What is the True Cost of Replacing an Employee to an Organization?

There are times when employees have to be replaced. This might be because they have become unmanageable or because another company has wooed them.

Employee replacement is not without its costs. As it can be quite expensive, companies should do their best to recruit and retain talent whose interest aligns with their own. If this is not done, productivity will decline, the morale of the remaining employees will reduce, and ultimately the company’s bottom line will suffer.

But what is the true cost of replacing a company employee be calculated? Replacing an employee requires that direct and indirect costs are calculated. Different employees in different strata and positions in a company incur different costs commensurate with their post when they are replaced.

This article is about how the true cost of replacing an employee can be calculated. Having had to let employees go as well as had the opportunity to observe the effects and the costs my companies incur as a result of this, I have put together this guide on calculating the true cost of replacing an employee to an organization, especially for small businesses.

Many Human Resources manager speculate that the cost to replace an employee will be as much as that individual’s annual salary. The United States Bureau of Labor Statistics states that employee turnover happens more frequently in industries such as hospitality and service industry, trade and utilities industry, retail industry, construction industry, and the customer service industry. This means that all these industries regularly experience the replacement of employees which means that a lot of money is being lost due to turnover. This necessitates the need to have a means of calculating how much exactly is being lost to this and find ways to minimize if not entirely put a stop to it.

Certain studies (such as SHRM) estimate that each time an organization replaces a staff member; they lose from 6 to 9 months of that employee’s salary on an average while another study puts the conducted across firms in the United States sets the dollar cost of replacing an employee at about $17,000 on average.

According to the first study where between 6 to 9 months’ salary is lost on a single employee, imagine an organization letting go of some employees who earn about $40,000 per annum and see how huge a loss that will be for the organization.

Some other studies estimate that the cost is much more; as much as double the employee’s original salary. This is especially true for employees in executive levels or the upper echelons of the organization.

The following is how much it costs to replace employees at different levels in an organization according to a study by CAP:

– It will cost about 16% to replace an employee that is being paid lower than $30,000 a year. Such jobs are high-turnover. This means the cost of replacing an employee earning $10,000 per annum is $1,600.

– The cost of replacing an employee working in a midrange position and earning between $30,000 to $50,000 per year is 20%.

– Replacing a worker in the upper levels of management such as a CEO is about 213%. This is due to the amount of education and other such things involved.

Calculating the true cost of replacing an employee is daunting. This is because many costs are hard to quantize and put a tangible amount on. The following are, however, the factors that should be looked at and brought into the equation when calculating the true cost of replacing an employee. They can be split into two which are direct costs and indirect costs. The direct costs are those that are, as already mentioned, quite easy to measure while the indirect costs are those that are quite hard to measure.

Examples of direct costs are; external recruiter and head-hunter fees, advertising and job posting fees, training programs and courses fees, etc.

Examples of indirect costs are; the time it takes the employee to attain peak performance, time lost interviewing and screening candidates, the time taken to draft the job description, time lost by other employees trying to help the recruit settle into his position.

Direct Costs Incurred When an Employee is Replaced in an Organization

– The cost of advertisement: job posting ads will have to be sent out to advertise that there is a vacant position at the organization, this will have its costs attached.

– The cost of recruiting the new employee: there will be some costs incurred in the process of recruiting the new employee such as new agreements to sign and so on.

– The cost of onboarding the newly recruited employee: the new employees will have to be taught the position for which he/she has been recruited to. This refers to the cost of training to equip him/her with the necessary skills and knowledge required to fulfill the job description and perform efficiently in the position.

– Overworking of other staff: if the position the employee used to work in is one that is crucial, there will be a need for one or of the other employees to cover up and try to combine this with their job. This will lead to a loss of productivity. There is also the loss that will be accrued from paying these employees overtime wages.

– Separation agreement costs: these are costs associated with things like legal, medical, financial, retirement cash-out, and the likes

– Head-hunter fee: if the recruitment of a company employee is outsourced to an outside agency, then, costs will be incurred in the form of head-hunter fees and signing bonus fees.

– Vacation costs: there might also be the need to pay the costs of an accrued vacation for an employee that is leaving your organization. This is yet another cost of replacing an employee.

Indirect Costs Incurred When an Employee is Replaced in an Organization

– Drafting a job description: this is the cost of time required to draft a job description, get responses from interested candidates, interview shortlisted candidates that seem promising, and screen them.

– Exit interview: a responsible organization will be interested in knowing why an employee is disgruntled and has chosen to leave their organization and probably take up employment at a rival company. This is why exit interviews are done; to find out why an employee has chosen to leave and see if something might be done about it so that other top talents won’t decide to use the door and desert the organization too. Exit interviews, however, come with their own cost in the form of time that could be applied to other efforts. So, yes there is a time cost due to conducting an exit interview.

– The loss of sales leads: when an employee is lost, it reasonable to expect that that employee will take with him/her the knowledge of sales leads in his/her possession. This is a cost that is notably harder to estimate than the other.

– Cultural impact: the loss of an employee will lead the other employees to question themselves and ask why that could have been. This could lead to problems and distractions as they may begin to harp on things that would otherwise be considered irrelevant.

– The loss of productivity: this depends on how specialized and demanding the post the employee has been employed to fill is. It may take newly recruited employees as much as two (2) years to reach peak productivity for some jobs.

– The loss of engagement: the loss of an employee can result in the demoralization and disengagement of other employees which will in effect result in the loss of productivity.

– The loss of company knowledge: replacing an employee will result in the company losing somebody who has an understanding of company ethics and operation. Somebody who understands the company’s goals and objectives and how it strives to attain those. Somebody who, by possessing company knowledge will automatically be an ambassador of the company.

How to Calculate the Cost of Replacing an Employee

The following is a guide on how to calculate the true cost incurred in calculating how much it costs your organization to replace an employee. You are advised to use this as a benchmark, a sort of blueprint for creating your own sheet. This is because the factors used here might not be the same ones you should be concerned about.

1. Create two sections; one for direct costs and the other for indirect costs

2. On each section, think about, and list the factors you know will come into play in the process of replacement.

3. Put the estimated cost you will incur on each factor.

4. Make a summation of the cost you arrived at on both lists

As an example, imagine a company replacing an employee that earns $100,000 each year. Two lists are created about the direct costs of losing this employee as well as the indirect costs.

Direct costs

External recruiter fees: $10,000

Internal recruiter fees: $4,000

Job advertisement: $500

Cost of screening software: $500

Training programs: $1,000 (this includes seminars, online courses, and the likes)

Overtime fees paid to other employees for filling in: assuming the situation persists for five weeks, that is $10,000 at $2,000/week

The cost incurred during separation agreements: $1,000

Total direct cost: $27,000

Indirect Costs

The loss of productivity: $40,000 (This is as a result of the employee having to spend some time getting to peak productivity. Assuming that an employee performs at a level of 60% efficiency for the first six months. This means 40% productivity is lost which will affect the company’s total productivity.)

The cost incurred as a result of the exit interview: $50 (let’s assume this takes 2 hours at the rate of $100/hour

The cost incurred due to conducting interviews: $150 (based on an assumption of 3 hours at the rate of $50/hour)

The cost incurred due to the drafting of a job description: $50

Impact on other employees: employee replacement can adversely affect the productivity level of other employees who might begin to wonder and ask questions, something that will probably translate to a decrease in productivity. Let’s estimate productivity lost due to this as 2% with the dollar cost dependent on the company’s margins. Let’s assume a loss in productivity of 2% leads to a loss of $20,000.

Total indirect cost: $60,250

Total cost incurred: $87,250

This is just an example of how to calculate the cost of replacing the employee of an imaginary organization without the full information available. This particular employee is certainly not in the upper echelons, or a lot more will be lost in the form of industry knowledge, knowledge of how the company works and so on. So, to calculate the true cost of replacing an employee in your organization, consider the different areas in which you will be experiencing losses, put them together in a list and work from there. This will let you know how much your company is losing to this each year.

This is the reason why companies must do all within their power to reduce employee turnover. Efforts must be made at creating an environment where employees feel appreciated and where they are engaged in their work such that they will feel like a part of the organization and will not have reason to want to leave.

This also makes it paramount that companies are cautious when recruiting so that they recruit the right staff. One that understands their values and is ready to work alongside them in achieving their goals and objectives. This is so that the company will not have to let such employees go as a result of their not working up to par and creating problems for the company.

How You Can Reduce Employee Turnover

Job description: Ensure that your job descriptions are very explicit so that the employee knows what exactly it is he/she is signing up for. That the responsibilities attached to that particular post are outlined in a clear and concise way which brooks no misunderstanding. That way, attention can be given to those who fully understand what they are required to do and who have the qualifications,

Pre and post recruitment testing: ensure that you test the skills of the employee before and after recruiting them to ensure that they are up to the task. This allows you to measure their attitude, their punctuality, and so on.

Leadership: one of the reasons why employees jump ship (by which I mean quit one organization for the other) is as a result of poor, inattentive leaders.  To reduce employee turnover, there is a need to be a good leader, and that includes paying attention to what is and what is not working so that adjustments are made. To reduce the loss of your talent, you need to demonstrate excellent leadershipOpens in a new tab. skills.

All of the above are geared towards getting the right employees and retaining them.

Related questions

What is employee retention?

Employee retention is the ability of a company to retain its talents. This means that employee turnover for such a company is low as the employees are contented and satisfied with the company and its policies. An organization with employee retention of 90% has demonstrated an ability to retain 90% of its employees over a specified period. Employee retention doesn’t just happen; it happens as a result of the company making strategies on how best to keep their employees satisfied and retain them.

What is employee engagement?

Employee engagement is how engaged employees are with their jobs. This describes the amount of passion and commitment they have to their jobs and their organizations. This should not be confused with employee satisfaction, however, as they are quite different. An employee that is engaged will put in more effort towards their job than one that is satisfied.

Steve Todd

Steve Todd, founder of Open Sourced Workplace and is a recognized thought leader in workplace strategy and the future of work. With a passion for work from anywhere, Steve has successfully implemented transformative strategies that enhance productivity and employee satisfaction. Through Open Sourced Workplace, he fosters collaboration among HR, facilities management, technology, and real estate professionals, providing valuable insights and resources. As a speaker and contributor to various publications, Steve remains dedicated to staying at the forefront of workplace innovation, helping organizations thrive in today's dynamic work environment.

Recent Posts