Employee turnover: the good, the bad, and the ugly

It is a common truism in Human Resources that labor turnover is generally bad news for a given company and that management must take precautionary measures to reduce it, or at least to keep it under control.

When there is market demand for the services performed by an employee that leaves a company, the latter finds itself with unforeseen expenses to qualify, source, hire, and “onboard” a suitable replacement.

Aside from being out-of-pocket, which is directly reflected in the balance sheet, the wound is usually deeper than that. There are hidden costs, linked to the loss of business in the area that the former employee was presumably contributing to, during both the period in which the position is open and the time it takes to accommodate the new employee and retrain him or her to reach the peak level of productivity of their predecessor. These hidden costs may also be traced back to the loss of knowledge that may leave a gap and affect other employees in the department and hinder cooperation and so forth.  These indirect costs are hard to properly quantify, but typically dwarf the direct accounting costs that are immediately felt in the cash flow statements. Estimates of the impact taken from literature range from 25% to 200% of the departing employee’s annual compensation, with the figure probably being industry or even business dependent.


A walk down Econ Street

I would like to take a stance on the topic, and suggest, that for every business model and market positioning strategy adopted by an employer, there exists an optimal value for the turnover rate, and that this is merely a performance indicator to be optimized, just as any other business metric. As a side note, a specific market positioning strategy might prove unworkable if there are inconsistencies between the model applied to manage and recruit personnel, and the spot the company is trying to corner for itself in the market. It is therefore important to keep the concept in mind when designing a business model. All else being equal, the more pronounced the undersupply of talent in a market segment, the more attention such issues should command in the mind of executives, and the higher the return on investment of retention strategies used to mitigate turnover. This statement may seem self-evident, but many a business plan has suffered the consequences of overlooking this simple fact in its financial projections.

I’d like to set out an example. Economists are familiarized with an abstract construct called the Laffer curve, a name adopted in honor of its creator, the American economist Arthur Laffer. It goes like this.

Suppose you work for the government and are charged with the noble task of maximizing tax revenue. To simplify matters, assume that you can either increase taxes, by raising fees for existing programs or creating brand new taxation schemes, or rather decrease them, to the joy of your fellow citizens. If you become too greedy and set a tax rate of 100%, you completely annihilate any entrepreneurial incentive in the marketplace, and the invisible hand of Adam Smith is suddenly brought to a halt. Tax revenue under these conditions would therefore be exactly zero.

Going to the other extreme, you can decide not to interfere and allow value creation to flow freely, by setting the tax rate at 0%. This action stimulates the economy and raises living standards, but there is no money left to fund public schools and hospitals, or otherwise take care of any impending market failure that may come your way. Tax revenue is therefore also zero in this case. As a result, given that economic activity is positive and revenue can never be negative, Math 101 states that there is a point somewhere in between a tax rate of 0% and 100%, where the resulting tax revenue is maximized.

Remaining debates on the topic might center around long term versus short term maximization, because taxes generally hinder growth, and authorities must strike a balance between current and future government financing needs, but the analysis nonetheless stands for itself as valid (and has been used in political debates, namely during the Reagan administration).


The Laffer curve applied to HR

What does all this have to do with the original topic of this post you may ask? Back to business. We can draw an analogy between tax rates and labor turnover, and use the Laffer curve as a guidance to ponder the topic. A company with a turnover rate of 100%, where all employees hypothetically leave and need to be replaced within one calendar year, would have a hard time, not only with the goal of attaining profitability, but merely with managing to subsist and remain alive as a corporate entity. I imagine we all agree that this is a bad outcome for all the stakeholders involved.

This is when things get interesting. Let’s assume we have a company with 0% labor turnover. To understand the likely effects of this second hypothetical scenario, at least in Spain, we can look no further than the public sector. As a matter of policy, public sector employees are notoriously hard to dismiss, criminal acts notwithstanding. Rather than focusing on the well-known idea that this disincentivizes employees, I would like to raise awareness of another aspect that I believe directly impacts workplace dynamics in such a context: Workplace conflicts and its impact on decision-making.

Throughout my professional career in the consulting sector, I have engaged with all sorts of clients, across many different industries, including in the public sector. I have noticed a certain pattern of behavior in the latter that I fear might be directly related to turnover, or the lack thereof. Many of the public sector clients I have worked with tend towards very hierarchical and politically charged work environments. While this might be an isolated observation, it is interesting to think about what the underlying cause may be, if the effect is indeed proven to be present.

Conflict is bound to occur in the workplace – It’s human nature. While some conflicts may be more timely resolved than others, there are always some that may remain dormant and become entrenched in daily relations, slowly poisoning the well and raising their ugly head in the worst moments. John from accounting may wage a silent war against Susy from procurement as a result of an incident that took place two years ago for example. In companies with very little turnover, this fact complicates decision-making procedures, sometimes even inhibiting sound business decisions that would be relatively straightforward otherwise.

Turnover therefore, when embraced as a source of change, helps clear the environment and ease tensions. Political enemies at the workplace, those on the losing end of such internal battles may become ostracized and leave shortly afterwards. It may be that their successors be a better cultural fit for the company and remaining employees, a form of corporate Darwinism. When turnover is close to impossible, the historical record of unfortunate clashes obstructs this natural process, and the resulting corporate structure that arises tends to suffer the consequences over time, limiting its overall effectiveness as an organization. And this, we might conclude, is a poor outcome as well.


Our approach to company culture

I currently work at Stratio. A start-up committed to helping leading organizations transform and build their digital strategy around Big Data. At Stratio, we embrace change and innovation. What we really care about is people. We rely on our employees as key drivers of the value creation process offered to our clients. While many businesses may proclaim and air bold taglines such as “employees are our greatest asset”, we actually mean it: People are our be all and end all.

Being great, means making people happy and that is our number 1 goal. We want to create a great place to work, because our future depends on it. When turnover means new opportunities, new ideas, then Stratio sees the benefits – We are always looking to attract and retain the best talent and have grown from a team of 15 to 170 in just two years. Recurrent turnover is accepted as a challenge to overcome.  We focus on fostering career growth by enabling challenging assignments or offering the proper training opportunities, while still meeting business needs. It is a balancing act and there may be mistakes along the way, but we are dedicated to the task.

Curious? Come join us. We are hiring.

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