"Few people realize the enormous expense involved in hiring. Worse, there’s too much emphasis on reducing the cost of hiring these people rather than the impact they can make."

At a webcast I did for LinkedIn last week on how to measure the quality of hire for new hires, one attendee asked how to measure the ROI of the people they already hired. At the time I suggested the person could use our ROI of Hiring Great People Calculator to get started.

Calculating the ROI of Better Hiring Decisions

To determine the ROI of better hiring decisions you first need to relate compensation to profitability. The strongest people obviously generate more profit than average people. The ROI of hiring these people can then be calculated by comparing how much more profit they generate to the increased cost required to hire them. Here’s how to do this.

First, look up or ask your controller the revenue per employee at your division or group. This ranges from $300 thousand to $700 thousand for most companies. For example, GE is about $450 thousand, Microsoft is about $700 thousand and DuPont is about $600 thousand. To demonstrate the ROI calculation, let’s use $500 thousand. You can make a conservative estimate of variable profit per employee by taking the average of gross margin and operating margin. For this case use 40%. This means that on average each new hire is expected to generate $200 thousand in variable profit ($500 thousand x .4). If the average salary of new hires is $100 thousand it means the profit generated per dollar of compensation is $2.00 ($200K/$100K).

It’s easy to argue that the average of the top third in any normal distribution is at least 30% higher than the average of the total group. In the sample case this means the profit generated per dollar of salary is $2.60 for the top third vs. $2.00 for the average employee. For someone earning $100 thousand a top-third person will generate a total of $260 thousand in variable profit vs. $200 thousand for an average person, or $60 thousand more per person per year. The ROI can be calculated by determining the added cost required to hire a top-third person (maybe $5-10 thousand) to generate the $60 thousand in additional profit.

It doesn’t take more than the back of a napkin to see that the ROI is well over 500% the first year. Since the acquisition cost is one time but the increase in profitability continues every year the person stays hired, the ROI is well over 1000% in subsequent years.

The ROI of Spending $10 Million or More on Salary

On a big picture level this ROI impact is even more startling. Consider that the total annual salary of 100 new hires at $100 thousand each is $10 million. For the case study example, the variable profit generated by this group on average is $20 million. This rises to $26 million if the top third is hired. The one time cost to gain this additional $6 million every year is probably a few hundred thousand in a few extra recruiters, some LinkedIn Recruiter licenses and some extra passive candidate recruiting training.

If your company will be hiring 1000 people in 2016 this is $100 million in salary and $200 million in variable profit if the quality of these people is comparable to those already hired. The company will earn an additional $60 million (every year) if everyone hired is in the top third.

Few people realize the enormous expense involved in hiring. Worse, there’s too much emphasis on reducing the cost of hiring these people rather than the impact they can make.

Determining the ROI of People You Hired in 2015

You can use this same approach to calculate the ROI of the people you’ve recently hired. For this take all (or a representative sample) of the people you’ve hired in 2015. Have the hiring managers compare these people to those already on the team and grade these people as top third, middle third or bottom third. Then figure out the weighted average (email me if you’d like us to make the calculation for you) of those above your company’s current average. For example, if 12 people are in the top third (30% better), 6 in the middle third (the same), and 2 in the bottom (30% worse), your total group is 15% above the current average. This improvement results in a variable profit increase of $300 thousand if their average salary is $100 thousand ($100k x 20 x .15). The ROI calculation might get a bit tricky since you need to figure out the incremental cost required to hire these 20 people.

More important than the ROI calculation is the value of the simple grading exercise. With this you can then figure out what was done differently to hire the top third versus everyone else. In addition, you can figure out what you did wrong by hiring the underperformers. The likely reason is the wrong strategy, ill-defined jobs, too much emphasis on active candidates or disengaged hiring managers.

Most important, though, is the recognition that hiring better people is the gift that keeps on giving.

Happy Holidays!