What Do Your Employees Really Cost You?

In his book No B.S. Ruthless Management of People & Profits, business coach and consultant Dan S. Kennedy presents a straightforward assessment of the real relationship between employers and their employees, and dares you to take action. In this edited excerpt, the author describes his formula for determining the true cost of your employees.

Few business owners properly calculate employee cost because they leave out several very important numbers.

Here’s how they typically do it: wages plus taxes plus benefits plus overhead. So let's say an employee is paid $12 an hour and you add 30 percent to cover taxes, Social Security, workers’ comp and so on. That puts us at $15.60 an hour. Then add the health care plan, the 401(k) matching contributions, the Christmas bonus, etc.—let’s say that calculates out to another $1 an hour.

Some owners neglect to calculate overhead, but it belongs in there because employees use up soap and toilet paper, steal office supplies, require heat and air conditioning, and take up space. If it costs this hypothetical business owner $2,000 a month for their space, utilities and supplies, and they have four employees, that’s $500 each divided by 160 work hours, or $3.12 an hour. Now we’re up to $19.72 an hour. But we're just getting started.

The first big number omitted is the do-over number -- the cost of mistakes. Consider the American automakers. These companies are awash in recalls. Hundreds of thousands of cars have to be done over. None of that cost gets taken back out of the employees’ paychecks. The company just eats it. Translation: Your employees make mistakes with zero consequences or cost; you bear 100% of the burden for their mistakes. And make mistakes they will.

Employees will make and ship defective goods, ship goods to the wrong place, pack goods poorly so they break, damage raw materials, waste materials, annoy and drive away customers, not answer the phone until the eighth ring instead of the third as instructed thus letting prospects you paid money for give up and hang up, and on and on. There's a hard cost in all this that must be factored into your employee cost in advance, because you can’t charge them for their mistakes as they happen.

Obviously, this cost varies by business, by employee and by employer. No formula for calculating it exists that I know of. But for the sake of this hypothetical example, let’s conservatively say that our pretty good hypothetical employee costs us about $400 a week from waste, mistakes and outright theft. Divide that by 40 hours, and add $10 an hour to the employee’s cost. Now we’re up to $29.72 an hour.

The next big number all the bean counters ignore is the cost of your time. You have to hire, fire, train, coach and police. Again I know of no formula, but let’s just say it’s an average of two hours a week per employee.

Now what’s your time worth doing the highest-value things you do? To be simplistic, let’s assume you make $100,000 a year divided by roughly 2,000 work hours, which makes your time worth $50 an hour. If your employee sucks up two hours of your time each week, that’s $100 divided into her 40 hours, adding another $2.50, which brings their total cost to $32.22 an hour.

The final big number is the cost of their absence and replacement. You have to cover your employees' jobs when they're absent. You do this by either having other employees short and cheat their own responsibilities to cover the absent employee or by taking your higher value time to cover it or by bringing in temps that cost double or triple your employee’s wages. Will your employees be absent this year? Of course, for at least 20 days, combining vacation, personal and sick time. Then every few years, one will quit or be fired, and you’ll incur advertising, hiring and training costs to replace them. Factor all that in: Twenty days of your time multiplied by your $50-an-hour value is $400.00 a day and $8,000 a year. Working backward, that comes out to approximately $4 an hour added to $32.22, bringing the total cost to $36.22.

And I bet you had no idea you were actually paying this employee $36.22 an hour, did you? And that’s my point: I’ll bet you’d require more of this employee and manage them differently if you did know. And now you do.