Better hires, less waste: a potential profit bonanza; What are turnover and mediocre employee performance really costing your organization? The CFO of a firm that designs and develops workforce selection systems offers thoughts about how and why it's vital to find out.

• Author: Koch, William D.
• Position: Human capital

In recent years, enlightened CFOs have begun to take a closer look at their organizations' personnel costs. The reason for this is twofold. For one, in many cases, personnel costs, including payroll, represent an organization's greatest expense. Moreover, given the considerable size of these costs, they can represent a significant drain on profitability.

What CFOs are finding as they look more closely is that personnel costs cannot and should not be treated as the exclusive domain of human resources (HR). Instead, they should be viewed in terms of their larger impact on the organization as a whole. Consider, for example, the costs associated with employee turnover, which can be in the eight-to-nine-figure range. In fact, one Fortune 25 organization's estimated turnover cost is in excess of $1 billion! That's a significant hit on the bottom line and one with cost implications that, of course, extend far beyond the HR department.

But turnover is only one cost driver that demands greater focus from CFOs. Another is the expense associated with hiring or keeping "less than the best" employees. The effects of these costs are exacerbated when the organization doesn't take action to improve the performance of low-performing employees or delays terminating them.

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To understand what a powerful cost driver turnover can be--a cost driver that is, in fact, a profit drain--as well as the full implications of hiring less-than-the-best employees, a more comprehensive view of personnel costs is needed. By assembling all the costs of hiring, employing and replacing people, a strategic cost picture emerges that reveals potential for profitability improvement.

As these costs reside across many budgets, CFOs need to initiate a cross-functional team to identify and compile the true total. Such an effort is analogous to the Six Sigma approach to quality.

Understanding End-to-End Personnel Costs

The first step is to identify the relevant cost centers. For a salesperson, HR has hiring costs; sales has turnover, compensation and productivity; Legal bears costs associated with any legal actions related to the salesperson's performance or termination; G & A has unemployment insurance costs.

A conceptual model of the personnel costs that an organization incurs might include three categories--hiring process costs, performance costs, and separation costs (see Figure 1). Hiring process costs include advertising, headhunters, testing, interviewing, etc. Separation costs include severance, unemployment, legal costs and the value of management's time during the termination process. Performance costs include real costs and opportunity costs associated with how well employees perform.

This model also includes two cost drivers, turnover and differential performance. When per-unit process costs are multiplied by...