How to Calculate the Cost of Bad Hiring Decisions — and Avoid Them in the Future

While inquiring about the status of a hiring manager interview training proposal, a client told me she would get back to me as soon as they got their budget approved for next year. As part of our discussion, I asked how much they included in their budget for bad hires.

My client’s answer was that she hadn’t given this much thought, but she was intrigued by the idea. She also asked how she could figure out the cost of bad hires since it was an obvious and recurring cost, but one that was hard to put a number to. Some of the cost was taken by the legal department, but most of it was in lost performance and hard to even begin to calculate.

It’s my opinion that companies and talent professionals should be paying closer attention to the price of bad hires. Here’s what I told my client, including how to calculate for poor hiring decisions and how to avoid repeating those mistakes in the future.

Calculate the cost of bad hires with this formula

To get started on calculating a ballpark cost for bad hires, I told my client to first estimate her annual total salary expenditure for new hires. She said she would be hiring about 200 people in the next 12 months — including one-third hourly, half senior staff, and the balance managers and executives. Without doing any weighted averages, we estimated that the average compensation for each new hire was about $125,000 to $150,000 per year, including benefits and overhead. Multiplying this by the 200 new hires would result in a total first-year increase in salary-related costs of $25-30 million.

Next, I asked my client — based on her past experience — how many of these new hires would severely underperform, voluntarily leave, or get terminated in the first year. She said about 10-15%. Since the amount paid to these people is a sunk cost, one could argue that the underperforming person's total compensation should be the minimum dollar amount for every bad hiring decision. Given her company’s $25-30 million annual increase in salary expenses for 200 new hires, this is two-and-half to three million dollars that’s wasted every year. And this is a conservative estimate, since it doesn’t reflect the opportunity cost of not hiring the right person due to lost productivity and higher quality performance. But as a starting point, it’s a good floor to determine the companywide impact of bad hiring decisions.

I then suggested she could save this amount by doing just four things (shown in the graphic above) at the cost of pennies on the dollar or less:

1. Clarify expectations before approving the requisition. Performance is problematic if candidates are hired without a clear understanding of the performance objectives beforehand. Interview accuracy will soar when you ask candidates to provide examples of accomplishments most related to thoughtful and clearly stated performance objectives.
2. Don’t invite anyone onsite until the hiring manager conducts a phone screen. An exploratory phone screen focused on fit, performance, and potential can not only save time and reduce the impact of first impression bias, but only helps convince strong passive candidates that the opening is worth further investigation. This is a huge “win-win” since stronger candidates will now be seen in-person.
3. Replace the 30-minute get-to-know-you sessions masquerading as interviews with organized panel interviews. A well-organized panel interview with 3-4 people is the best way to increase assessment accuracy by reducing bias and giving everyone the chance to hear the same evidence. An unorganized panel is as much a waste of time as the series of 30-minute interviews.
4. Make sure all interviewers justify their decisions in a live formal debriefing session. Emotional decisions and bias of all kinds can be hidden in a written summary or a thumb up or down. Requiring people to explain their decisions and share their evidence with this type of multi-factor scorecard can reveal potential hiring mistakes long before any offer is made.

Since hiring mistakes are rarely budgeted but always expected as part of doing business, these four simple steps should be built into every company’s standard hiring practices. My client agreed.

The bigger idea here is that it’s essential to replace a hiring system that lets anarchy override commonsense with a practical and enforced business process for hiring. Aside from saving 10-15% of your total annual new hire salary expenditure every year, you’ll also hire a stronger and more diverse workforce.

And, bottom line, not doing this is the real cost of bad hiring decisions.

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*Photo by StellrWeb on Unsplash