Imagine a problem has just occurred that will cause your company to lose $15,000 per month in revenue, and might soon cause a string of similar problems. Which solution to the problem would you choose?
Solution A) This solution has no upfront costs, but it diverts your internal resources away from their current work, takes 4 months to implement (costing $60,000 in revenue) and is projected to lose an additional $24,000 during year one, with the likelihood of continuing losses of $36,000 per year thereafter. This solution has a 50% chance of failing completely and if it does fail, it might trigger a cascade of similar problems.
Solution B) This solution has an upfront cost of $15,000 (which was not in your budget). It requires no diversion of internal resources, and takes 2 months to implement (2 months faster than Solution A). By the end of year one, Solution B will recoup the $30,000 revenue lost during its two month implementation, and is likely to generate an additional $36,000 in annual revenue thereafter. Solution B has a performance guarantee, and significantly reduces your risk of this problem cascading into other areas.
If Solution B seems like the obvious choice, let’s review what happened the last time a vital person with hard-to-find skills resigned from your firm. Did you consider using a search firm to fill the job? If so, did the conversation sound like this? “I hoped our HR department might be able to find someone to fill this job. We thought if we could handle the search internally, we might save money on search fees. And if HR failed, we could always hire a search firm later.” Or, perhaps your internal deliberations sounded like this? “We did not budget for any search fees, so we had to do it on our own.” Both conversations probably sound familiar, and on the surface they might even sound reasonable. But when you look carefully, you realize that that both conversations make the same four assumptions. They assume:
- There is no cost to leaving a position vacant. There is zero cost to the lost productivity of both the employee and the team.
- There is no risk to leaving a position vacant. Under-staffing and over-working the current team will not result in any turnover risk. Zero.
- Any hiring process that results in a hire is just as good as any other. A hiring decision will be just as good whether you have only one candidate to consider, or a full slate of 6 qualified people.
- Any person hired in this job will deliver equivalent results. There is no difference in productivity or performance between an “A player” and a “C player.” Zero difference.
So if all four assumptions are laughably wrong, how did you ignore them in your decision making? Research shows exactly why it happens. Recruiting costs are very easy to calculate, but it is far harder to calculate the cost of not hiring, and harder still to calculate the cost of hiring badly. When faced with that kind of complexity, busy executives look at what they do understand (recruiting costs), and ignore what they don’t understand (the cost of hiring slowly and badly). The snap decision becomes: “We can’t afford to pay a search fee.”
High performing organizations are different. Because they have specific performance targets to meet for every position, the cost of not hiring (or hiring badly) is far more obvious. So they have an easier time balancing their recruiting costs against the return on investment of making a good hire quickly.
This is exactly what our Solution A and Solution B example did for you above. With good information, the trade-offs were easy to make. It was the gathering of the information that was complex. (Which is precisely why so many people will skip the next section of this post and just read the conclusion).
A Better Framework to Evaluate Hiring Costs
The only reason for hiring is to achieve a business result. In business, that result is profit. In a nonprofit, that result is achieving your mission—the mission that satisfies stakeholders and leads to additional funding. So to evaluate different recruiting options, you need to ask yourself a few questions:
- Speed of hiring: What is the likelihood that we can be successful recruiting on our own? How long will our recruiting efforts take versus the speed of using a search firm? What is the expected cost of leaving the position vacant for that long? (You want to consider lost productivity as well as the increased risk of turnover).
- Quality of hiring: What search process is most likely to result in our hiring a top performer versus a less productive person? And what is the expected value of hiring a top performer versus an average candidate?
My example uses national averages to determine the “return on investment” from hiring. In larger companies the average Revenue-Per-Employee is about $360,000. In smaller companies, it can be as low as $180,000 per employee per year. So assuming you run a small company, when someone significant quits, you’re losing at least $180,000 in revenue for every year the position is vacant—or $15,000 per month. If the position is vacant for 3 months, you’ve lost $45,000. Assuming that job performance matters for this role, a high performer in the job is at least 20% more productive than an average employee, and a low performer is probably at least 20% less productive. So a high performer creates $18,000 per month in revenue ($15,000 * 120%), and a low performer creates $12,000 per month in revenue ($15,000 * 80%).
Using those conservative averages to compare our two solutions:
Solution A (Hire on your own)
Typically, your overstretched HR department has no time to spare, and can only recruit by posting ads. Often, your understaffed hiring manager will fall behind in reviewing resumes, dragging out the hiring process a bit. So “trying it on your own” will probably take about 4 months to make a hire. Of course, by hiring in this way you increase your odds of hiring a low performer, because after 4 months most managers get pretty desperate to hire anyone at all. So if a low performer takes 4 months to hire, and then works the rest of the year (8 months), in the course of a year they only create $96,000 in revenue ($12,000/month * 8 months). Therefore, the expected cost of this approach is $84,000 in lost revenue ($180,000 average revenue per employee per year vs. the $96,000 actually generated). But of course that’s only if nobody else quits and you actually manage to make the hire on your own. You still have a 50/50 chance of needing to pay a search fee to fill the position.
Solution B (Engage a Search Firm) If you outsource the hiring problem to a qualified search firm, you will pay a search fee up front (In this example, we’re assuming $15,000 for the fee). But in doing so, you’ve offloaded the work outside your firm, so the search should go faster. If the search firm helps you hire a high performer in 2 months, then the high performer will be able to work for 10 months this year and create $180,000 in revenue their first year ($18,000 * 10 months). This is the same productivity an average performer would achieve in 12 months of work, so you can “break even” for the year by upgrading from an average to a top performer. In the first year alone, you get almost twice the revenue impact from engaging a search firm ($180,000 vs. $96,000), and you can hire twice as fast (2 months vs. 4) which reduces the risk of creating other turnover problems on your team. Unlike internal hiring, a reputable search firm usually has a lengthy performance guarantee in case the new hire does not work out.
Conclusion
High performing organizations have better performance data to evaluate the business impact of their decisions. In every decision, they ask “How will this action bring us closer to our goals, or take us further away?” And when it comes to performance, there are few decisions more important than who you hire and how you hire.
So whether you use precise calculations specific to your environment or approximations like I did, you’ll always make better decisions when you trade off the cost of your recruiting methods against the estimated return on that investment.
Additional resources:
Revenue per Employee (Gazelles)
Profit per Employee (McKinsey)
Common cognitive biases – unconscious reasoning errors many of us make.
How to Prevent a Work Avalanche - avoiding the problems of under-staffing.
