Cost of hiring the wrong person

In our experience companies often hire sub-optimal employees for a role due to a rush to fill the position quickly or not spending enough time vetting candidate’s personality and skill fit within the organization. HR (human resource) team is frequently tasked with reviewing tens or hundreds of resumes and short listing candidates against a job description under a timeline crunch and HMs (hiring managers) need support to free up their own bandwidth and meet committed timelines. The collective team effort sometimes tends to focus on hiring the best available candidate at that point in time rather than one that meets the minimum fit criteria, at the very least. In other words, compromising quality for time.

We also find that many companies tend to laser focus on salaries as the primary cost of hiring a resource, while in fact there are several other considerations to keep track of. Additional tangible costs may include hiring costs paid to recruiters and headhunters, jobs advertisement costs, training and professional development costs, health insurance, pension and post retirement costs, possibly severance or employment termination costs, any relocation related expenses, etc.

Furthermore, the intangible risks and opportunity costs pile up rather quickly. From negative impact on other employees’ morale to missed opportunities, poor customer experience leading to damage to sales and overall company momentum, these associated risks may be quite serious.

Let’s examine a likely scenario of hiring the wrong sales person for a mid-size software company in Pakistan. The average monthly salary for an entry-level role is around Rs. 25,000. Lets assume this new hire only stays in the role for 6 months. We estimate 6-months budgeted expenses including salary, training and advertising costs at Rs. 248,000. Assuming the salesperson’s quota for 6 months is Rs. 1,200,000 and he only secures Rs. 150,000 in orders (or 1/8th of his set quota), that would create a sales gap of Rs. 1,050,000. Adding budgeted costs and sales gap we arrive at an estimated total cost of Rs. 1,298,000 vs. a total income of Rs. 150,000 generated by the salesperson. Hence the cost of hiring the wrong salesperson in this case is 8.7x the benefit – clearly unsustainable even without factoring in negative ripple effects of loss of morale and productivity on other employees. Below is the estimate breakdown as per our assumptions.

Source: Vector Partners (Pvt.) Limited

There have been numerous studies conducted worldwide highlighting the real total costs associated with wrong hiring decisions. According to Recruiter.com the cost of terminating an employee after two-and-a-half years is approximately $830,000, based on annual earnings of $70,000. As the company scales up the cost of a wrong hire also rises. According to a study conducted by CareerBuilder.com, for US-based companies with 500 employees or less the cost is $11k, with employees between 500 and 999, the cost is $22k and for companies with more than 1,000 employees the cost is around $24,000.

In the late 90s when I was building my technology startup I was given a tip by an industry veteran to always reduce two types of churns, customer and employee and know that they are significantly correlated. I also learnt that acquiring a new customer vs. preserving existing relationship can be 10x costly and a similar rule of thumb applies to hiring a new employee vs. developing an existing one who is a sound fit for the company. Regardless of the exact cost-to-benefit ratios for individual companies, in our opinion hiring should be a strategic decision and not a tactical one. Eventually all businesses are successful or not based on the quality of teams driving them. Therefore, companies should actively avoid the penny-wise, pound-foolish routine and exercise more patience and discipline in screening and developing high ROI (return on investment) talent.