How much does it cost companies to lose employees?

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(MoneyWatch) Pop quiz: An average performing employee comes to you with evidence that he is underpaid by 5 percent. Your company's budgets are already tight. He makes $50,000 a year. Should you: 

A. Offer a 1-2 percent raise; B. Offer nothing. In this economy he's lucky to have a job; C. Offer a 5 percent raise; D. Give him $50 gift card to the local mall.

With job applicants lining up around the block, it might seem like good business sense to let employees quit rather than raising their salaries to be competitive. But a recent study from the Center for American Progress drives home why that isn't so: Employee turnover is expensive.

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Turnover costs include productivity losses during training, recruiting and lost work while a position is vacant. For all jobs earning less than $50,000 per year, or more than 40 percent of U.S. jobs, the average cost of replacing an employee amounts to fully 20 percent of the person's annual salary, the liberal-leaning think-tank found in a study that looks at 31 corporate case studies.

So in the above example, choosing to not give even a middling performer a raise may net a temporary cost savings, but if he quits you'll be out 20 percent of his salary. The best option? Bump his pay up 5 percent. Although employee replacement costs are a one-time expense and a salary increase is ongoing, it would take four years of at higher salary to equal the cost of replacing him one time. 

High turnover, lower-paying jobs (those under $30,000 a year) are slightly less expensive to replace, at only 16 percent of annual salary, but that still adds up quickly. For instance, 37 percent of hotel/motel and food services employees voluntarily quit a job in 2011. That represents a major expense to businesses already running at the margin.

MIT Sloan business professor Zeynep Ton found that such businesses could reduce their turnover by changing their internal policies. For instance, Wegmans Food Markets, which consistently ranks in Fortune's Top 100 companies to work for (this year it's number No. 4), has a full-time turnover rate of only 4 percent for it's hourly workforce [disclosure: I used to work for Wegmans.] In other words, those same policies that make it a great place to work also lowers turnover costs.

While the costs of losing a "normal" employee are high enough, CAP found that the cost of losing an executive is astronomical -- up to 213 percent of the employee's salary. 

CAP also says that offering workers low-cost benefits, such as sick days and a little flexibility, can significantly lower turnover. The upshot is clear: While there is no perfect package of salary and benefits that will stop employees from jumping ship, companies should take turnover costs into account.

[alipeles]

A healthy organization should have a well defined salary review process. Better than making a reactive 5% adjustment, the manager should confidently remind the employee of when his/her compensation will be reviewed and give well supported assurances that the process at that time will be fair and consider data on the going rate for the role.

We don't want raises given as rewards for complaint, nor do we want employees to feel that they must complain in order to receive fair compensation for their work.

[lelnet]

The irony is, if you've got someone who's implicitly threatening to quit over 5%, there's probably some other reason he really wants to quit. Something you might be able to resolve without spending extra cash.

Chances are, an employee like that is really looking to quit because he thinks, for one reason or another, and justified or not, that you're being a jerk. If you can get to the root of that and resolve it, money might never come up again. If not, 5% probably won't hold on to him for long.

Never worked at Wegman's, or even visited as a customer, but somehow I suspect that an understanding of this is the true key to their low turnover rate.

[bonadventure100]

"..the cost of losing an executive is astronomical -- up to 213 percent of the employee's salary".

Really now. This isn't proof but I worked in a company in which the executive quit and it took them a full two years to hire another one. Guess what nothing really changed.

[gbgentleman]

Then that suggests he was either 1) a bad manager who offered nothing but an additional management layer or 2) someone who had delegated enough knowledge to you, the workers that allowed you to continue without him.

My guess is if it took two years, the answer is 1. If nothing changed, I presume that also meant no innovation, no new business...etc.

[JasonPotter]

As with most things in life, this can be taken too far. I have worked with a handful of clients who have remarkably low turnover, over a long period of time. Over time (think 15-20 years) this has led to stagnant thinking and an overall weaker team, in my opinion. I attribute this to the fact that HR is totally adverse to losing/firing people exactly for the reason mentioned above - they recognize the cost of replacement (kudos to them!) - but they are so adverse, that there is little motivation to be a top performer.

Since everyone is special, no one is - as the saying goes. This has led many of the very top performers the company is hoping to retain, to often leave after they are frustrated with mediocre performers being rewarded continually.

Somewhere in between would be more ideal - recognize that turnover has a cost, but recognize that if the teams are not managed appropriately then there can be negative consequences as well.

[1notrub11]

Nicely said. While this article recognizes important factors in employee turnover, it is very shortsighted - as you are pointing out.

[skeezix06]

I can't speak for others but the fact is I don't care how much other people get. I don't know what they're getting. I don't even ask. An intelligent person doesn't try to track their co-workers to see if someone's getting more than they are because it's a total waste of time.

If I did leave, I would leave because of company policy not co-worker envy.

[jaykay3141]

It's even more expensive in high tech. Where I work it takes about 6 months for a new hire to become an effective contributor on a small project, and as much as a couple of years before they can "fly solo". I did some back-of-the-envelope calculations and estimated that between formal training, time spent mentoring by more senior employees, and initial lower productivity we invest upwards of $70,000 in each technical person.

The problem is most of those dollars are so-called soft costs; i.e. they're not on a line item anywhere. If a person quits over a couple of thousand in salary, the bean counters response is usually "So? We'll just hire a replacement. There are plenty of people who want to work." Bye-bye 70 grand.

[marine1957]

I entirely agree with the premise behind this article - it's costly to allow an employee to quit.

However, even if management knows this full well, PRIDE will keep them from putting themselves under the control of this principle - prideful management will not be controlled by principles. (But note how fervently management requires the employee to put themselves under their own control.)

[kschwink]

Excellent point!