What Are Employee Separations?

An employee separation occurs when an employee ceases to be a member of an organization. The turnover rate is a measure of the rate at which employees leave the firm. Well-managed companies try to monitor their turnover rate and identify and manage causes for turnover. The goal is to minimize turnover and the costs of replacing employees. Replacement costs, particularly for highly skilled positions, can be surprisingly high. For example, replacing a U.S. Navy fighter pilot may cost more than $1,000,000. However, multiple turnover rates can be calculated, and it is important to focus on the correct numbers. Exhibit presents the basics about calculating turnover rates. An excessively high turnover rate compared to the industry standard is often a symptom of problems within the organization.

Employee separations can and should be managed. Before we discuss the management of separations, however, we examine both the costs and the benefits of separations.

Exhibit

Turnover happens in all organizations. The rate of turnover can vary over time and across companies and industries. Before determining whether your turnover rate is high compared to other time periods or to other organizations, be sure you calculate it accurately.You need the number of employees exiting each month and the average number of employees on staff during each of those months. The following formula calculates this rate:

Let's consider the following situation. Over the course of 6 months, you have had 12 employees leave a department. The average number of employees in the department is 50. Given these numbers, your annualized turnover rate is:

12/50 X 12/6 = 0.48

Over the 6 months your turnover rate has been 24 percent; however, the formula indicates that this rate is 48 percent on an annual basis.

Knowing the overall turnover rate can provide a rough comparison point. However, breaking the overall rate down into various components can help you to understand the sources for turnover and help to determine whether you have a problem. A helpful way of breaking out the overall rate is to use the categories as shown in figure below.

"Source of turnover" refers to whether the employee decided to leave the organization (voluntary) or management made the decision to end the employment relationship (involuntary). "Type of turnover" can be divided into people who left the organization (external) and employees who left the job but took another position in the organization (internal).

You can calculate turnover rates for each of the four cells in the source-by-type matrix. A high rate of turnover that is voluntary and external, a high quit rate, could be of particular concern and be symptomatic of organizational problems.

The Costs of Employee Separations

The cost of turnover can differ across organizations, and some costs associated with turnover can be difficult to estimate. For example, an organization's geographic location may necessitate a particularly high cost of recruiting new employees, which causes the cost of turnover in that organization to be unusually high. The effect of lost talent on sales, on productivity, or on research and development all may be tremendous, but difficult to estimate.

Employee turnover affects the bottom line. A recent survey of over 200 insurance brokerages demonstrates the relationship between employee turnover and firm profitability. The brokerages were arbitrarily divided into two groups: those with profitability that exceeded 20 percent of sales and those with profitability under 20 percent of sales. Employee turnover in the lower-profit group was approximately twice as high as turnover in the higher-profit group. The profit level in the high-profit group was 30.3 percent of sales, and the profit level in the lower profit group was 11.4 percent of sales. Although turnover might not be the only cause of these profit levels, these findings indicate that employee turnover is an important factor in bottom-line performance.

Unfortunately, organizations can find it difficult to reduce employee separations when turnover is part of the system. The Manager's Notebook, "Voluntary Turnover in China," is part of the business reality in China.

It is common to estimate the cost of turnover from a conservative 25 percent to 300 percent of the lost employee's annual compensation. 10 Looking at the most conservative end of that range, at an average salary of $30,000, the cost of a turnover would be $6,000.

For a company with 1,000 employees and a 20 percent turnover rate, the annual cost of turnover would be at least $1,200,000-not a trivial cost, and it could be much higher depending on the situation. Following figure presents only some of the costs associated with replacing an employee. The costs can be categorized as recruitment costs, selection costs, training costs, and separation costs.

Recruitment costs

The costs associated with recruiting a replacement may include advertising the job vacancy and using a professional recruiter to travel to various locations (including college campuses). To fill executive positions or technologically complex openings, it may be necessary to employ a search firm to locate qualified individuals, who most likely are already employed. A search firm typically charges the company a fee of about 30 percent of the employee's annual salary.

Selection costs

Selection costs are associated with selecting, hiring, and placing a new employee in a job. Interviewing the job applicant includes the costs associated with travel to the interview site and the productivity lost in organizing the interviews and arranging meetings to make selection decisions. For example, a law firm's decision to hire a new associate may require the participation of many junior associates as well as senior partners who may charge clients hundreds of dollars per hour for their time.

Other selection costs include testing the applicant and conducting reference checks to make sure the applicant's qualifications are legitimate. Finally, the company may have to pay relocation costs, which include the costs of moving the employee's personal property, travel costs, and sometimes even housing costs. Housing costs may include the costs of selling one's previous house and the transaction costs of buying a house in a more expensive market.

Training costs

Most new employees need some specific training to do their job. Training costs also include the costs associated with an orientation to the company's values and culture. Also important are direct training costs-specifically, the cost of instruction, books, and materials for training courses. Finally, while new employees are being trained they are not performing at the level of fully trained employees, so some productivity is lost.

Separation costs

A company incurs separation costs for all employees who leave, whether or not they will be replaced. The largest separation cost is compensation in terms of pay and benefits. Most companies provide severance pay (also called separation pay) for laid-off employees. Severance pay may add up to several months' salary for an experienced employee. Although length of service is the main factor in determining the amount of severance pay, many companies also use formulas that take into account factors such as salary, grade level, and title.

Less frequently, employees may continue to receive health benefits until they find a new job. In addition, employers who lay off employees may also see their unemployment insurance rates go up. Companies are penalized with a higher tax if more of their former employees draw benefits from the unemployment insurance funds in the states in which they do business.

Other separation costs are associated with the administration of the separation itself. Administration often includes an exit interview to find out the reasons why the employee is leaving (if he or she is leaving voluntarily) or to provide counselling and/or assistance in finding a new job. It is now common practice in larger firms to provide departing employees with outplacement assistance, which helps them find a job more rapidly by providing them with training in job-search skills. Finally, employers incur a cost if a position remains vacant and the work does not get done. The result may be a reduction in output or quality of service to the firm's clients or customers.