The True Costs of Firing an Employee
The cost of letting go an employee may be higher than you think. Terminating an employee is never easy, but when inadequate performance or the lack of demand for a specific position negatively affects your business, it may be your best choice. Nevertheless, terminating employees can impact the bottom line — from COBRA and severance payments to the hidden costs of high turnover — so it behooves employers to know what termination truly entails before acting.
How much does it cost to terminate an employee?
Estimates vary, but experts agree that the cost of terminating an employee is considerable. There are many direct and indirect expenses connected with termination (more on that below) — most significantly, the costs involved in filling a newly opened position. A 2016 report from the Society for Human Resource Management (SHRM) found that the average expense to bring on a new worker is $4,129, requiring approximately 42 days to get the position filled.
Employers must acknowledge that the cost of high turnover can have a significant impact on their business. Employees have relationships and skills that can affect the bottom line, and certain positions can be difficult to fill.
It's important to note, however, that there can be positive effects of letting an employee go.
"Termination can sometimes be productive for a company. Such situations may include when having the employee on board is costing the business too much money in lost productivity and revenue. Or when that employee's presence causes distress to other employees and it has gotten to the point where that person has become uncoachable," says Shannon Anderson, Paychex HR consultant.
The direct costs of terminating an employee
When an employee leaves, there may be costs associated with COBRA requirements (if you have more than 20 employees) and paying out separation benefits such as a severance or accrued time off.
Businesses then face the challenge of filling the vacancy. This can involve covering the costs of bringing on contingent workers or paying other staff overtime to complete that position's tasks.
It takes money to place job advertisements, use recruiters, or pay for placement agency fees. There are also related staff costs of time spent interviewing job candidates and, in some cases, of paying for candidate expenses when conducting interviews. Finally, there are training costs associated with getting new employees up to speed, from conducting internal orientations to paying for training courses.
Severance pay and accrued time off
At both state and federal levels, severance pay is generally regarded as an agreement between employer and employee. No federal mandate exists stipulating that businesses offer severance pay to their former employees. Although there are some state mandates for severance pay applicable to the closure of a plant or business, most private employers are not mandated to offer severance pay.
Severance pay may be required where employees have an employment contract or union agreement in place that provides for severance upon termination. It may also be required for public employers and for employers closing a business. It's a good idea to consult with an expert who's knowledgeable in the law to determine the potential obligations.
Severance pay is typically available to employees who are terminated through no fault of their own. Examples might include employees who are let go due to mergers, acquisitions, and changes in customer demand. Typically, severance is not paid to employees who are terminated for cause or leave voluntarily.
In many cases, severance pay offered to employees is contingent upon signing a termination agreement that may contain clauses relating to non-disparagement and an agreement not to litigate against the company (sometimes called waiver and release agreements). Before creating a severance pay contingency agreement, find out whether the state where your business operates has laws that govern its content.
The Consolidated Omnibus Budget Reconciliation Act, commonly known as COBRA, allows employees who have been separated from an employer, or experience other eligible qualifying events, to continue to pay for group health benefits on their own.
Your business may be required to offer COBRA if you offer group health insurance and had 20 or more employees on more than half the typical workdays during the last calendar year. Some states also have regulations regarding continuation coverage that you should understand and implement if they apply to your business.
If the employee is enrolled in a company-sponsored group health insurance program, they may be entitled to continued health insurance coverage in compliance with COBRA or a similar state law. For those eligible for COBRA coverage, the Health Insurance Portability and Accountability Act (HIPAA) certificate of coverage (COC) must be provided no later than the COBRA election notice (44 days). If the employee is not eligible for COBRA, the COC must be provided within a reasonable time after coverage ends. Ask your health insurance provider to ensure that your company is in compliance with notice requirements to employees.
It's also customary to give departing employees a benefits-status letter that outlines any relevant information regarding the company's life insurance and retirement plan programs (where applicable). Employers in some states are also legally obligated to provide terminated employees with a notice explaining how they can claim unemployment benefits.
Hiring a replacement
As noted above, there can be many potential expenses related to recruiting and hiring a replacement employee (both in terms of hard dollars and time spent), including:
- Revising job descriptions (when necessary).
- Posting ads on job boards.
- Hiring a recruiter to find the right replacement.
- Covering travel and lodging expenses for out-of-town job candidates.
- Reviewing numerous resumes received after a job posting.
- Determining which candidates to pursue.
- Arranging interview schedules for both the candidate and your internal interview team.
- Meeting with the team to assess the most promising candidates.
- Training and onboarding, again, requiring time and effort from current employees as well as necessitating classes and seminars.
Even the best replacement employee may need time to master job responsibilities and build relationships with customers and coworkers.
The indirect costs of terminating an employee
The indirect cost of terminating an employee may be harder to quantify but can be equally or more devastating to a business. Turnover can cause a drop in employee morale and have an impact on the overall company culture. There can also be productivity losses and potential impacts to quality and customer service. Employees leaving can damage relationships with clients, industry reputation, and overall positioning of your business.
The “hidden” or indirect costs of employee turnover can be significant, regardless of the business or industry. Soft costs can be just as expensive as hard costs. These include:
Existing staff is stretched to cover the vacant position, or no one is available to fill the job, resulting in less work accomplished.
Overworked remaining staff
Those who remain must cover the duties of the open position in addition to their own jobs, which could hurt morale and risk further turnover.
Lost organizational wisdom
Departing employees take their know-how with them: job-specific procedures, information, contacts, and industry knowledge.
These can be obvious, such as sending a new hire to outside seminars or workshops. But staff time spent orienting and training new personnel can also affect your bottom line.
These losses in time and productivity mean that employee retention should figure high on your organization's priority list. Hiring the best people for the job and retaining those individuals — preserving the organization's investment — constitute the best employee turnover strategy for your business.
How to reduce the cost of high turnover
Employee turnover refers to the rate at which employees join and leave a company in a given year. Some terminations are involuntary (layoffs, termination for poor performance, etc.), while others occur when employees choose to leave an organization for other opportunities.
Some reasons for employee turnover include:
- Unmet expectations
- Conflict with management styles
- Lack of work/life balance
- Pursuit of better compensation and benefits, or an alternative opportunity
Anderson offers the following tips for improving your employee retention rate:
- Clearly communicate expectations of your employees.
- Have a handbook and job descriptions. Make sure roles are clear.
- Promote a positive company culture and make sure employees are heard and don't feel intimidated.
- Pay employees fair wages. Of course, some jobs are more highly valued than others, but you should always strive to pay employees fairly and properly.
- Solve disputes and issues promptly and fairly.
- Train your employees.
Employee retention starts on day one. With the right orientation and guidance, a new hire can overcome anxiety and feel good about an employer from the outset. Appropriate training helps eliminate a new employee's frustrations (stemming from a lack of skills or experience). In many types of business, customer service training is equally important, so employees understand how to act with courtesy and understanding in the face of customer complaints.
In addition to proper customer service training, give employees authority to make low-level decisions on the spot: adjusting a bill, accepting a return on a product because "it wasn't right," etc. Responding to customer complaints in the moment is beneficial for patrons and employees alike.
Get help with hiring and reduce turnover
The quality and character of the people you hire will help determine the direction your organization will take for years to come. Consider the benefits of working with HR experts who can help ensure that you have the right hiring solutions in place to make your process as efficient and effective as possible.