The loss of key employees may cost you more than you think.
By Dr. John Sullivan

This article was originally published July 25, 2005.
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 organizations growing talent needs. Calculating COV is critical, because organizations 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 organizations 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 organizations where the HR budget is controlled by a CFO who continues to see the function largely as an administrative one.

Cost-focused organizations 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 realizes 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 organization calculates the actual costs of having a vacancy in key roles. In some key jobs — particularly in industries where time to market is a key factor in driving corporate success — the cost of a single vacancy has been calculated to be between $7,000 and $12,000 per day. In one unique case, it was as high as $200,000 per day.

Unfortunately, calculating the actual COV for all positions in an organization would be ultra complex and time consuming, which is why many organizations opt to use a simplified formula that estimates the cost. (For key roles, should you want to calculate the actual cost, many of the factors you would need to include in your formula are discussed later in this article.) It is important to note that there is no magic or even standardized 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 preemptively eliminates any resistance or doubt they would cast on your efforts otherwise.

Part 1: 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 (220). 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 Harvard 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 1x salary calculation without any argument, but if you go above 2x their salary, you need to get the approval of the finance department (again, their preemptive approval lends credibility) to utilize 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 can not 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 over time to do the work.

Part 2: The Business Impacts of a Vacancy
If you are serious about the economic impacts of slow time to fill and turnover, here is a detailed list of the factors that should be used in the calculation of COV — working with a GM and finance, of course. You should work with functional leaders in marketing, sales, engineering/production, and finance to develop actual costs or acceptable guesstimates for each bullet relevant to your organization.

Product Development and Productivity

1. TTM 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.
   
   
2. In industries that rely on the seasonal launch of new products (e.g. toys), vacancies in key skill positions may dictate that products and projects be delayed till the next season or dropped altogether.
   
   
3. 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.
   
   
4. The mother's milk of corporate competitive advantage goes to hell in an environment where key people are leaving. Incidentally, the reduction in innovation starts long before any individual actually leaves.

Team Impacts

1. 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.
   
   
2. If a team environment exists, a disruption in team cohesiveness may occur. This can result in a longer TTM (time to market) and a loss of focus, which can also impact TTM.
   
   
3. Vacancies may affect the idea generation of others because co-workers are frustrated or overworked.
   
   
4. Vacancies may cause overworked employees (because they have to fill in) to tire, which may cause increased accidents or an increase in error rates.
   
   
5. Excessive vacancies may lead to increased "whining," grievances, and even union activity.
   
   
6. If the team leader is the vacancy, then time to productivity is likely to be even more negatively impacted.
   
   
7. A vacancy may make a manager reluctant to terminate poor performing employees. Vacancies coupled with poor performers can cripple the team.

Individual Employee Impacts

1. 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.
   
   
2. Vacancies may frustrate other employees, causing them to lower their productivity.
   
   
3. Vacancies may frustrate other employees, causing them to quit at higher rate than they normally would be.
   
   
4. Vacancies may frustrate other employees, causing them to be sick, late, or absent at a higher rate than they normally would be.
   
   
5. Vacancies may cause the team to miss its goals, thereby reducing the possibility of individual and team incentives, which may further reduce productivity.
   
   
6. Increased stress on overworked current employees (caused by having to fill in) may cause increased absenteeism and tardiness.
   
   
7. Vacancies may hold up vacation time for current employees which may lead to increase stress or frustration.
   
   
8. 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.
   
   
9. 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.
   
   
10. 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

1. Teams with vacancies require high maintenance and more management attention, decreasing the time they can spend on more strategic management issues.
   
   
2. Managers often have to skip their normal management planning and responsibilities in order to fill in for the vacant employee.
   
   
3. When managers fill in for vacant employees, that time can't be spent on the best employees.
   
   
4. Vacancies in management and team leader positions have a multiplier effect on productivity and the recruitment of others.
   
   
5. There are opportunity costs for things a manager and co-workers could have done if they didn't have to carry the extra load of filling in for a vacancy.
   
   
6. 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

1. Excessive vacancies may send a message to customers and suppliers that the organization 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.
   
   
2. Any fill in of a salesperson or account rep may provide customers an opportunity or excuse to look for other suppliers.

Your Competitive Advantage, Culture, and Value

1. 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.
   
   
2. 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 organization.
   
   
3. Vacancies in key positions may send a message to analysts and the stock market that the organization is getting weak.
   
   
4. Vacancies may send a message to competitors that the organization is vulnerable, which can lead to increased competitive pressures.
   
   
5. A large number of vacancies means that the organization is losing employees, which means a weakening of the corporate culture. New employees with new values may change or dilute core values and "corrupt" current employees.

Your Image and Recruiting

1. Excessive vacancies sends a message to competitors that the organization is getting weak. This might encourage them and improve their own confidence so that they become bolder in the product and employee poaching markets.
   
   
2. Vacancies may impact new recruiting because vacancies send a message to future recruits that the organization is not easily able to recruit replacements.
   
   
3. Large numbers of vacancies may also send a message to your current employees that the organization is headed downhill.
   
   
4. High vacancy rates may over-stress recruiters and the recruitment process.
   
   
5. Vacancies may send a message to outside recruiters that the organization is vulnerable, which can lead to increased "headhunter" activity.

Out-of-Pocket Costs

1. 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.
   
   
2. Vacancies can mean the underutilization of plants and equipment.

Other Miscellaneous Concerns (and Costs) That May Arise

1. The new hire may be a lower quality (low performance) candidate.
   
   
2. New hires are unlikely to be immediately productive, thus resulting in increased costs.
   
   
3. Some "vacating employees" take others with them soon after they leave. A "break in the dike" of one leaving may cause the whole intact team to leave.
   
   
4. Many new hires don't work out and must be replaced within six months, essentially stretching the length of the vacancy.

In the case of start-ups and small departments, where there is little cross training, the cost may be more dramatic. If you only have ten employees and lose two, you have a 20 percent vacancy rate (which is a big deal!).

In a tight labor market, vacancies in hard-to-hire jobs may not be replaceable, at any cost. Spending the time to avoid vacancies or to fill them rapidly with top performers may have a huge ROI — especially if departing employees go to a competitor with your ideas, causing their revenues to increase as yours go down.