The cost of employee under-performance

Aug 20 2007 by Nikos Bozionelos Print This Article

What's an employee worth? Should we measure it? Can we measure it? It is said of philistines that they know the price of everything and the value of nothing. Shrewd managers need to know both the price and the value of their employees. Indeed, it is difficult to see how they can make sound decisions without doing so.

Instead of asking 'Can/should we measure an employee's worth?' we might be better off considering: 'Can we afford NOT to know what our employees cost and what the value of their contribution is?'

A rigorous analysis of both can reveal huge financial losses or gains that depend upon employee performance.

One way of considering the matter is to ask: what monetary value should an employee add, directly or indirectly, in order that the organisation is not losing money by employing that individual?

The obvious answer would be for the individual to produce as much as he or she costs in gross income plus other benefits. But this approach is very inaccurate! Pay is only one of the many costs that an organisation has to meet. Other costs must be added: those of purchasing and maintenance of equipment, telecommunications, utilities, transport, real estate, and so on.

That's why no organisation whose employees produce, on average, monetary value that equals their gross salaries would be able to survive for any significant period of time, let alone be profitable.

So if an employee has to add more in value than the cost of their gross salary, how much more must they make? Extensive research has indicated that the income that the employee must generate so that their employment is marginally profitable is twice their gross salary.

This is commonly referred to as the rule of double. However it is only a general rule. In certain industries or types of businesses, the multiple can be even greater.

At this point we can return to the initial question we posed: what is the cost to a company of employing individuals who under-perform and what is the value of those who perform well? Both are the outcomes of selection, training and development, leadership and motivation throughout the employee's life-cycle.

The value added by a good performer is half the amount that their employer is paying them
So how can we measure the value of people to the bottom line? Organisational scientists have concluded that the monetary difference for the employer between an employee who has average performance and an employee who has good (but not "outstanding") performance equals one half of their gross salary.

So the value added by a good performer, compared to an average performer, is half the amount that their employer is paying them.

The monetary difference for the employer between an employee who has poor (but not outrageously bad) performance and an employee who has good performance equals their gross salary.

Let us now illustrate this with examples. The difference between a junior administrator earning £25,000 whose performance is 'average' and a junior administrator who is performing 'well' is half of the annual salary i.e. £12,500. However the gap between a 'poor' performer and a 'good' performer doubles to £25,000.

These differences become even greater for employees at the extremes of the performance continuum. The monetary difference for the employer between the performance of an 'outstanding' employee and an 'extremely poor' employee equals twice their annual salary.

Therefore, in the case of our previous example, the annual monetary difference for the employer between a junior administrator with 'extremely poor' performance and his/her counterpart who performs at an 'outstanding' level equals £50,000 – a significant difference to the bottom line even for a junior employee.

As levels of skill and accountability increase, these numbers become more impressive still. The annual difference between a 'good' (but not outstanding) and a 'poor' (but not outrageously bad) middle manager whose gross annual salary is £50,000 ranges from a minimum of £50,000 to a maximum of £500,000.

Similarly, the difference between a good and a poor senior manager whose annual compensation is £100,000 ranges from a minimum of £100,000 to a maximum of £1 million.

At the most senior levels, we enter the realms where the difference in skill and performance can mean the difference between success and failure for the entire organisation. This is the reason that the selection of these individuals needs to be seen as critical for most organisations.

But don't forget that even at the lowest organisational level, performance differences can translate into significant sums. For example, organisational scientists in the USA estimated some years ago that the average annual monetary difference between a 'good' and a 'poor' cleaner was US$5,800 (around £3,000). And if the number of cleaners employed is large, losses or gains can be huge.

Given that many services such as cleaning, catering and back-office services are typically outsourced by larger organisations, this raises the important question of the extent to which the value added by the specialist outsource provider is fully taken into account when deciding to outsource.

We know that such a "balanced scorecard" exercise is not carried out universally. But it is impossible to know if an outsourcing decision is correct by looking only at direct costs such as wages or the contract fee.

Once we are convinced that having higher-performing employees adds significantly to the bottom line, and can even quantify by how much, we know what return we are getting for our outlay on wages and other costs. But how do we assess 'higher-performing', and how can we be sure that those are the people we are hiring?

Management is not a precise science, but we can reduce the guesswork involved in all such areas. Indeed, given that the payroll is the single biggest item of expenditure for nearly all companies, it is extraordinary how much guesswork is still relied upon in these areas.

Questions of performance can be broken down into two types: task performance, and contextual performance. Task performance relates to technical skills: how good an accountant or software engineer is at accountancy and software engineering respectively.

Contextual performance relates more to matters such as: does the employee go the extra mile? Do they say 'yes' to additional duties to help the team out? Do they help with induction of a new member?

A supervisor's judgement has been shown to be a good indicator of actual workplace performance and this can be used to produce the traditional bell-curve distribution of poor, average and superior performers.

But this same judgement is a very poor predictor of performance at the hiring stage. A traditional, unstructured interview, the selection method that most organisations still use, has been shown to be no better than hiring people at random from the street as a means of ensuring superior performance.

When assessing one's own staff, a supervisor has the accumulated wisdom from overseeing and assessing his or her team's output, receiving feedback about them from internal and external customers and seeing the links with the unit's output. None of this is available at interview stage.

Here, all manner of irrelevant factors may be unconsciously taken into account: what someone is wearing, how tall they are, how good-looking and so on have been shown both to have a significant influence on hiring decisions, but obviously no impact upon performance.

In order to ensure the best recruitment practice, we need to look at a different range of options. Successful hiring tactics include structured interviews, work samples, intelligence (cognitive ability) testing and personality testing, all of which have been proven to be better predictors of job performance than traditional unstructured interviews.

While structured interviews and systematic testing can involve a considerable outlay, the high failure rate of most of the alternatives means that this investment will quickly be recouped.

Research carried out a few years ago suggested that if the US Federal Government used more sophisticated hiring techniques instead of relying on informal interviews, it would save itself $600 million a year – a figure that would be even greater now.

Yet more rigorous hiring practices do not have to be expensive. For example, I came across the case of a very small web-design company which uses the technique at the heart of its recruitment process. It doesn't occupy itself with checking qualifications. Instead, a candidate is left with a web problem to deal with and given two hours on the computer to come up with ideas.

It sounds obvious, but testing people for what they will actually be doing on a day-to-day basis is a highly pragmatic and effective means of identifying task competence.

It is also the case that without the diligent maintenance of procedures, standards can slip. Structured interviews have a tendency to become unstructured over time.

Of course, recruitment is only the start of the challenge: paying, motivating and managing people naturally has a huge impact on performance – particularly contextual performance - whether people identify sufficiently with the manager and the organisation to put in discretional extra effort and thought.

Nevertheless, hiring people needs to be treated for what it is – a major investment decision that has a great bearing on whether or not the business succeeds. Rigour has to be applied consistently throughout the process, from the original hire, to the management and measurement of performance, deploying proven methods to assess return on investment.

Precision cannot be guaranteed, but the scope to reduce guesswork and waste is considerable.

About The Author

Nikos Bozionelos
Nikos Bozionelos

Nikos Bozionelos is Professor of Organisational Behaviour at Durham Business School.He teaches and consults at executive level on personal and career development as well as on international and cross-cultural management.