Not Investing In People Can Cost Your Startup $4M Annually.

Upon speaking with more than a hundred leaders and managers, the vast majority confronted an investment in people with skepticism and asked for guaranteed, data-proven facts showing it would work. So, I decided to calculate the millions of dollars it would cost them if they didn't.

If you've been a regular reader of OMD Ventures, then you'd know that I believe investing in people is the big misbegotten investment opportunity as most companies become predicated on the creativity of its knowledge workers. Though it may sound obvious, most companies only pay 'lip-service' to it and never execute. Most are too fearful and will only willingly execute if it will guarantee a result, easily ignoring the fact that "abnormal results require abnormal actions." The opportunity exists because it's not obvious enough to the market yet. One shouldn't expect big returns investing in what the market deems to be obvious.

Empirically speaking, an investment in people should translate to the long-term financial results of the company. Look at Zappos, Google, Atlassian, Basecamp etc... But such case studies are not good enough for most. Ignoring that most start-ups make outrageous 100% annual growth projects off of egregious assumptions (confirmed by speaking with the finance and investor folks in such 'high growth startups'), most want numbers.

Many high growth companies boast their willingness to eat up exorbitant costs in the name of growth. Yet, I do not believe many have considered the large compounding cost of not investing in their people. That's right, compound interest works both ways. Just like how one must invest now to see positive results in the future, the same can be said for not investing. The negative effects will compound too.

The common criticism with investing in people for performance is the difficulty in quantifying it. As is the case with the skeptics, when you present the upside scenario, they like to point out all the possible things that could go wrong. What if we looked at the opposite then?

Invert, always invert
— Charlie Munger

What if we examined what would happen if the organization didn't invest in people? Inverting the question.

A: “What if we train them and they leave?”

B: “What if we don’t and they stay?”

I previously wrote about motivation factors and why companies were going to lose their top performers. Because let's be honest, bottom performers won't leave when they know they are getting free money. So how much is this costing you if a top performer were to leave or if disengaged individuals stay?

How much will it cost if you did not design an organization that truly thought to incentivize its people for the long term? Let's start with the basic costs first.

How much is the financial upkeep of an employee?

The basic components to consider would be costs related to:

  • Salary

  • Employment taxes

  • Work space

  • Personal equipment

  • Benefits

Let's look at the cost of a solid knowledge worker in a technology company. Practically, every new knowledge-based company is a technology company because who doesn't use software now right? Assuming your company is looking for the best talent because who goes out advertising they are looking for "mediocre" talent, the minimum salary will be $70,000. Here is a well formulated argument made by Basecamp on why the minimum salary in the entire company is $70,000.

With a salary of $70K, how would we account for all the other related costs? Every company will be different of course. But a range I've identified seems to float the total cost of an employee (including all related costs) to be 124% to 275% of the base salary. Let's go right down the middle and say 200% for the cost of a top-of-the-line knowledge worker: engineer, designer, investor, scientist, any kind of creative role.

So, an employee with a $70K salary can cost you $140K with the very least being $87K and the most being $192K.

Cost of Disengaged/Unmotivated

According to a 2013 Gallup survey, actively disengaged employees cost the U.S. $450 billion to $550 billion per year. They found 87% of workers worldwide and 70% of employees in the U.S. (84% in Canada, 83% in the U.K.) are either not engaged or actively disengaged. On a similar note, Achievers believes only about 21% of employees are actually engaged.

Gallup defines an actively disengaged worker as someone who is “unhappy and unproductive at work and liable to spread negativity to coworkers." and they believe an actively disengaged employee costs 34% of their salary. The cost can come from several factors, per Josh Bersin they include:

  • Lost productivity—it may take a new employee one to two years to reach the productivity of an existing person.

  • Lost engagement—other employees who see high turnover tend to disengage and lose productivity.

  • Customer service and errors—for example new employees take longer and are often less adept at solving problems.

  • Cultural impact—whenever someone leaves, others take time to ask why.

Now assume x% of your total workforce is disengaged. The bigger the number of employees the bigger the %. It's intuitive common sense here as bigger companies have more fat, care less about their employees and are just filled with bureaucracy. It's the simple Taleb argument of bigger things being fragile compared to the smaller lean-mean-fighting-machines.

Since our original example above touches upon a knowledge-based company that has a mindset to acquire the best talent, I will also assume that this company has the sane management that believes in building an effectively lean team. Not the kind of team that is ballooned with hundreds of mediocrity, paid for by exorbitant venture money. A company of 50. Let's assume that 10% are disengaged, 5 of these knowledge workers. This is a small company of knowledge workers earning $70K. Collectively, these 5 cost anywhere from $435K to $960K annually. Now, 34% of that is an additional $148K to $296K in costs from the disengaged and unmotivated. Sure, one can say that Gallup's 34% is arbitrary and it may not be same for your company. Though that is true, there is an undeniable truth that there is a cost and denying that is blind hubris.

So, for a company of 50, that pays for top talent knowledge workers, and does a great enough job to only have a 10% disengagement rate compared to the average 70-80% of most large companies..... the annual cost to the company will be around $600K to $1,200K. If this 50 person company was so poorly mismanaged despite the small size... and had even 30% disengagement.. we are looking at $1.8M to $3.6M in costs.

But that's not all.

Cost of Turnovers

From my experience, most people who leave large bureaucratic companies... or just ones that foster a culture of disengagement and ill-motivation are the top performers. Many who stay despite the disengagement are the ones who aren't willing to work at changing the company, look to exploit management's neglect and are.... plainly speaking... the mediocre performers who just clock in to do the bare minimum. You may disagree with me and that's fine. My experience comes from auditing, consulting, investing in hundreds of companies of all sizes and also having white-collar friends working in these kinds of companies.

So when people leave, you bet it's going to cost you to replace them. Let's focus on the willing departures, where the employee is willing to forgo the severance because the organization culture is so poorly managed.

Some factors to consider would include:

  • The cost of hiring a new employee including the advertising, interviewing, screening, and hiring.

  • Cost of onboarding a new person, including training and management time.

  • Training cost—for example, over two to three years, a business likely invests 10 to 20 percent of an employee's salary or more in training

There are even the not-easily quantifiable intangibles like

  • Lost relationships with stakeholders from the employee’s departure

  • Lost knowledge of existing processes that management may not know of

  • Hit on morale when a top-performer leaves a major gap in the operations

Excluding the intangibles, the pure costs to replace a lost employee with the searching, on-boarding and training costs can range from 20% to 75% of the outgoing employee's salary. This % will be much higher for the more senior/competent/importance of the particular position... to an upwards of even 213%. For knowledge-based companies, a range seems to be close to 100-300% of salary.

So, for the previous example of the above-average company that only has 5 (10%) of its employees in the unmotivated/disengaged column.... let's say 2 of the top performers leave because they are tired of 'carrying' the 5 disengaged on their back. This can cost an additional $140K to $420K in base costs, ignoring all the intangible hits to the operation that can result in lost sales. Same as before, the bigger the company, the more turnovers there will be. Hence, the costs may ratchet up even higher for operations of 100 or 150.

Cost Ignoring Loss of Upside

The final bare cost for an above-average knowledge-based company of 50 may experience costs between $740K to $4M annually if they fail to engage and motivate 10 to 30% of their total workforce. Now, there are so many assumptions at play here so it's not a concrete absolute.

However, most of the knowledge companies (i.e. tech startups) have been begging for numbers on the cost and most seem fine with throwing in tons of assumptions into their revenue projections so I think my own range may fit their forecasting criteria.

It's also great to keep in mind that, once again, this cost does not include all the intangibles related to loss of sales, and increases in operational costs for losing great employees or having existing ones sabotage the current operation.

The Obvious Bet

The best investors always make asymmetric bets. The phrase of 'big gain requires big risk' is for losers. The best investors follow "Heads I win big, tails I don't lose much."

Given the obvious and massive downside of NOT investing to build an organization that puts the success of the individuals in your company first, it would only be prudent to invest in your people earlier than later. We already know the potentially large costs of omission. So, by acting, we can work to lower such downside immediately. What this presents is the future unlimited upside of actually investing in your people. The part that is difficult to quantify but so obvious.

Per "Organizations with high employee engagement will derive benefits in addition to happy employees: The stock value has higher earnings per share, and the businesses experience 22 percent higher profitability, 21 percent higher productivity, 10 percent higher customer engagement, 25 percent to 65 percent lower turnover, 37 percent lower absenteeism, 28 percent lower shrinkage (theft), and 48 percent fewer staff safety incidents."

Once again, more assumptions but it's just obvious. Just like I don't need all the data points to tell me smoking kills. Once again, obvious.

We know what will happen if we delay or neglect to invest in people. Yet many will still do, just like how many start smoking despite knowing the negative impact. It's not for a lack of data but for a lack of caring. Let's call a spade a spade. If you aren't investing in your people now, you aren't going to until your company is on the verge of imploding or because you were never in it to build something for the long term.