How to Calculate the ROI of Hiring Stronger People
October 8, 2014
Question: When is a bird in the hand worth less than two in the bush?
Answer: when the quality of the bird in the bush is far better than the one in the hand.
When it comes to recruiting, the equivalent of this saying are passive candidates. While it might take more work to find and hire these people, typically getting them on board leads to an increase in talent quality, bigger ROI and a significant competitive advantage.
The trick of course is calculating that ROI and using it to support your passive recruitment strategy and investment. To help crack that, I came up with a ROI calculator model. Below you can read details on how to calculate your returns per hire and then you can use the Quality of Hire ROI calculator to play around with specific numbers. The results are quite compelling.
Basic Approach for Calculating the ROI of Hiring Stronger People
1. Determine the incremental profit contribution for a typical new hire.
Multiply the revenue per employee by the variable profit margin and you will get the average profit contribution expected for each new employee. This can be adjusted for salary by dividing average profit per employee by the average compensation. The table below shows this information for a number of different companies. The $2.40 shown for Sample Company means that a typical new hire who earns $100,000 per year would generate $240,000 in additional profit for the company. This multiplier is used to for determining the ROI for different salary levels and for different levels of performance.
2. Estimate the increased profit contribution for hiring a top-third employee.
Assuming the performance of a company’s workforce is reasonably evenly distributed, the performance of those in the top-third is about 15% above the average. For Sample Company this bumps the average profit per dollar of compensation from $2.40 to $2.75. In other words, a top-third person earning $100,000 would generate $275,000 in profit compared to a $240,000 for an average person. That is $45,000 more per year. Better: this is a gift that keeps on giving, since the person generates this additional profit every year.
3. Figure out the investment required to hire the top-third.
While there is positive profit contribution for hiring the top-third there are some upfront costs associated with it. You have to factor in paying additional recruiters, performance-based hiring training, and a possible salary premium. In our model we initially assume a 5% salary premium with the expectation that a top recruiter can fill at least 25 positions per year with a top-third person.
Here is an example to help clarify how to calculate the ROI of hiring the top-third:
- For Sample Company assume we’ll be hiring 100 people over the next 12 months at an average compensation of $100,000. This is a total of $10 million in additional compensation.
- The total variable profit contribution of this would be $24 million using the $2.40 multiplier to convert a dollar of compensation into profit.
- Total profit would increase by $3.6 million per year if the 100 people hired were 15% more productive. Over four years this equates to an extra $14.4 million additional profit.
- The total investment required to hire 100 people includes any salary premium plus the cost for 4 additional recruiters, 4 additional LinkedIn Recruiter licenses and the cost to train the recruiters and hiring managers to use performance-based hiring. In these examples this come up to $2.7 million ($2.0 million of which are from salary premiums).
- The ROI for generating $14.4 million in profit over four years at a cost of $2.7 million is 434% with a payback of 4 months. Few CEOs or CFOs wouldn’t be willing to run a small pilot to validate this type of return.
It’s pretty clear that the impact of hiring the top-third pales in comparison to the cost. Surprisingly, by emphasizing the career move rather than a compensation increase, we haven’t observed much of a compensation difference in hiring a top-third person vs. and average performer for the same job. This is why we think using performance-based hiring is a critical aspect of implementing a hiring the top-third talent program.
Contact me if you’d like to be part of small pilot to validate these assumptions and actually determine what it takes to hire the top-third on a consistent basis at your company. As a minimum you’ll discover when two birds in the bush are worth far more than one in the hand.
I’ll be presenting more on this topic during LinkedIn’s upcoming Talent Connect conference.
* image by Zack Mccarthy
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