Employees are not equipment. They are not commodities and are not interchangeable cogs that you can replace with an identical one with little or no effort. Employees are what can make or break your business, so it makes sense to not only recruit the best employees you can but also to retain those employees once you have them. Often companies spend large amounts of time and money recruiting the right people just to train them and lose them to their competition within three years. But it doesn’t have to be this way. People usually don’t change jobs on a whim. It takes some level of discomfort and dissatisfaction to nudge them back into the job market.
According to many recent studies, the cost of replacing a skilled employee can exceed their annual salary. That means that if a $80,000 developer, is recruited away from your company, it will cost you at least $80,000 to replace them. Sound incredible? Read on.
The cost of replacing an employee goes farther than their salary. To understand the true cost of losing a skilled, trained employee it is necessary to understand the value that is walking out the door when she leaves. Often, the market value of skilled employees has increased since the exiting employee was hired. In growth economy like the one we are currently experiencing, the market value of a skilled employee may have increased by over 20% since you hired them, and that’s not even taking into consideration the value your company has added to them with training and experience.
In addition to their market value, by the time an employee become proficient at a skilled aspect of your business, you have invested months of training and paid that employee for the several more months to several years it takes to truly learn and understand the particular aspects of the business that they are providing a solution for. This means that when an employee is recruited away, not only will you have to replace them, but you will also have to invest the time (and salary) in training their replacement to the point that they can perform the job at the level of the employee who left. In some highly specialized industries, this could easily equal two or more years’ salary.
A growing economy translates to scarcity of employees with desired skillsets. Basic economics shows that scarcity increases value. In other words, companies are more willing to pay a higher salary than they were five years ago. This is one of the reasons your prized employee was recruited away from you…another company recognized that your employee was worth more than you are currently paying them. From your point of view everything was fine…you hired him for a salary that he was happy with, but over the past three years, his value has increased relative to the available labor market. So you gave him the standard 4% raise to barely beat inflation, but he still got recruited out from under you. Why?
The reason your competition beat you out and recruited your star employee away from you without you even knowing it was happening was because they realized that his value had increased beyond cost of living. Unfortunately, you thought you were adequately compensating him when in reality, you were failing to keep up with demand. The end result is that your employee walked and now you are facing an $80,000 bill for your failure to recognize the reality of the situation. This is an important point to understand. You are not competing with employees’ current pay, you are competing with other employers’ pay scales. Giving an employee a 5% raise when her market value has increased by 15% is not going to be seen as an incentive to stay.
But there is more to the equation than that. A smart manager will ask “Why did my star employee even start looking for a new job in the first place?” This is where reality overrides conventional wisdom. In reality, it is possible to retain good employees without getting into the “maximum salary” game. How? If you are taking care of things, she probably never would have started shopping around for a better salary.
In my years of experience, I have realized (mostly through introspection on why I, myself, left jobs) that salary isn’t really what people stay with a job for. Instead, it is what acts as a “stand-in” for other things when those other things aren’t there. When an employee accepts a job offer, it is implicit within that acceptance that they consider the compensation adequate. Otherwise, they would hold out for a better offer with you or with some other company. While growing labor market values do put some pressure on employers to increase employee pay to keep up, pay is not usually the thing that brings them to start shopping around for a new job.
What I have discovered is that employee retention depends heavily on the fulfillment of three basic needs, which I think of as the Three Pillars of Retention:
- Compensation
- Work Environment
- Engagement
It is important to understand each of these three “pillars” or retention to use them to your advantage.
- Compensattion – This is the most straightforward of the three pillars. More salary (plus benefits) equals a more desirable position. This is often considered the most important (or only) factor in employee retention. In reality, it is a distant third.
- Work Environment – Ironically, this is the most overlooked aspect of employee retention. People are people. They value a relaxed, low-stress work environment. They may not admit it, but it really does matter. Work environment also encompasses the feeling that they are progressing and being properly recognized for their contributions to the company.
- Engagement – Employees are people. They have a desire to feel that their work is filling a need and is not just “busy” work. Over the long term, they need to be a part of projects that they really care about and that are interesting enough to keep them engaged. They need a challenge that matters. This is the primary thing that makes the difference between looking forward to going to work or dreading it for most employees.
The key to understanding employee retention is actually simple. Looking at the list of three pillars, you MUST provide your employees with a SOLID showing on any two. All three are not necessary. This means that you can get by if your salary levels are below industry standard, but you had better be providing an awesome work environment and some really interesting work. If your work is dull, but you are providing a great work environment and above-industry salaries, you will retain your key employees. But if you fail to provide exemplary levels on any two of the three key Pillars of Retention, you will lose your key employees and it will cost you dearly. What many companies fail to ask themselves is “Would it cost me less to keep my current employee than to replace him or her”.
Usually, when an employee comes to their manager and announces that they “have another offer for 20% higher pay”, the money isn’t really the point. The point is that they are not happy with their current job, and if they are going to remain unhappy, they should at least get compensated for it. Once they are sitting in your office with a resignation letter in hand, it is probably too late to change their minds. This is because whatever you promise at that point is meaningless. If you offer to match the other company’s pay, then you are admitting that you have been underpaying them all along, otherwise you would let them leave without negotiating. If you promise to improve their work environment or put them on interesting projects, you are again admitting that you failed to do so in the past, so why would they believe you will do it in the future? No, by the time it gets to this point, you have probably lost that valuable employee. The time to do something was long, long before they get to the point where staying at their current job became unattractive to them. The time to do something is now.
What this means is that if you truly can’t afford to pay employees the industry standard, you should be working extra hard to provide them with an exceptionally good work environment and an exceptionally high level of job satisfaction. If they are happy and are being paid adequately (although not exemplary), they will probably never start looking for something new. By the same logic, if your work is necessarily mundane, you should be providing an awesome work environment and above-industry standards on your pay scale. The key is to never give them a legitimate reason to start looking. Once they start looking, half of the battle is already lost. From that point on you are just playing catch-up.
Failure to excel in two of the three pillar categories will result in a steady stream of employees leaving and in you incurring the constant cost of replacing them. In my experience, this is a hard-fast rule that will always result in good employees leaving when it is not followed. I say good employees will leave because these pillars seem to have a lesser impact on employees who are just coasting through life. They may lack the initiative to improve their skillsets or increase their market value, so they are usually content to put up with almost anything as long as they aren’t being held accountable for results and are getting paid. The end result is that good people leave and bad people won’t leave, so you end up retaining exactly the wrong people.
The good news is that your company DOES NOT have to pay the highest salaries to retain good people. But if it does not, it MUST provide an awesome work environment and rewarding work in its place. By the same logic, if you are paying better than industry salaries, but have mundane work and a hostile work environment, you are not on a sustainable path. You must do something about the environment or the appeal of the projects that your employees are working on if you plan to have them around in a year or two.
Two out of three. Meet it or stay above it, and you will retain your best employees, Fall below it, and you will spend way too much money to make sure that your ever-changing employees are up to the task. As the old saying goes “Two out of Three ain’t bad”. It’s your decision.