Why Employee Turnover Hits the Bottom Line; Employees leaving an organization can influence financial performance, and some of the reasons may not be obvious

March 26, 2014

CFO.com | US

Why Employee Turnover Hits the Bottom Line

Employees leaving an organization can influence financial performance, and some of the reasons may not be obvious.

John Boudreau

Most financial systems are good at measuring the transaction costs involved in separating a departing employee, finding and acquiring a replacement, and developing the new employee to a performance level at least equal to that of the one who left. Indeed, in our book,Investing in People, Wayne Cascio and I show how to calculate turnover costs, which many studies show can be 1.5 times the salary of the departing employee, or even higher.

Based solely on the cost calculations, many managers and leaders assume that the turnover rate (how many employees leave in a year divided by the total number of employees) should be as low as possible. If every avoided employee separation saves 1.5 times the amount of the employee’s salary, or more, it’s easy to calculate high returns from turnover reduction.

But recent research published in the Journal of Management suggests the actual situation may be more complex. The study offers useful insights to help leaders focus on the turnover that’s most pivotal to financial performance. The authors used an approach called “meta-analysis,” which gathers up all the studies that have examined a particular question and combines them to discover underlying patterns. (The same idea is becoming more mainstream in medical research, as described recently in The Economistarticle, “Metaphysicians.”)

After analyzing 48 studies on relationships between turnover rates and organizational performance measures, the authors, Julie Hancock, David Allen, Frank Bosco, Karen McDaniel and Charles Pierce, found:

The correlation between organizational turnover and profits is -.03, so turnover does relate to lower profits, but the direct relationship is rather modest (explaining about 0.1% of profit variation).

The negative correlations are three or four times stronger when performance is measured as customer service (-.10) or as quality and safety (-.12), which are more directly under employee control.

Quality/safety outcomes have a positive correlation (.21) with profitability, so the effect of turnover on profitability through quality/safety is approximately -.025 (the product of .21 times -.12), which is a large portion of the total effect (-.03) of turnover on profits.

An interesting finding was that the effects were not much different whether turnover was voluntary (the employee decides to leave) or involuntary (the organization dismisses the employee). Managers often think of voluntary turnover as “regrettable” or “bad” and involuntary turnover as “desired” or “good.” Dismissing poor employees may remove bad apples, but the research suggests that the level of such turnover has about the same negative association with profits as when employees decide to leave.

Why? It may be that involuntary turnover reflects mistakes made earlier in the talent pipeline (sourcing, hiring and assigning employees) that have harmful effects before they are corrected. If you’re constantly fixing selection mistakes by dismissing poor employees, that’s a drag on your organization’s performance, just as when good employees leave.

The research suggests that turnover may be more pivotal in specific jobs, such as those where it affects quality/safety. That means organizations might benefit from carefully focused investments in turnover reduction, rather than one-size-fits-all formulas that assume all turnover is equally bad. In Investing in People and Retooling HR, I havesuggested that a useful metaphor for employee turnover might be inventory turnover, where it is obvious that not all turnover affects the organization in the same way.

Organizations might also benefit from applying big-data techniques like meta-analysis to map the connections between employee turnover, quality, safety, customer service and profitability. These measures exist in almost every organization, so it’s surprising that the researchers found relatively few studies (48 independent samples) that connect them. A big-data approach to employee turnover may offer an untapped opportunity to target your human-capital investments and improve your financial performance.

John Boudreau is professor and research director at the University of Southern California’s Marshall School of Business and Center for Effective Organizations, and author of Retooling HR: Using Proven Business Tools to Make Better Decisions About Talent. He can be reached at editor@talentmgt.com.