal distribution curve (or the ‘Bell Curve’). It’s seen across performance appraisals and compensation models but (little did I know) it doesn’t reflect the reality.
In fact, the evidence from those who’ve really analysed the data suggests that it’s more like a ‘power line’ or ‘the Pareto rule’ (i.e. the 80.20 rule: 80% of input results in 20% of output). So in employment, 80% of revenue comes from 20% of the people.
Source: The Best And The Rest: Revisiting The Norm Of Normality Of Individual Performance, O’Boyle & Aguinis, Personnel Psychology
The real way to measure your employee’s (or contractor’s) productivity value
Dr John Sullivan is a professor, author, corporate speaker, and advisor, who is recognised internationally as an HR thought leader. In his article for TNTN How to Measure the Dollar Value of a Top-Performing Employee he suggests a 7-part step to determine what a top-performing employee versus an average one can do for your bottom line:
Step 1 - Start by working with the King of Metrics
Your CFO will hold all the data.
Step 2 - Determine what an average employee is worth
Use the average revenue per employee (the total corporate revenue divided by the number of employees) as a baseline.
Step 3 - Consider using external performance multiplier data
e.g. A top 1% employee at GE and Yahoo performs 10 times higher, whilst at Google, it’s x300.
(More on how to find this data below.)
Step 4 - Determine the “differential multiplier” between an average employee and a top-performing employee in the same job
A “top-performing employee’s performance ranks in the top 1 percent and an innovator produces product or process features that improve it by at least 25 percent”. However, it varies depending on the job - “‘easy-to-learn routine jobs’ will be much smaller than in jobs that require innovation, creativity, and continuous adaptation to new technologies and business challenges”.
Step 5 - Quantify the added value of a top performer using the multiplier
Multiply the average revenue per employee by the “top performer multiplier” to get an average ROI impact.
Step 6 - Consider adding additional “top performer values” to the calculation
e.g. game-changers, relationship-building, attracting new customers, speed, patent value, monetisation, problem solvers and recruiting magnets
Step 7 - Determine whether top performers can be developed internally
Implement leadership development, coaching, and training and wait 12 months to see if there is an improvement. However, as he points out,
“It is much faster and there is a much higher ROI than results from externally recruiting top performers and innovators as opposed to developing them. This advantage comes in part because the business impact of recruited top performers is immediate and adding them to your staff will help your firm, while simultaneously hurting your competitors when they lose their top talent.”
The average performance multiplier differential
In the article, Dr Sullivan provides some basic guidelines:
- Minimum top-employee performance multiplier: +33% of the average employee, or 3x their salary
- Average top-employee performance differential: 10x of the average employee, or 10x their salary
- An exceptional innovator: 100x the average employee, or 1,000x their salary
That seems steep, but the sources referenced above back this up. However, I still wasn’t satisfied that this would be enough to stand by any value calculator. Then I found this…
The ONS’ calculator: “How productive is your business?”
The interactive tool lets you calculate the productivity of your business and benchmark it against other businesses of a similar size in your industry.
However, to do this you need to know your turnover (or sales), your purchases of inputs (excluding investment), and how many people you employ. But what if you don’t know this? Work with the basics first: Use our True Cost to Hire Calculator to quickly see how factors such as increased training needs or increased salary demands affect new hire costs? Then take the average differentiator benchmarks mentioned above for guidance on whether the outstanding candidate is worth the extra 5%.