The Financial Impact of Eliminating Your Mashup Hiring Strategy

Picture 3In a previous article, I suggested that most companies don’t have a formal hiring strategy in place that drives planning and decision-making. As a result, some default strategy predominates how hiring is done; generally, some mashup of competing ideas. Typically this is hiring manager-driven with individual managers determining who gets hired.

Few managers are great at this, and many can’t attract top talent. Lack of oversight and an audit trail complicates the organizational need to get better. Adding to the mashup problem is the comp group determining the pay ranges, the OD group describing the interviewing methodology, and the recruiting department trying to drive down costs while letting each recruiter do his or her own thing. Unless the company is an “employer of choice,” the performance of a mashup hiring strategy is uneven, with the best candidates bypassing the “approved” process entirely, sneaking in the back door.

This is unfortunate, since the impact on company performance of better people is undisputable. A maximize quality of hire strategy coupled with appropriate processes and used by everyone throughout the company, is an essential component of long-term company success regardless of current economic conditions. As part of this, HR/Recruiting should be responsible for ensuring the strategy is implemented properly.

The focus of this article will be on describing the financial impact of this type of raising-the-bar hiring strategy. This starts by benchmarking your current hiring process. One way to do this is to take a sample of recent hires and divide them into three equal groups — top, middle and least best. Even with a tepid recovery, many of those in the top-half are likely to pursue other opportunities, just due to the need to continue to grow. On some level, burnout causes everyone to become less effective, so if you don’t do anything, your overall talent level will decline. To offset this and to raise your company’s current talent bar, you’ll need to implement programs that allow you to hire more people in the top group and stop hiring people in the bottom group. The financial impact of this shift is described in the formula:

Financial impact of hiring people in the top third instead of the bottom third = 2DC(1+MPL)N.

For an average company, in a average industry, the pure financial gain for this shift is 110-130% more than the person’s salary! I’ll prove this in a moment.

Here’s the short definition of each of the terms:

  • N: the number of employees shifted into the top group from the bottom group.
  • D: percent difference in performance between the top and the middle groups of people you now hire.
  • C: average compensation of the people hired.
  • M: revenue per employee (RPE) divided by average compensation, aka the revenue/comp multiplier
  • P: profit/savings contribution as a percent of revenue or total cost. This is the cost savings or profit contribution opportunity each person makes.
  • L: leverage factor for those who have the potential to make a bigger impact on the organization.

In this model, two dimensions of personal contribution have been captured. One is the direct cost savings due to productivity and the other is the bigger business impact the person can make on the organization. This includes factors like grow sales, design products, hire better people, and increase customer retention.

Now to the proof of the enormous financial impact of making this shift. To do this let’s use an example of the financial impact of hiring 100 people in the top group instead of the bottom group for our “average” company. As part of this assume an average compensation of $75 thousand. For the productivity piece, assume the top group is 25% better than the middle group, and the bottom group is 25% worse than the middle. In most companies the performance difference (D) in productivity, better quality, lower turnover, etc., ranges from 20-40%, so this is reasonable.

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Let’s also assume the company’s RPE is $300,000. This results in a revenue/comp multiplier (M) of 4 ($300K/$75K). We’ll assume the profit/savings contribution (P) as a percentage of sales is equivalent to the company’s variable operating margin of 40%. This component captures how much each dollar of salary relates to sales and ultimately to cost savings and/or earnings. Finally, we’ll assume the leverage factor (L) is 1, an appropriate figure for a staff level position. Those who have a bigger role, like managers or those in marketing, could have a higher value for L, and some process positions could be lower. Collectively, these are very conservative assumptions for determining the financial impact of hiring people in the upper group instead of the bottom. Also, recognize that this shift is in comparison to your current hiring processes, not to the population at large.

Using these assumptions, this equates to a net financial gain or increase in profit of $97,500 for each person hired in the top-third who replaced someone not hired in the bottom group. For 100 people this is equivalent to approximately $10 million in increased bottom-line profits. (Email me if you’d like to see the calculations for your company.)

To better understand the significance of this, consider that on average the 100 people hired would be expected to bring in $30 million in sales (100 times $300,000 RPE) and a generate a contribution margin of $12 million (40% of $30 million). If you only hired the best group, the contribution margin would be $17 million. If you hired only the bottom group, the margin would be $7 million. This is the $10 million difference of hiring better people.

If you want more details on how to use this formula, there’s a recorded session on the Recruiter’s Wall, plus we’ll be holding a webinar with Jobs2Web on December 9, 2009, demonstrating how to use this information to calculate the ROI of any new recruiting project. If you missed the date, you’ll find this recording on the Recruiter’s Wall, too.

The financial impact of a raising-the-bar hiring strategy is huge. Conceptually few would disagree. However, without a financial metric to clarify the magnitude of this, most companies default to a mashup strategy, with no one really responsible for improving overall talent quality. As a result, the talent bar keeps dropping as managers hire below the average, and the best leave for greener pastures. While an employer branding strategy can offset some of this natural decline, more needs to be done to ensure your company’s talent bar continues to grow. Understanding the financial impact of raising the talent bar can be an important first step.

Lou Adler is the CEO and founder of The Adler Group – a training and search firm helping companies implement Performance-based Hiring℠. Adler is the author of the Amazon top-10 best-seller, Hire With Your Head (John Wiley & Sons, 3rd Edition, 2007). His most recent book has just been published, The Essential Guide for Hiring & Getting Hired (Workbench, 2013). He is also the author of the award-winning Nightingale-Conant audio program, Talent Rules! Using Performance-based Hiring to Build Great Teams (2007).

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3 Comments on “The Financial Impact of Eliminating Your Mashup Hiring Strategy

  1. Congrats Lou on another intuitively brilliant contribution to focusing light on the dark corner where many organizations have lost their keys to the talent kingdom– making the best hiring decisions technically and practically possible.

    What you don’t say in this article is what an organization needs to do in order to shift 100 hires from the bottom third into the top third. Let’s look at it another way using the proven analytics of utility analysis.

    Just as physics has E=MC**2, selection has the utility equation, where the Profit Impact of more accurate hiring= (NHires X Average Tenure X Funnel Power X Performance Dollar Impact X Decision Power) – (Increased cost of making better hires)

    Funnel Power is a mathematical function of the number of candidates per hire. It is 0 when the number of candidates per hire is 1, and maxs out at around 3 when there is 1000 candidates per hire. There is no argument among experts on this value.

    Performance dollar impact is the average difference in the annual performance dollar value of top third vs. bottom third employees. As you point out, for some roles this is a larger number than others. For high volume craft labor, it has run at 40-60% of compensation in 20 published studies. For more highly leveraged roles (such as stock broker) one study found a 10X compensation ratio. For the sales organization you describe, a value of $75,000 is likely conservative.

    The Decision Power number is the difference in the correlational validity of the old vs. enhanced method for making hiring decisions. Let’s conservatvely pick a validity difference of .3 to reflect the published proven value available from a combination of job-related tests and structured Performance Interviews.

    THEN– Hiring 100 people into a sales organization having the characteristics you decribe (and adding an assumed average tenure of 2 years) has the following projected profit impact: 100 X 2 X 2.2 X $75,000 X .3 or $9,900,000.

    So science really can support a smart, intuitive, recruiter with a savvy sense for where the money sits on the table, waiting for someone to scoop it up.

    Finally, let’s not forget costs. Normally, we speak of ROI as (Savings – Costs)/Costs. But in the case of investing for better selection, the costs of operating a web-serviced selection system, with online registration, assessments, scheduling, and work flow is LESS than what is being spent right now on labor that yields poor results. So hiring better talent often costs LESS, meaning the cost component would be negative and ROI less meaninful than a Net Present Value for deciding to adopt selection best practices.

  2. Very nice article. I would point out that the financial impact of not having a strong recruiting strategy is felt even at “employers of choice”. To cite just one example I have seen at BountyJobs, many companies leave it to individual recruiters to keep thier own individual stable of search firms – usually based on relationship, proximity or most likely, pure coincidence. At a strong firm, the costs of not having a cohesive vendor strategy can get masked.

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