Implementing a Hiring Strategy to Maximize Financial ROI — Part of a Series

In earlier articles in this series, I made the contention that the average talent level of most companies hasn’t increased in the past 10 years. I contend that this is largely due to a follow-the-crowd or “blame some bureaucratic rule” excuse.

Here are two of the articles in this ongoing series, for those who want to catch up with the bandwagon.

Part 1: The Financial Impact of Not Hiring the Least Best

Part 2: Should the Recruiting Department Be Charged With Financial Malfeasance

The root cause of the problem seems to be the lack of a CEO-driven talent strategy, combined with some CFO-like financial rigor. Most companies have talent-related mission statements, but these rarely convert to a strategy. If they did, cost per hire would be tossed out, replaced by some quality of hire metric.

For some reason converting the “talent is #1” mission statement into a real strategy with real tactics seems all but impossible unless a big employer brand is driving it. That’s why the CFO needs to get involved by looking at the financial impact of bad hiring decisions. Gallup is doing a lot of work in a related area, by directly examining the huge financial impact of worker satisfaction and engagement on earnings. Something similar should be done on the hiring front, since this is where the problem originates.

Every hiring decision has a direct financial impact. The best people save money and produce more. To calculate this profit impact at the hiring decision level all you need to do is to compare the profit contribution of a well-above average target employee to the person being hired. I suggest using the top third of your current employee base as the target, and compare all future hires to this level. The difference represents the opportunity lost in dollars. Calculating this is not hard to do.

In Part 1 of this article series, I presented a model that involved multiplying revenue per employee by some reasonable estimate of variable contribution margin. This results in average variable profit per employee, or APE. Since all employees are not created equal, it’s reasonable to estimate that the top third of the people you hire generate 20% more APE than the average, and the bottom third generates 20% less. This 20% difference is D in the model. Some might argue that D is greater than 20%. Few would argue it’s less. For calculating the financial impact of not hiring a top-third person, it’s a reasonable floor.

For example, Amazon’s APE is approximately $140,000 per employee. (Send me your stock ticker symbol if you’d like to see your company’s calculation or go to my blog to see how to calculate this.) With D equal to 20%, it means that each person in the top third generates $168,000 in APE and each person in the bottom third generates $112,000. This is a difference of $56,000 per person. The simple math equation is “Lost profit=2D*APE.”

For most companies the profit lost by hiring someone who winds up in the bottom third instead of the top third ranges from $50,000 to $100,000 per person. (This is valid for typical staff-level positions, with a multiplying factor on top of this depending on management level and position importance.) If you do this 100 times a year, this turns out to be a lot of money — a loss of $5 million in per tax profit using the $50,000 impact.

Now for the big picture strategy and financial impact part. Instead of multiplying the lost profit by 100, substitute one third of the people you expect to hire in the next 12 months. The reason: one third of the people you hire in the next 12 months will wind up being in the bottom third of your workforce. And for most of you, this number is a lot bigger than 100.

Of course, no one goes out of their way to hire someone who’s going to wind up in the bottom third, but somehow it happens anyway. Usually this is due to weak systems, the pressure to fill positions, ineffective sourcing, weak technology, incomplete assessments, overburdened recruiters, and/or hiring managers who can’t assess or attract strong people. A hiring strategy designed to measure the financial ROI of each hiring decision would have minimized the impact of these mistakes, especially if someone on the CFO team was involved in the pre-hire calculation.

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This all starts by thinking about each hiring decision as part of a bigger, “raising the talent bar” hiring strategy. If you’ll be hiring 1,000 people over the next 12 months it’s obvious that 333 people will wind up being in the bottom-third. Shifting just 100 people into the top third will earn your company at least $5 million in additional pre-tax profit, and your average talent level will increase. If it costs you less than $500,000 per year to pull this off, it becomes a pretty big ROI, so making the business case is pretty easy.

I’ll present the actual calculation to measure new hire ROI in the next article in this series, but for now I’d like to suggest there are some things you need to consider first. Here’s my short list:

  1. Do you have a maximize-quality-of-hire hiring strategy in place now that drives decision-making?
  2. Has your average talent level improved over the past 10 years? Why, or why not?
  3. Do you tend to hire the best person available at the time given budget, comp, and time restraints or the best person possible without the restrictions?
  4. Is your sourcing targeting the 85% of candidates who aren’t looking, or is it focused on the 15% of people who are looking? Which group has the greatest number of top people in it? Is your sourcing budget being spent as wisely as possible?
  5. Are your recruiters and hiring managers able to find, assess, recruit, and hire the top third at your current comp levels? How could you improve your quality of hire without changing your comp plan? (Hint: convert jobs into career moves, rather than lateral transfers.)
  6. What is actually driving your company’s talent strategy? Don’t be surprised to discover it’s some mashup of your comp plan, a cost per hire metric, your ATS, legal team, and your antiquated processes. Your answer to question 3 above provides some insight to this.
  7. Without making any excuses of how hard this is to do, how are you now measuring quality of hire? (I suggest using a talent scorecard which compares all candidates against a company’s top-third performance metric.)

Last question: should the recruiting department’s performance be measured by some productivity and cost metrics, or by how well it helped raise the company’s talent bar? Obviously, a lot of things would have to change to excel at both, but maybe that’s a good place to start.

  • http://www.shakercg.com Joseph Murphy

    Thoughtful suggestions and excellent questions.
    Here is another: Has your CFO met your CIOP? http://bit.ly/cQ3FzV

  • Prince Paul

    Lou Adler is again at his best here.In fact I am consulting organisations on “Hiring Strategy” and found that CEO’s still are continuing to rely on their HR Staff for this crucial business function. The moment we consult with the HR , we get a long list of complaints on poor quality candidates dished out by Recruitment Consultants as the main ill.
    Is it really a issue of CEO Vs HR , when it comes to Better Hiring ? And the HR wins in most cases considering the mess recruitment process normally is and CEO’s rather avoid messy things !!!!

  • http://www.cordellandcompany.com CorDell Larkin

    Lou,

    The answer to your question about how the recruiting department should be measured depends on whether the organization wants people to be part of its competitive strategy or not. If acquiring higher performers is part of the organization’s HR strategy, then the recruiting department’s most important metric should be something like [average new hire performance / average existing hire performance]. Let us call this the ANHP measure. Any recruitment department that can consistently achieve above one (>1.00) on this metric is generating real value for its organization.

    To those who dismiss Lou’s arguments about the financial impact of not hiring the best you can read my firm’s “War for Talent” research. Our latest study, which you can read about at http://bit.ly/cSHpmY, analyzed human capital productivity over a five year period using operating income per employee, operating cash flow per employee, and total number of employees at Alcatel-Lucent, Cisco, Ericsson, Juniper, and Motorola. As we usually find in these studies, the company with the top performing stock, in this case Cisco, also had the highest average operating income per employee and operating cash flow per employee. To top it all off, Cisco did this while growing its total number of employees 70 percent, from approximately 38,000 to approximately 65,000, during this period.

    While I believe operating income per employee and operating cash flow per employee over a multiyear period is a great signal of a company’s overall talent management prowess, it also reflects other factors of production, such as materials, technology, and process, and takes into account talent identification, development, retention and motivation as well as talent acquisition. As such, using them to analyze the potential ROI from improving new hire quality in any job or job family that is not directly linked to revenue is likely to be seen as a bit of a stretch (this does not mean it should not be done). However, if the recruitment department wishes to become strategic in nature the organization will have to define quantifiable, objective (and ideally financial) measures of performance for every job and/or job family to use an ANHP type metric to prove it is adding value.

    If operating income per employee or operating cash flow per employee are used then measuring the ROI of the recruiting department, or any changes in recruiting technology, people, or process, becomes rather easy. The equation would look something like this;

    (change in average operating income per employee X number of new hires) – (cost of recruiting department, or cost of change in recruiting technology, people, or process) / (cost of recruiting department, or cost of change in recruiting technology, people, or process) X 100.

    CorDell Larkin
    http://www.linkedin.com/in/cordelllarkin
    @cordellco