What Are Employee Separations?
An employee separation occurs when an employee ceases to be a member of an organization.6 The turnover rate is a measure of the rate at which employees leave the firm. Well-managed companies try to monitor their turnover rate and identify and manage causes for turnover. The goal is to minimize turnover and the costs of replacing employees. Replacement costs, particularly for highly skilled positions, can be surprisingly high. For example, replacing a U.S. Navy fighter pilot may cost more than $1,000,000.7 However, multiple turnover rates can be calculated, and it is important to focus on the correct numbers. Exhibit 6.1 presents the basics about calculating turnover rates. An excessively high turnover rate compared to the industry standard is often a symptom of problems within the organization.
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“Source of turnover” refers to whether the employee decided to leave the organization (voluntary) or management made the decision to end the employment relationship (involuntary). “Type of turnover” can be divided into people who left the organization (external) and employees who left the job but took another position in the organization (internal).
You can calculate turnover rates for each of the four cells in the source-by-type matrix. A high rate of turnover that is voluntary and external, a high quit rate, could be of particular concern and be symptomatic of organizational problems.
Employee separations can and should be managed. Before we discuss the management of separations, however, we examine both the costs and the benefits of separations.
The Costs of Employee Separations
The cost of turnover can differ across organizations, and some costs associated with turnover can be difficult to estimate. For example, an organization’s geographic location may necessitate a particularly high cost of recruiting new employees, which causes the cost of turnover in that organization to be unusually high. The effect of lost talent on sales, on productivity, or on research and development all may be tremendous, but difficult to estimate.
Employee turnover affects the bottom line. A recent survey of over 200 insurance brokerages demonstrates the relationship between employee turnover and firm profitability.8 The brokerages were arbitrarily divided into two groups: those with profitability that exceeded 20 percent of sales and those with profitability under 20 percent of sales. Employee turnover in the lower-profit group was approximately twice as high as turnover in the higher-profit group. The profit level in the high-profit group was 30.3 percent of sales, and the profit level in the lower profit group was 11.4 percent of sales. Although turnover might not be the only cause of these profit levels, these findings indicate that employee turnover is an important factor in bottom-line performance.
>Unfortunately, organizations can find it difficult to reduce employee separations when turnover is part of the system. The Manager’s Notebook, “Voluntary Turnover in China,” is part of the business reality in China.
It is common to estimate the cost of turnover from a conservative 25 percent9 to 300 percent of the lost employee’s annual compensation.10 Looking at the most conservative end of that range, at an average salary of $30,000, the cost of a turnover would be $6,000. For a company with 1,000 employees and a 20 percent turnover rate, the annual cost of turnover would be at least $1,200,000—not a trivial cost, and it could be much higher depending on the situation. Figure 6.2 presents only some of the costs associated with replacing an employee. The costs can be categorized as recruitment costs, selection costs, training costs, and separation costs.
Global
Recruitment Costs Selection Costs Training Costs Separation Costs
Advertising
Interviewing
Orientation
Separation pay
Campus visits
Testing
Direct training costs
Benefits
Recruiter time
Reference checks
Trainer’s time
Unemployment insurance cost
Search firm fees
Relocation
Lost productivity during training
Exit interview
Outplacement
Vacant position
FIGURE 6.2 Human Resource Replacement Costs
Recruitment Costs
The costs associated with recruiting a replacement may include advertising the job vacancy and using a professional recruiter to travel to various locations (including college campuses). To fill executive positions or technologically complex openings, it may be necessary to employ a search firm to locate qualified individuals, who most likely are already employed. A search firm typically charges the company a fee of about 30 percent of the employee’s annual salary.
MANAGER’S NOTEBOOK Voluntary Turnover in China
Global
Employee turnover in the United States and Europe average around 5 percent annually, while voluntary turnover in China is approximately 19 percent. Turnover rates in China have been found to vary across companies and range from 11 to 40 percent. Multinational companies doing business in China face an employee turnover rate that is approximately 25 percent above the global average.
What accounts for the high quit rate in China? Simply stated, demand for labor exceeds supply. Companies in China are dealing with labor shortages and fighting for the talent they need to effectively operate their businesses. A shortage of talent in China is identified as a barrier by multinational and Chinese companies. A slowdown in the Chinese economy is expected to somewhat lessen the overall shortage of labor, but a need for talented managers is expected to grow.
The need for experienced workers, particularly those with management experience and training, means that there are a number of job openings that can hire employees away from their current jobs. The highly competitive job market makes for a more mobile workforce and a higher employee turnover rate.
Wage rates in China have increased as a means to retain and attract labor. However, it is not just about wages. Companies in China are also finding that they need to provide employees a good value proposition in order to retain their talent. For example, offering leadership and management skills training can be a valuable benefit to employees and increase their commitment to stay with the employer. Providing paths for people to move forward in the organization and being transparent about what it takes to move forward on those paths can also contribute to employees deciding to stay with the organization. Although there are steps that organizations can take to reduce employee turnover, it is part of the business reality in China that job opportunities are plentiful. Having those opportunities certainly makes voluntary turnover a more difficult problem to manage.
Selection Costs
Selection costs are associated with selecting, hiring, and placing a new employee in a job. Interviewing the job applicant includes the costs associated with travel to the interview site and the productivity lost in organizing the interviews and arranging meetings to make selection decisions. For example, a law firm’s decision to hire a new associate may require the participation of many junior associates as well as senior partners who may charge clients hundreds of dollars per hour for their time.
Other selection costs include testing the applicant and conducting reference checks to make sure the applicant’s qualifications are legitimate. Finally, the company may have to pay relocation costs, which include the costs of moving the employee’s personal property, travel costs, and sometimes even housing costs. Housing costs may include the costs of selling one’s previous house and the transaction costs of buying a house in a more expensive market.
Training Costs
Most new employees need some specific training to do their job. Training costs also include the costs associated with an orientation to the company’s values and culture. Also important are direct training costs—specifically, the cost of instruction, books, and materials for training courses. Finally, while new employees are being trained they are not performing at the level of fully trained employees, so some productivity is lost.
Separation Costs
A company incurs separation costs for all employees who leave, whether or not they will be replaced. The largest separation cost is compensation in terms of pay and benefits. Most companies provide severance pay (also called separation pay) for laid-off employees. Severance pay may add up to several months’ salary for an experienced employee. Although length of service is the main factor in determining the amount of severance pay, many companies also use formulas that take into account factors such as salary, grade level, and title.
Less frequently, employees may continue to receive health benefits until they find a new job. In addition, employers who lay off employees may also see their unemployment insurance rates go up. Companies are penalized with a higher tax if more of their former employees draw benefits from the unemployment insurance funds in the states in which they do business.
Other separation costs are associated with the administration of the separation itself. Administration often includes an exit interview to find out the reasons why the employee is leaving (if he or she is leaving voluntarily) or to provide counseling and/or assistance in finding a new job. It is now common practice in larger firms to provide departing employees with outplacement assistance , which helps them find a job more rapidly by providing them with training in job-search skills. Finally, employers incur a cost if a position remains vacant and the work does not get done. The result may be a reduction in output or quality of service to the firm’s clients or customers.
Who conducts the exit interview? The exiting worker’s manager is usually a bad choice, because he or she is often the reason for voluntary separations. The interviewer should have very good communication skills and be in a neutral position regarding the employee’s departure. Some organizations are moving to Web-based exit interviews, assuming that people may be more open about their reasons for leaving without a face-to-face interaction.11 However, some workers may find that the human interaction and concern of a skilled interviewer allows them to open up more than would a Web-based interaction.
An overriding issue is how turnover and the various costs associated with it can be reduced. One important factor to recognize in managing employee turnover is that turnover often occurs early in the employment relationship. For example, an organization may experience most employee turnover within the first 30 to 60 days of employing a worker. However, many organizations calculate only annual turnover rates, and this gross measure can mask the reality that most of the turnover occurs in the first two months of employment. A reduction in turnover in the first months of employment can pay dividends for the rest of the year. Reducing the voluntary quit rate in the first month of employment can mean that fewer workers need to be hired as replacements for the rest of the year.12
The Benefits of Employee Separations
Although many people see separations negatively, they have several benefits. When turnover rates are too low, few new employees will be hired and opportunities for promotion are sharply curtailed. A persistently low turnover rate may have a negative effect on performance if the workforce becomes complacent and fails to generate innovative ideas.
Employees may receive some potential benefits from a separation, too. An individual may escape from an unpleasant work situation and eventually find one that is less stressful or more personally and professionally satisfying.
Reduced Labor Costs
An organization can reduce its total labor costs by reducing the size of its workforce. Although separation costs in a layoff can be considerable, the salary savings resulting from the elimination of some jobs can easily outweigh the separation pay and other expenditures associated with the layoff.
Replacement of Poor Performers
An integral part of management is identifying poor performers and helping them to improve their performance. If an employee does not respond to coaching or feedback, it may be best to terminate him or her so that a new (and presumably more skilled) employee can be brought in.
Increased Innovation
Separations create advancement opportunities for high-performing individuals. They also open up entry-level positions as employees are promoted from within. An important source of innovation in companies is new people hired from the outside who can offer a fresh perspective.
The Opportunity for Greater Diversity
Separations create opportunities to hire employees from diverse backgrounds and to redistribute the cultural and gender composition of the workforce while maintaining control over hiring practices and complying with the government’s Equal Employment Opportunity Commission policies.