Factoring the Extra Cost of Hiring an Employee

Posted by Pekin Insurance on Oct 24, 2016

Whether making a replacement or bringing in new talent, the cost of hiring an employee is more than you might think.

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For the last month or two, Joe has been having some significant performance issues that never existed before. He's coming into the office late, missing deadlines, and turning in shoddy work. His manager has had one conversation with him, but Joe continues to come up short. The manager believes Joe's performance can improve but insists that the time and energy necessary to do this will cost too much in lost revenue. But is the cost of hiring an employee to replace Joe less than the cost of lost revenue?

The short answer is, probably not. That's because the cost of hiring an employee includes a lot more than just wages. In addition to annual salary, you've also got to consider the cost of recruiting, benefits, payroll taxes, and training, to say nothing of other potential costs.

New hire versus replacement

A new hire is someone who you hire to add to your existing staff, whereas a replacement is someone hired to fill an open position that was previously filled.

New hires tend to cost more than replacements for a couple of reasons. The first is that a new hire means additional costs, not replacement costs. So right off the bat, you have to add the new hire's salary, benefits, and taxes to the ledger. Combined with other hiring costs, you're talking about up to three times the base salary to hire that new employee.

Replacements aren't much cheaper. That's because even though the salary, benefits, and taxes are replacements, the other hiring costs still exist and must be calculated when determining the cost to replace the employee. 

Breaking down the costs

So what is the cost of hiring a new employee? For new hires, plan to spend up to three times the employee's base salary. For replacements, expect to spend roughly 20% of the employee's base salary. Here's how the costs break down:

Annual salary

This cost varies significantly, but for illustrative purposes, let's say the annual salary is $50,000.

Health insurance

Depending on whether or not your company subsidizes any portion of health care, insurance for a new employee can run up to $5,000 per year. Let's assume 50% subsidy and say the cost is $2,500 per year.

Payroll taxes

This figure is roughly 7% of the employee's base salary. In the example we're using, that's $3,500 per year.

Recruiting expenses

Advertising alone runs just under $1,000, to say nothing of whether or not you use a third party recruiting agency, which will usually cost 20% of the employee's base salary. That figure drops if you use an in-house recruiter, but the pay, benefits, and taxes for that recruiter will add into the cost. Let's ballpark this one at $10,000.

Training

The approximate cost of training a new employee is somewhere around $1,000, but that's assuming it only takes a week for the employee to learn enough to take over a job completely.

So for these five foreseeable expenses, the cost of hiring an employee in this situation would be $67,000—or 1.3 times the employee's base salary. 

Other potential costs

There are other expenses you have to factor in as well. If this is a replacement situation, you have to consider the cost of lost productivity and morale amongst remaining employees. The exiting employee might have a severance package, plus the cost of unemployment insurance. For a new hire, there may be travel or relocation fees, sign-on bonuses, and background/drug screening costs. That $67,000 can quickly turn into $75,000 or even $80,000.

When should I hire a new employee?

Let's return to Joe. In the case of an underperforming employee who still shows potential, it makes much more sense to foot the bill for training than to make a hasty replacement. $10,000 is a lot less than $67,000.

Of course, sometimes a replacement can't be avoided. If an employee just isn't hitting the mark and you've done everything you can to engage them, you'll likely have to invest in a replacement hire. Just make sure that you've done all you can to save the employee first. It may seem easier and cheaper to cut ties and start with a fresh face, but the cost of replacement is much higher than the cost of managing the employee to success.

Employee or contractor?

When new headcount is needed, you might consider hiring an independent contractor. An independent contractor is an individual who owns an LLC or other registered corporation and who receives payment through accounts payable and then gets a 1099 at the end of the year instead of a W2.

These individuals generally should work offsite and use their own equipment since they aren't employees of your company. This option can be much cheaper because you save money on health insurance as well as on payroll taxes since the individual is responsible for their own payroll taxes.

In short, be prudent with any hiring decisions. The cost of hiring an employee usually outweighs the cost of keeping someone around and always exceeds the cost of a contractor. If you don't need the headcount, then wait. If you can get by without replacing a role, give it a shot. You'll be saving yourself a whole lot more than an annual salary.

Save money where you can. Contact Pekin Insurance today to get a quote on your business liability insurance.

What costs have you incurred when hiring new employees? Share your experiences in the comments below.

    

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