How often have you heard or even said to yourself, “I can hire someone for $12.00 per hour to do that job.” As an executive and even an MBA graduate, I’ve made similar “back of the napkin” calculations myself when considering a business concept or business expansion only to find my estimates to be well off the mark.
It wasn’t until I started building and managing far more sophisticated financial models over the past eight years requiring a high level of forecast accuracy that I came to understand the real cost of an employee. Now everytime I hear someone say, “I can hire someone for…”, my reaction is to immediately blurt out, “Not so fast!”
It’s not that we as business leaders are stupid. Taxes, benefits, insurances are all real costs of which we are painfully aware. However, it seems we often experience what I call Accounting Allocation Blindness (AAB). AAB is a condition which occurs when all the costs associated with employing people are allocated into so many financial buckets; some fixed and others variable, that it becomes too complex a puzzle to reassemble in our minds.
Beyond base wage, there are 7 expense categories to consider.
1. Taxes and insurance
2. Health benefits
3. Hiring, training, and attrition
4. Office space and equipment
5. Supervision and administration
6. Retirement programs
7. Wellness programs and perks
To calculate the real cost of an employee, only the first five are considered in this article. Let’s also assume that we are talking about an entry level position of $12.00 per hour. All of the taxes such as Social Security tax, Medicare, unemployment and workers compensation insurance will add up to about 11.9% of wages. The costs will vary by state, but not by much.
Now add the cost of hiring, recruiting, training and attrition. If turnover rate is 18 months on average, then add 14% of wage rate to the cost. Hiring and firing have a real cost and it’s getting increasingly more challenging to attract and keep the interest of employees. For workers age 20 to 24 average tenure is less than 16 months and just over 5 years for employees 24 and older. The fact is Baby Boomers are not much different than millennials in workplace attitudes. They just happen to be in a different phase of life.
Benefits. Oh, benefits. Certainly the largest of the cost categories. Healthcare and other benefits expense vary widely based on offering and contribution levels. For our example, let’s assume an average monthly contribution of $600 per month per employee with some good vacation and sick days thrown in will add up to 34% of the base wage rate. The impact of benefits theoretically declines in proportion to wages earned, or does it? Think about other benefits typically offered to management and executive staff including additional coverage benefits, bonuses or perks.
One frequently overlooked cost category is supervision and administration. A good rule of thumb for modeling is to have one supervisor for every 6-8 employees, but make sure to include some HR, IT and accounting support for each new person on the payroll. When it’s all said and done and time is allocated, add about 23% of wages.
The most ignored cost category is office space, workstations, and supplies. Sure, these are largely fixed costs but worth considering when starting a business or expanding one. A good rule of thumb used by builders is 1000 square feet for every 5 employees. You must calculate in space for lobbies, hallways and please include adequate restrooms. A corporate office where I worked recently had very inadequate facilities. It was a pain and a waste of time to search three floors to find an open stall. As wages go up, so does the floor space, cost of furniture and so on.
Average lease rates in New York, for example, are $75 per square foot or $15,000 per year per employee. San Francisco $65, Seattle $32, Dallas $23. In my home market of Salt Lake City, the cost per square foot is a modest $21 or about $5,250 per employee per year. Now add some annual cost amortization for workstations, computers, supplies, and together it equates to about 30% of wage rate.
Other cost factors not calculated in this analysis might include software and other tools required to get the job done. Using industry standard IVR/call routing software may cost in the range of $75-$150 per seat plus minutes used. Other customer relationship management (CRM) software tools may add $50-$120 per employee. Add broadband connectivity, internal management tools, and so on… You can certainly rack up $2-5 per hour in additional costs.
Finally, after calculating all of the basic cost categories, a $12.00 per hour employee in my hometown market of Salt Lake City is $25.55 per hour. A $50,000 annual salary produces a cost of approximately $82,000. Not all cost categories rise proportionately to wages. Take a look at the chart to better understand the relationship between wage rates and the real employee cost curve.
In the context of the great debate over minimum wage rates, it’s interesting to think about the real cost of minimum wages at $8.00 per hour versus $15.00 per hour with a relative cost of $19.50 and $30.08 per hour respectively.
What we know today is that the basics don’t cut it. Wellness programs, on-site perks and retirement programs are additional dimensions employers must consider to be competitive. Attitudes and expectations are shifting. Hiring and retaining talent is critical. It’s complicated and challenging, but by better understanding the real costs, or the real needs, of the workforce, business leaders can and must be better prepared to plan and budget for success.
At Accelerant, we are taking a close look at how telecommuting and workforce virtualization can improve performance, inclusion and cost efficiencies. Workforce and workforce management is an interesting field of discovery.Technology and connectivity are opening alternative relationships between employers and employees. Solving issues of population growth, air pollution, access to employment, rural and urban economic growth will require breaking down the walls of traditional workforce management.