Asset management

8 May 2006

How much money should you throw at an employee when they threaten to quit? Should you be thinking about outsourcing jobs? Are your people an asset or a payroll overhead? Welcome to the P&L of People

Accountants look at them as overhead, HR professionals see them as assets that need to be nurtured, and line managers focus on how effectively they get the job done. Everyone has a view on employee cost and value - the problem is that they rarely agree on the conclusions.

Few entrepreneurs would disagree that huge value is locked up in their employee base, from the skills, knowledge, creativity and experience of each individual to the relationships they forge with customers, partners and suppliers. By the same token, everyone recognises that the payroll run and direct costs associated with employees are one of the fastest - sometimes the fastest - drain on cash. Balancing those two conflicting forces - the asset versus the overhead - can get complicated, and as a result, employee-related management decisions are often tough to call. If one of your key employees were about to quit, you might ramp up their package to tempt them to stay - but how far would you be prepared to go?

The real cost of hiring and retaining employees

Working out employee value tends to start with the cost base - and even here, the equations can get complicated. True, the direct outlays such as salary, benefits and company national insurance contributions are all transparent. But after that, the details get a little fuzzy. Much of the associated overhead - the insurance, the cost of the space they occupy, the furnishings, computer equipment, networking and so forth - tends to get rolled up into broad overhead categories for accounting purposes, with an average allocation made per person. There's nothing wrong with this approach - your time is far better spent driving down the real cost of insurance and IT equipment than worrying about how to allocate each item to individual employees. But there are times when it pays to have a more granular insight.

A few years ago, the Royal Bank of Scotland studied a wide range of factors that come into play when an employee quits, from the direct costs of hiring and training a replacement to the associated productivity drop. It concluded that it typically costs one year's salary to get a new person up to speed. If you were to assess your own senior employees, the answer might not be that different.

To begin with, there are a number of costs associated with the actual recruitment process, such as advertising or agency fees, administrative overhead to manage the process, and the cost of management time in interviewing. You then need to train the new recruit (both through formal courses and on-the-job training, which eats up other employees' time). Then there are the indirect factors. Would your R&D programme be hit if a key technical expert were to quit? What would the impact be on your customer or supplier relationships if their preferred contact left? What are the opportunity costs for other people in the organisation - how many sales could you be making, for example, if you weren't spending time talking to prospective candidates? And what's the drop in productivity while the post is vacant and as a new person comes up to speed?

All of this sheds new light on the decisions you make once someone hands in their notice, or when you become aware that a key employee is getting demotivated. It might be worth investing a couple of months' pay to try to keep them, rather than risk losing the equivalent of six to twelve months salary to replace them. Or it may be useful to think laterally. Would they benefit from a concerted training programme so that they can develop new skills? Have their circumstances changed - through marriage or having children, for example - and if so, would they appreciate new kinds of benefits?

Seeking out cost-savings

The flipside of the retention debate is that there are probably many employee-related areas where you could save money. It's worth taking a look every now and then at outsourcing, for example. How much time are your employees spending on administrative or support tasks that could be better done by a third party service provider, such as accounting, payroll, or IT? The outsourcing equation isn't cut and dried (see 'Virtual Reality') but for many basic administrative tasks you may be better off buying time as and when you need it, rather than keeping headcount on your books.

Above all, it's important for start-ups to keep checking whether they're employing more people than they need. Corporate recovery experts generally agree that leaner is better - if you can cope without increasing payroll in the medium term, it's best to keep it that way.

By Keith Rodgers, Webster Buchanan Research