Calculating the cost of vacancies

by 16 Oct 2007

The loss of key employees may cost you more than you think. John Sullivan examines whether great hires produce more revenue and profit and details strategies for measuring the dollar impact of great recruiting

Calculating the cost of a vacancy (COV) is a critical activity, one that’s necessary to determine the actual business impact of talent shortages that result from a gap between the time talent is needed and the time required by the recruiting function to supply such talent. As a metric, it can be configured to measure the dollar impact of voluntary turnover and involuntary turnover, or the impact of a slow recruiting process that’s incapable of meeting the organisations growing talent needs. Calculating COV is critical, because organisations are unlikely to place the requisite emphasis on addressing recruitment issues if they are unaware of the negative impact such vacancies may be generating.

So many organisations these days have become so laser-focused on cost containment that they often overlook the possible longer-term detrimental impacts their actions regarding talent may have. This is especially true in organisations where the HR budget is controlled by a CFO who continues to see the function largely as an administrative one.

Cost-focused organisations end up seeing a position vacancy as a short-term reduction in expenses; after all, salaries do show up on the balance sheet as an expense (not an investment). That’s why it’s so critical to demonstrate the business impact of not having a performing employee in key positions. Even the dumbest finance person realises that without having a single employee, no matter what the cost savings, the firm would produce zero revenue.

If you have the time, I strongly recommend that your organisation calculates the actual costs of having a vacancy in key roles.

It is important to note that there is no magic or even standardised formula for the calculation of the cost of a vacancy, because the factors that must be considered are largely dependent upon the position, the industry, and the current stage in the product lifecycle.

Whatever formula you select, be sure to develop it in conjunction with the finance department. Their early involvement is essential, in that it adds credibility to your calculations and pre-emptively eliminates any resistance or doubt they would cast on your efforts otherwise.

The simplest formulas

If you just want a simple, direct means of calculating COV, here are a few basic formulas you can use.

Average revenue per lost employee. When you have no position-specific data available, take the company’s revenue per employee (which is the company’s total revenue divided by the number of employees) and divide that by the number of working days in a year. This provides you with the average revenue produced by an employee on a daily basis. The principal here is that if an employee is not in place, you cannot generate the revenue that that one employee would have generated on average.

Salary multiplier of revenue that is lost. When you have no position-specific data available, you can base your cost of a vacancy calculation on the premise that every employee generates a certain amount of money (a multiplier) above their salary. You calculate the multiplier by taking the total dollar amount the department or company spends via payroll for one year. Then divide the payroll by the number of employees to get the average employee salary. Next divide that number (the average employee salary) into the revenue per employee, and you get a number which is the salary multiplier (it is usually between two and seven). You then multiply the multiplier times the individual’s daily salary, and you get the amount of revenue or value that each employee is expected to generate everyday. Again, the principal here is that if an employee is not in the job that day, he or she can’t generate the average daily salary multiplier (daily revenue).

Simple salary multiplier. For this calculation, you use no specific company information. Instead you rely on research that has indicated that the individual’s value is between one and three times their salary (a HarvardUniversity study found that it was three times a person’s salary, which many analysts have found to be an accurate estimate). You can use a one times their salary calculation without any argument, but if you go above two times their salary, you need to get the approval of the finance department (again, their pre-emptive approval lends credibility) to utilise this as a realistic substitution for the actual cost of a vacancy.

Revenue lost. For revenue-generating jobs such as a sales role or loan officer, you take the average yearly revenue generated by a person in this job and divide it by the number of working days in a year. The principal here is that if there is a vacant job in a revenue-generating position, that revenue will be lost if no one is in that position.

Budget expenditure per employee that is lost. For administrative positions where there is no direct measure, you take the department’s annual budget and divide it by the number of employees in the department. That is the average budget expenditure per employee. Then divide that by the number of working days and you get the budget value of each person. The principal here is that if you don’t have an employee in the job every day, they cannot produce the value reflected in the budget allocated to them.

In any of the above calculations, if the vacant position is replaced by a temporary employee, you have to determine the lower productivity of a temp compared to having a regular employee in the same position. If the manager fills in to do the added work, it is generally okay to assume that because they won’t be doing their regular job, there will be some dollar consequences. You can also calculate the higher error rates and lower productivity that any fill-in is likely to generate and add the extra costs of overtime pay if regular employees must work overtime to do the work.

The business impacts of a vacancy

You should work with functional leaders in marketing, sales, engineering/production, and finance to develop actual costs or acceptable guesstimates for each item relevant to your organisation.

Product development and productivity. Time to market is dramatically impacted by the entire production chain. Because departmental schedules and plans are closely interwoven, any disruption in one department may adversely affect all others. In industries that rely on the seasonal launch of new products (such as toys), vacancies in key skill positions may dictate that products and projects be delayed till the next season or dropped altogether.

Also, being understaffed (due to the vacancy) will lower the probability of a department meeting its productivity targets, which could have a cascading impact on other inter-related departments.

Team impacts. Team results may be dramatically impacted by the disruption caused by the lost productivity, lost experience, lost leadership and lost skills of the vacated person. If a team environment exists, a disruption in team cohesiveness may occur. This can result in a longer time to market and a loss of focus, which can also impact time to market.

Vacancies may affect the idea generation of others because co-workers are frustrated or overworked, while vacancies may also cause overworked employees (because they have to fill-in) to tire, which may cause increased accidents or an increase in error rates.

Excessive vacancies may lead to increased “whining,” grievances, and even union activity, and if the team leader is the vacancy, then time to productivity is likely to be even more negatively impacted. Further, a vacancy may make a manager reluctant to terminate poor performing employees. Vacancies coupled with poor performers can cripple the team.

Individual employee impacts. A vacancy means that a current employee must do the work of the vacant position. This can cause a cascading effect when others have to fill-in for their position, resulting in many rusty people doing unfamiliar jobs and decreasing productivity.

Vacancies may cause the team to miss its goals, thereby reducing the possibility of individual and team incentives, which may further reduce productivity. Further, increased stress on overworked current employees (caused by having to fill-in) may cause increased absenteeism and tardiness.

Vacancies may hold up vacation time for current employees which may lead to increase stress or frustration. Understaffed departments will not be able to send current employees to training and conferences, which may lead to increase stress, decreased worker knowledge, and frustration.

If temps or fill-ins must be hired, they usually have a higher error rate than the average employee and they are unlikely to generate many new ideas. Superstar employees often resent being asked to fill-in when lesser employees’ positions are vacant, which may cause them to quit also.

Increased management time and effort. Teams with vacancies require high maintenance and more management attention, decreasing the time they can spend on more strategic management issues.

Vacancies in management and team leader positions have a multiplier effect on productivity and the recruitment of others. There are opportunity costs for things a manager and coworkers could have done if they didn’t have to carry the extra load of filling in for a vacancy.

If the vacancies are caused by top management decisions (hiring or budget freezes), it can cause managers to lose hope. This can impact morale and it may lead to a high management turnover rate.

Customer impacts. Excessive vacancies may send a message to customers and suppliers that the organisation is getting weak or doesn’t care about them. It may cause a period of confusion for suppliers and customers regarding whom they can contact and the stability of the relationship. Errors resulting from vacancies may lower sales volume and occasionally result in lost customers.

Any fill-in of a salesperson or account representative may provide customers an opportunity or excuse to look for other suppliers.

Your competitive advantage, culture and value.Excessive vacancies may cause panic and encourage the quick hiring of poor performers. Once a team is saddled with a large number of poor performers, you may never be able to hire any new top performers.

Vacancies at the CEO, CFO, CTO, and other top manager positions can adversely impact external financing and the willingness of others to partner or merge with the organisation. Vacancies in key positions may send a message to analysts and the stock market that the organisation is getting weak.

Your image and recruiting. Excessive vacancies sends a message to competitors that the organisation is getting weak. This might encourage them and improve their own confidence so that they become bolder in the product and employee poaching markets.

Vacancies may impact new recruiting because vacancies send a message to future recruits that the organisation is not easily able to recruit replacements. Large numbers of vacancies may also send a message to your current employees that the organisation is headed downhill.

High vacancy rates may overstress recruiters and the recruitment process, while vacancies may also send a message to outside recruiters that the organisation is vulnerable, which can lead to increased headhunter activity.

Out-of-pocket costs. Having to hire high-cost consultants as fill-in help could mean higher costs. If hourly employees are involved, it probably means additional overtime costs. Vacancies can mean the underutilisation of plants and equipment.

Other miscellaneous concerns (and costs) that may arise are that the new hire may be a lower quality (low performance) candidate. New hires are also unlikely to be immediately productive, thus resulting in increased costs. Some vacating employees take others with them soon after they leave – a “break in the dyke”of one leaving may cause the whole intact team to leave. Many new hires don’t work out and must be replaced within six months, essentially stretching the length of the vacancy.

Spending the time to avoid vacancies or to fill them rapidly with top performers may have a huge return on investment – especially if departing employees go to a competitor with your ideas, causing their revenues to increase as yours go down.

Dr John Sullivan is professor and head of the HR program at San Francisco State University, and is a noted author, speaker and advisor to corporations around the globe