6 MINUTE READ
Calculating “cost per hire” is a very common exercise in recruitment. But just because the metric is widely used doesn’t mean it adds value.
It’s easy to see why it’s so popular. Measuring cost per hire is appealing because it’s easy to do immediately and objectively, easy to control, and it seduces everyone into thinking they are doing something positive by saving money.
But if you only measure cost and ignore value of hire then you have effectively prioritised cost over quality. You are attempting to increase your value per hire by decreasing cost per hire, not by increasing quality or contribution per hire. That doesn’t make any sense.
In all other areas of business, managers never look at costs alone. Instead they compare the costs to the value of the output that spending produced, aka Return On Investment (ROI).
Reporting hire cost without linking it to the financial impact of quality hires is simply a bad business practice. Here’s why:
It’s a distraction
Recruitment’s primary focus should always be to bring quality hires into the business. But measuring cost per hire forces your recruiters to think like accountants rather than strategic players in the company. It shifts their focus from quality to price.
What you choose to measure inevitably drives the behaviour of your staff.
- If you measure cost per hire, people focus on it.
- If you compensate people on their cost per hire metrics, they REALLY focus on it.
Risk of delivering a poor candidate experience
Overworked recruiters and low budgets can negatively impact candidate experience. A bad candidate experience will hurt your offer acceptance rates and your employer brand. Candidates can easily tell a cheap operation.
Attracting quality candidates is expensive
Gathering the resources to produce quality hires is always expensive. Great recruiters aren’t cheap and the best candidate sources like social media and referrals usually take longer and cost more than other less effective sources. It takes time to find and build relationships with strong passive candidates. On the other hand, job board ads are relatively cheap and easy to manage. But saving money in the short term can end up costing you a fortune due to a string of low quality hires. To put it bluntly, you get what you pay for.
Low cost = Slow hiring
If you cut costs by under-staffing your recruiting team, your “time to fill” will increase dramatically. These delays will mean an increase in costly vacant position days. Additionally, being slow to close on candidates who are in high demand may cause you to lose the very best ones.
Cost per hire is not externally comparable
If you are measuring cost per hire in order to demonstrate that your recruitment costs are competitive with other companies, you are in for a surprise. Not only are the formulas used by other businesses not equivalent, but getting accurate hire-cost numbers from your competitors is almost impossible.
Cost per hire almost always underestimates real costs
Almost all cost per hire efforts fail to also calculate the cost of bad hires, the low retention rate of hires, the lack of diversity of hires, and the need to terminate bad hires. Omitting these negative performance factors means you will under-report the actual costs by a significant percentage.
Using Employee Lifetime Value to track ROI
According to the Brookings Institute, 85% of a company’s assets are in the form of intangibles like knowledge and employee talent.
So it is a mistake not to measure the return on your investment in people in that same way you would with any other asset. When you do, the fundamental hiring decision shifts from “How much will this cost?” to “Who will deliver the best long-term value for the money spent?”
Measuring ROI isn’t as straightforward as cost per hire, but there is a framework that can be used to help you articulate it: Employee Lifetime Value (ELTV).
By calculating ELTV, you are in a better position to determine how best to invest in recruitment efforts for open positions.
To determine average ELTV value, you can take your company’s average yearly revenue, divide it by the number of employees who contribute to that revenue, and then multiply by the average tenure of an employee.
You can imagine your employee’s lifetime value as starting low—negative, actually—then rising to a high point and staying there for much of their tenure, before falling off to zero when they leave the company.
This is illustrated in the graph from Greenhouse below. The X axis represents time, spanning from the start date to the day the employee leaves, and the Y axis represents employee output. (Note: The numbers on the Y axis represent relative value).
A potential hire’s value is negative because they aren’t yet contributing, but you are using resources to consider and recruit them. Onboarding is a period of reduced value as the employee contributes at a low level while they learn the ropes. But, eventually, they contribute more and more, until their value rises to a net positive.
The bulk of an employee’s tenure has them contributing at their highest level, hopefully, where they stay for years. This value may have peaks and valleys, as productivity ebbs and flows in response to events in their lives, both at and away from work.
Eventually the employee may plateau and consider other employment or retirement. Once they begin their exit, their value inevitably goes down again as they focus on their transition. It finally reaches zero on the employee’s last day.
During each of these phases, the employee’s value—how much they contribute toward revenue vs the resources expended to recruit, train, and retain them—can be calculated, yielding a total lifetime value.
Instead of focusing on reducing cost per hire, recruitment teams should instead concentrate on highlighting ways to improve ELTV. These include, not only how you look for employees, but how you train them and the management style and corporate culture of your company.
Start at the beginning of your hiring process. Are there ways to improve the process used to identify quality talent and speed up recruitment? New employees who learn and adapt quickly or have greater potential will have higher lifetime value, because they start ahead of the pack. By the same token, you can streamline onboarding, to get a new hire fully contributing as quickly as possible.
Management also plays a role in maximising ELTV. An insightful manager can point out areas of improvement and give the employee the tools to increase productivity. Professional development opportunities can also raise the ceiling on an employee’s skills, letting them contribute more toward company goals.
Finally, remember that this is an employee’s lifetime value, meaning the longer they stay with your company, the greater their value will be. Steps you take to improve retention—including improving benefits plans, increasing flexibility, and pursuing incentive programs—lengthen employee tenure and therefore increase lifetime value.
Determining and then working to improve your workers’ ELTV, is ultimately much more profitable than reducing cost per hire. However, it requires managerial courage to move away from industry norms and begin tracking value per hire over time.
What about contractors?
ELTV is traditionally always calculated for permanent employees. We help our clients take things one step further by calculating the value of contractor/consultant/interim staff as well.
When drawing up a project roadmap and budget, Contractor Lifetime Value (CLTV) should be taken into consideration. Calculating CLTV could help identify opportunities to combine two roles into one or could see you hire four contractors instead of five.
The benefits of a well-calculated CLTV are that across projects, you will have less downtime, more efficient training periods, and better continuity. This ultimately translates into considerable cost savings across a project lifespan.
To clarify, here is a recent example of how we used CLTV to save a client money,
CLTV case study
A media company undergoing a transformation project. They needed to hire a Mid-Level Business Analyst for 6 months and subsequently a Data Analyst for 6 months to complete a particular project. They intended to offer both contractors £400 per day.
Project length: 52 weeks
Total cost: £104,000 (£400 x 260 days)
After we investigated CLTV in this scenario, we found the company could save money by hiring a more experienced Business Analyst who could also do data analysis. The Senior BA/Data Analyst was offered a slightly higher day rate of £500 per day.
Project length: 39 weeks
Total cost: £97,500 (£500 x 195 days)
Calculating CLTV in this instance helped see the project through to completion more than ten weeks ahead of schedule. The overall projected savings in this instance reached into the tens of thousands of pounds.