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Economics of Employee Retention

It is a common fact that employee turnover in a company has significant cost consequences.  HR departments and managers deploy programs to create great work environments to prevent employee turnover. Some industries have higher turnover than others. However, despite the expected high turnover rate, companies are realizing that the acquisition cost of getting a new employee to replace someone who has left is meaningfully higher.

There are a number of tangible and intangible costs that have been connected to employee turnover:

  • Pre-departure costs—such as the reduced productivity of an employee who is discontented and using company time to look for another job, plus the costs of any efforts to retain the employee once he or she has announced his intent to leave.
  • Termination costs—those related to termination of employment, including exit interviews, security precautions, pay calculations, and other recordkeeping costs, plus the unemployment tax impact and payments for severance, accrued vacation time, retirement plan contributions, and any extension to benefits.
  • Recruitment costs—related to advertising, recruiting, interviewing, pre-employment evaluations, security and background checks, hiring bonuses, relocation, etc.
  • Training costs—the cost of training new employees in necessary job skills can be significant.
  • Productivity costs—related to new workers, who are generally less productive, require more supervision, and contribute less to customer satisfaction.
  • Vacancy costs—lost sales or lost productivity while the position remains vacant, plus the cost of overtime or temporary help to cover fill in.
  • Corporate culture – high turnover is a reflection of corporate culture. If potential candidate become aware of high turnover, this could further increase the corporate’s acquisition costs.

It has been estimated that the cost of employee turnover could range anywhere from 50% of the employee’s salary up to 500% of the employee’s salary.

Employee turnover= (Number of separations per year/ Average number of employees per year)*100

The general median is 130%.  Here is a specific scenario to think through:

Assume there are 100 employees in an organization. The average compensation is $50K per year. The employee turnover rate is 10%.  That means about 10 employees leave the company in any given year. If the average cost is $50K per year, and the median is 130% or 1.3X compensation cost, then the total impact in this scenario would be $650,000. Thus, it represents almost 13% of the run rate of payroll. If there are programs that could stem the flow out by 50%, that would save $325,000 which represents 6.5% of payroll. This is a fairly significant statistic. And since 130% is a median across all industries,  I contend that knowledge industries have a higher median than industries that are driven by low or medium skilled workers at the lower end of the pay scale.

So what are some of the ways that would minimize this turnover? First, whatever the turnover number, the company would want to compare themselves to similar organizations in the specific industry or region. In fact, some turnover may be healthy to the company. Second, one single program may not be good enough. They have to consider multiple programs that could be deployed concurrently or over time.

So, companies seeking a performance-oriented approach to employee retention might seek to enhance work value in some of the following ways (courtesy of the Performance Improvement Council of the Incentive Marketing Association):

Employee involvement in job design, goal setting, and selection of rewards.

Clear communication about company goals and ways employees can contribute to and share in its success.

Incentive programs that reward people for significant and measurable performance improvements.

Recognition programs offering meaningful recognition to employees for both tangible and intangible contributions to their company.

Project-oriented approaches in which all employees can work on diverse, limited-term assignments rather than being sequestered within a single department or function.

Developing talent exchanges to enhance careers by connecting employees with appropriate projects, roles, and positions within their companies.

Training through coordinated programs designed to enhance employee knowledge and then rewarding employees for that increased knowledge. Consider cross training to enhance skills and improve productivity. This both satisfies employees and equips them to perform better.

Fostering feelings of support by setting clear goals for employees and rewarding them upon accomplishment, and by promoting consistent values and recognizing people who embody them. This directs retention resources to actions and values that have a measurable benefit to the organization.

Creating an atmosphere of fun with spot “atta-boy” rewards, contests, or meetings, specifically related to organizational goals and values. This creates an atmosphere conducive to retention while keeping the focus on achieving goals.

Addressing the measurement issue by instituting “real-time” goal setting, performance measurement, and skills development programs to ensure that people always know where they stand, and to address performance issues and skill gaps before they become problems.

Fair Compensation. No one said that compensation will have no effect on turnover and retention. Determine a fair wage in your labor market and do what you can to meet it. A fair and equitable wage and benefits package is the foundation for a successful employee retention program.

Build trust. As mentioned above, a “climate of trust” is one of the factors that influence employee retention. Trust is built with employees through fair working conditions, management responsiveness to employee concerns, realistic performance expectations, and open communication, including one-on-one communications between managers and employees whenever possible.

Don’t limit motivation efforts to star employees. Incentive, reward, and recognition programs should be expanded to include as many employees as possible, rather than just the top 5 or 10 percent. Remember, it is the large middle range of employees that can contribute the most in terms of improved productivity and lower turnover costs.

The Role of Motivation

Higher levels of motivation can translate into a 53 percent reduction in employee turnover, according to a recent study by Stephen Condly, associate professor at the University of Central Florida, Orlando, conducted for the SITE Foundation. No retention strategy can succeed without addressing the issue of employee motivation.

“Incentives, Motivation, and Workplace Performance,” a study conducted by the professors at the University of Southern California for the International Society of Performance Improvement, found the following factors critical to fostering motivation and loyalty.

  • Work value. The research confirmed that people stay motivated when they value their work, no matter how mundane the task. Someone building a house for low-income tenants might get pleasure from the most arduous labor, knowing the good that can come from the effort. Organizations can foster work value by recognizing contributions in a meaningful way, and regularly communicating the organizational goals toward which each employee can contribute. They can add to satisfaction through use of incentive programs that set goals for quality or quantity, and reward those who achieve or surpass them.
  • Training. Many people draw satisfaction from developing the capability to do their jobs better or acquiring additional skills or responsibility.
  • Support. Most people gain satisfaction from knowing that their organization appreciates their effort. This often comes in the form of meaningful recognition to those who achieve their goals or who exemplify important organizational values.
  • Emotional appeal. Yes, people work better when they feel happy. Properly structured incentive and recognition programs can foster an atmosphere of fun and excitement, even in dreary jobs.
  • Measurement. Knowing how one is doing in the pursuit of a goal is another way to create satisfaction. Effective measures of quality and productivity keep employees focused on goals, especially if accompanied with proper recognition when they succeed.

Intrinsic and Extrinsic Motivation: Impact on Employee Engagement

The difference between intrinsic and extrinsic motivation lays the groundwork to reflect the qualitative dimension of motivation. The distinction is critical, in that – understanding it would serve the purpose of laying out the appropriate organizational architecture that would encourage the proper motivation that would drive employee engagement.

Intrinsic motivation reflects an engagement in activities that are performed with the sole end being satisfaction. An intrinsically motivated employee would do things simply for the sheer joy of doing things and assessing results. Tangible rewards or any rewards per se are not the ends that they drive toward. On the other hand, an extrinsically motivated employee is driven by tangible rewards – money, gifts, social approval; or they are driven specifically to avoid punishments – getting fired, rejection, being passed over for an important project, and career limiting responses.

Thus, in both instances, the theory was fairly mechanistic and behavioral. In fact, even intrinsically motivated employees can be framed in a mechanistic and behavioral world wherein the cause and effect relationship is an act and the joy of seeing a result. The only difference is that they are not connected to influences from without.  But what has become a fact is that if the organization provides the appropriate structure to allow employees to ignite their intrinsic drives, the organization will benefit more than the alternative framework. This does not mean that one has to do without the other; it does mean though that depending on the nature of the work and the stage of the company – either or both motivation archetypes can be activated which will elicit the right engagement to advance the cause of the company. The questions though remain – What, When and How?

What? The culture has to address deficiency needs. These constitute the needs like security in the job, reasonable pay, and opportunities for growth, promotions, recognition, etc. Deploying a structure that only satisfies the intrinsic inclinations will be less likely to succeed if the deficiency needs are not clearly addressed. This would mean that good organizations would embark and deploy programs to address and mitigate deficiency needs. However, all that the organization has provided upon successful deployment is a sense of shared relief.  But the organization needs to up their ante to allow for “growth needs” which is the manifestation of the intrinsic metric. That would mean to dive deeper on a case by case basis and as a group to deploy programs that fuel aspirational and idealistic goals of the employees. A great example that I immediately recall is the 3M model or the Google model wherein employees are given time to do their own thing on company time! Now this is obviously not practical for all companies, but certainly there is and will be some points that organizations can deploy to fuel “voluntary” engagement.

When?  Timing is important. An organization can set a directional tone, but when to deploy what is driven by a host of discrete or related factors – for example, rush to go-to-market, liquidity crisis, major software pushes, declaring and preparing for earnings’ release, etc.  When the organization is being driven on account of all these factors and more to ensure their survival, they do not have the degree of freedom necessarily to deploy the programs that promote “growth needs”.  In fact, some organizations in a hyper-competitive environment may always feel as if they are in a pressure cooker and thus cascade that pressure across the ranks and files of the company.  In the extreme case, if the organization is better insulated from the trials and tribulations of external factors, they would have a greater degree of freedom to nurture the “growth needs”.  Now the latter scenario is very important to understand since today we belong in the information age rather than the mechanistic industrial age. In fact, we are being ushered at a break neck pace into an age where insight gathered against information is the salient competitive distinction — the morass of data and information is fast becoming now a millstone around an organization’s neck. So to success in the Age of Insights, so to speak, the company MUST deploy programs that anticipate and nurture the “growth needs”. The case for it is amplified further by the simple fact that people are mobile and have more and more choices. Hence, the Best Place to Work is an important metric that companies and employees follow since these companies have provided the right mix. To reiterate, timing the programs is important but the fact that both programs must be deployed to ensure an engaged culture is less debatable.

How?  This is the penultimate question. Once the organization have assessed what is need and when, they have to execute. How do we establish a balanced set of programs that would fuel the appropriate level of engagement that will positively impact the organization? Conversely, how do we untether from legacy programs that were good for a particular set of circumstances, but may not be good going forward. This probably comes more in the realm of organizational psychologists but here are a few takeaways. First, employees have to be given free choice – in other words, given other alternatives, they would choose to do that alternative that optimizes and increases the value of the company the most.  A fine example would be co-founders banging away at their work 24X7 and fuelled by dreams and possibilities for their creation. Put on a spotlight on this behavior – Multiply this behavior a hundred fold to characterize mass group psychology, and then figure out what can be done to create a “permanent immanence” or the state of continuous excitement and engagement. What we know based on studies, that engagement arising out of intrinsic motivation results in creativity, well-being, cognitive flexibility, loyalty, etc. By comparison, we also know that engagement as a result of extrinsic motivation may be as good – or depending on your perspective, may be as bad as a sugar high. Engagement ceases immediately or slowly once the extrinsic motivator is removed.  In fact, a more extreme version suggests that introduced extrinsic motivation programs that serve “dependency needs” may actually depress engagement even lower than the original state.

So the general consensus appears to be to introduce not a plan but a surprise.  For example, rewards that are expected, contingent on engagement or on task completion, and tangible are more likely to be detrimental to intrinsic motivation than rewards that are unexpected, not contingent, and intangible. More studies have in fact shown that employers should pursue the internalization of an employees’ extrinsic motivation for these tasks. Thus commending employees with unplanned surprises coupled with surfacing the value of the activity in and out of the organization appeals to the individual’s innate sense of worth to the company and outside of it. Hence, recognition at deeper granularity that is served with an element of surprise in an open environment is one of the better programs that ignite employee engagement.

Organization Architecture – Evolving strain!

Innovation is happening at a rapid pace. An organization is being pummeled with new pieces of information, internally and externally, that is forcing pivots to accommodate changing customer needs and incorporating emerging technologies and solutions.  Thus, the traditional organization structures have been fairly internally focused. Ronald Coase in his famous paper The Nature of the Firm (1937) had argued that organizations emerge to arrest transactional costs of managing multiple contracts with multiple service providers; the organization represents an efficient organizational unit given all other possible alternatives to coexist in an industrial ecosystem. Read the rest of this entry