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Cost of Turnover

See also:
Hire For Traits, Not For Talent
Corporate Zombies: Combat the Rise of Unengaged Employees
Millennials: The Hippies of the 21st Century
Turnover in Collections is Destroying Your DSO

Cost of Turnover

If you take a look at any company’s income statement, you will notice that one of the largest expense items is salaries or compensation. While companies require employees to conduct business, it is expensive to have them. What happens when those employees leave? Many times, companies do not calculate the cost of turnover and how it impacts the bottom line.


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What is the Cost of Turnover?

The cost of turnover is the cost associated with turning over one position. This calculation includes the cost of hiring for that position, training the new employee, any severance or bonus packages, and managing the role when it is not filled.  Every company will experience some turnover. When a company has high employee turnover, they risk impacting the profitability of their organization, the culture, and the productivity.

Every organization should strive to retain their employees for as long as possible. If they see a uptick in employee turnover, then they should take action to reduce turnover and improve retention. This results in more efficient operations and higher profits.

How Turnover Impacts Profitability

Previously, we mentioned that turnover impacts profitability. There are various ways employee turnover impacts the profitability of a company, including employees picking up duties (overtime pay, injury, exhaustion, decrease productivity), the cost of hiring a new employee, and the overall state of the company’s culture. For example, a company that has a heavy presence on the web looses its marketing director. The current employees will have to figure out what that position actually did, pick up extra responsibilities, work overtimes, etc. If it was a planned departure (more than two weeks), then the transition may be more smooth; however, if it was an unexpected departure, then the company will be in a bind.

Now, it’s time to fill that vacant role. That takes time – especially, if you are slow to hire and quick to fire. In addition, the current hiring process is not cheap either. No matter where that employee lies on the income statement – in COGS or SG&A – employee turnover has a huge impact to the bottom line. Either, you experience a sales person that is not selling (decreased revenue and increased costs) or a support person that is just increasing costs.

Calculate the Cost of Turnover

So, how do you calculate the cost of turnover? First, know the primary costs that are associated to turnover 1 position. Those include, but are not limited to, the following:

  • Cost of hiring
  • Cost of training and/or onboarding
  • Any severance or bonus packages upon departure
  • Loss in productivity during vacancy
  • Errors in customer service
  • Loss of engagement from other employees

Use the following formula to calculate the cost of turnover:

Cost of Turnover = (Cost of Hiring + Cost of Onboarding and Training + Severance + Loss in Productivity) * Number of Employees Lost

Focus On Employee Retention

Turnover impacts profitability, so it is important that you focus on employee retention. There are several reasons to focus on employee retention, including consistency, the bottom line, culture, and reputation.

Learn how to be a financial leader who increases employee retention in their organization with our execution plans, whitepapers, webinars, office hours, and so much more in the SCFO Lab.

Consistency

Consistency is key in any company. If your company is experiencing turnover in a client facing role, then turnover will cause more problems than profitability. For example, a consulting agency has 5 project managers in a year. The clients do not know who is there project manager or if anything is getting dropped or who to contact. It’s simply frustrating. In another example, a company looses all of its experienced team members within a few months. Now, they have new employees that are not familiar with the process, systems, team, or company. It will be hard for that company to gain any momentum without a consistent staff or a staff dominated by rookies.

Bottom Line 

On average, every time an employee leaves, it takes 6-9 months of salary to find a replacement. For example, if a person leaves and made $40,000, that’s anywhere between $20-30,000 of hiring and onboarding costs that were not previously anticipated. If you lose a higher level employee, then expect to pay more. The cost of turnover makes a dent in the bottom line.

Culture

How can you establish a company culture when your workforce is constantly changing? Establishing a good culture is difficult to do, but establishing a culture when there is no consistent workforce is near to impossible. We have seen how culture impacts the financial results of the company.

Reputation 

Beyond company culture, high employee turnover impacts the company’s reputation. Job seekers research the companies when applying to a position. If you cannot retain employees, then what does that say about your company? Your brand and reputation will be impacted by turnover. Unfortunately for the company, there are online resources such as Glassdoor that give employees and ex-employees a platform to give honest feedback about the company.


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Employee Retention Definition

The employee retention definition is the company’s ability to retain its current employees. If a company has a 95% retention rate, it means that the organization retained 95% of its employees for the given period. Every company should strive to improve their employee retention rate as it influences the culture and impacts the company’s profits.

Effective Employee Retention Strategies

The following includes effective employee retention strategies.

Establish Clear Goals and Expectations

First, establish clear goals and expectations. Employees become frustrated when they are unsure as to what their duties and expectations are. Communicate clearly with your team what your expectations are and what their responsibilities are. In addition, make goals together as a team. They will be more attainable, and everyone will be on the same page.

Offer Competitive Benefits

Among many reasons, studies rate salary as a top reason why employees leave a company. If your company is not able to exceed competitive benefits, then at least offer comparable benefits. Remember, salary is not the only reason why employees leave.

Culture

Culture is proven to impact the financial results of an organization. Establish a company culture that makes it enjoyable for your employees to work there. Some companies like Zappos are extremely customer centric. Other companies may offer flexible working environments (remote work, flex desks, etc.). Moreover, create a culture of open communication. The #1 reason why someone leaves a company is not because of salary, but it’s because of the manager. If there is an issue, fix it the first time you hear about it.

Value Employees 

Above all else, make your employees feel valued. If an employee works 40 hours a week, then you (the company) take approximately 24% of their time up by work alone. And if that employee sleeps an average of 8 hours a night, then about 57% of their week is either working or sleeping. Then the remaining 43% is spent eating, running errands, and spending time with family and friends. With such a significant amount of time at the office, reassure them that their work is valuable. Show them how they are contributing to the bottom line.

Start addressing turnover by recruiting a star quality team that is right for your organization. Determine which candidates are the right fit for your company, and click here to access our  5 Guiding Principles For Recruiting a Star-Quality Team.

Cost of Turnover

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Cost of Turnover

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Theory of Constraints

See Also:
Total Quality Management
Activity Based Management
How to Manage Inventory
How to Manage Your Banking Relationship
Malcolm Baldrige National Quality Award

Theory of Constraints Definition

Theory of Constraints is a broadly applicable approach to managing business operations within an organization. Basically, the theory of constraints is a management philosophy designed to help organizations achieve their goals.

The idea is to identify the goals of the organization, identify the factors that hinder the achievement of those goals, and then improve the business operations by continuously striving to mitigate or eliminate the limiting factors.

The limiting factors are called bottlenecks or constraints. At any given time, an organization is faced with at least one constraint that limits business operations. Typically, as one constraint is eliminated another constraint will arise. The organization should then focus its attention on the new constraint. And this process repeats itself continuously.

According to the theory of constraints, the best way for an organization to achieve its goals is to reduce operating expenses, reduce inventory, and increase throughput. The theory of constraints includes three core principles, six steps for implementation, and a five step thinking process.

Dr Goldratt’s Theory of Constraints

The theory of constraints was formalized and introduced by Dr Eliyahu Goldratt in the 1980s in his book The Goal. Goldratt subsequently published other books and gave seminars and workshops on the theory of constraints. Also, other papers and books have been written about the theory of constraints by other authors.

Theory of Constraints Core Principles

The theory of constraints has three principles. These three principles are: convergence, consistency, and respect.

The convergence principle implies that a complex system is simpler to manage because an adjustment or correction to one aspect of the system will impact the whole system. The consistency principle implies that any internal conflict must be the result of at least one flawed assumption. And the respect principle implies that humans are inherently good and deserving of respect even when they make mistakes.

Theory of Constraints 6 Step Implementation

Step 1

There are six steps for implementing the theory of constraints. The first one is to identify a measurable goal. This is typically defined as throughput, or the amount of products or services produced and sold to customers. Basically, the goal is some concrete objective that involves the company’s success and profitability.

Step 2

The second step is to identify the bottleneck. This is any constraint that limits the production process. The constraint can be internal, such as a flaw or shortcoming in the production process, or it can be an external hindrance, such as a competitor or some other influential market force.

Step 3

The third step is to exploit the bottleneck. This means making sure the bottleneck is being put to its most profitable use. If the bottleneck is some slow machine that cranks out two types of products, a very profitable product and a less profitable product, you should make sure the machine is always working on the more profitable product.

Step 4

The fourth step is to subordinate all other factors in the operation to the bottleneck. This means optimizing the production process to the pace of the bottleneck. If the production process involves three machines, one can crank out 10 products per hour, another can crank out 20 products per hour, and the third can only crank out 3 products per hour, then you must operate the first to machines so they produce only 3 products per hour to keep pace with the bottleneck machine. This reduces excess inventory.

Step 5

The fifth step is to increase the capacity of the bottleneck. For example, referring to the previous paragraph, if the bottleneck can only produce 3 products per hour, then you should try to increase that output rate. Perhaps by outsourcing that phase of production, or by purchasing two more of those machines to increase output. Basically, you’ve identified the constraint, and this is the step where you mitigate or eliminate it – alter the process so this factor is no longer a constraint.

Step 6

And the sixth step is to start the process over with the next bottleneck. There is always at least one factor limiting the process. When you successfully manage that factor, another bottleneck will arise as the constraint. Implementing the theory of constraints method of process improvement is a never-ending endeavor.

TOC Six Steps

Below is the TOC six steps:

1. Identify the goal
2. Identify the constraint
3. Exploit the constraint
4. Subordinate operations to the constraint
5. Increase constraint capacity
6. Repeat with a new constraint

Theory of Constraints Thinking Process

The theory of constraints also includes a 5-step theory of constraints thinking process designed to organize the thought process involved in approaching a bottleneck and trying to resolve the problem relating to the constraint.

The five steps are as follows:

First, the people involved must agree on the problem. That is, they must all agree which factor is the bottleneck.

Second, the people involved must agree on what sort of solution is required. This could be something like increasing the output of machine number three in the production process.

The third step is to get everyone to agree that the solution will resolve the problem. That is, the proposed solution is the correct action for eliminating the bottleneck in question.

The fourth step is to look past potential negative ramifications of the process.

Finally, the fifth step is to overcome any hindrances to the implementation of the solution to the problem.

Theory of Constraints Benefits

There are several benefits to Goldratt’s theory of constraints. It is an organized way to approach a business operation and to try to improve it. TOC takes the analytical and diagnostic process and lays it out into a step-by-step procedure.

Also, the theory of constraints allows the managers involved in the process to focus on the constraints in the process. It is a way to galvanize efforts and energies and to focus attention on a single aspect of the process with the intention of correcting a clear problem to arrive at a clear solution.

Also, the organization that adopts and implements the theory of constraints will be continuously striving for process improvement. This is a way to ward of inertia and complacency and will most likely result in operations that continue to get more efficient and more productive and more profitable over time.

Theory of Constraints Criticisms

Some criticisms of Goldratt’s theory of constraints include the idea that Goldratt himself treats the theory as a product to sell and he acts as a salesman. Also, some say Goldratt’s theory of constraints borrows ideas and concepts from previous studies and theories, but Goldratt does not acknowledge these contributions to his theory.

theory of constraints

Theory of Constraints Sources:

Wikipedia article – “Theory of Constraints”; www.wikipedia.com

Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.

Cox, Jeff, Eliyahu M. Goldratt, “The Goal”, North River Press, Great Barrington MA, 2004.

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