The New Hire Formula: How Executives and HR Managers Determine The Potential Value of a New Hire

Okay, quick test: To grow your revenues $2 million, $20 million, or $200 million how many new employees would you require? How much incremental profit do you generate with each quality employee that you hire? Do you know?

In this post, we will walk you through a simple formula for “New Hire Value” that will become your BFF in assessing and presenting the value of various profit-generating hires. 

What is “New Hire Value?”

“New Hire Value” is the total dollar value of additional profit that will be generated by the business as a result of the addition of a new employee over that employee’s tenure with the company. In other words, if I hire and retain this person, what value will he or she bring to the organization?

The formula for “New Hire Value” in its most basic form is the difference between how much profit is generated by the employee annually for the company minus the cost to employ that individual all multiplied by the number of years that the employee is with the company.

The Five Components of “New Hire Value”

To calculate “New Hire Value” we combine five simple variables. These variables are:

• Additional revenue per new employee (Rev)
• Company gross profit percentage (GP%)
• Annual cost of new employee (EmpCost)
• Average years tenure for employees at the company (Yrs)
• One-time capital costs per new employee (OneTimeCosts)

Additional Revenue Per New Employee (Rev)

The first question we want to answer is: “If I add this new employee, how much new revenue will my company be able to add to the business?”

To identify a rough estimate of the additional revenue achievable with a new hire, there are a few approaches:

1. Divide your total revenues or sales by your total number of employees – this estimate would give you the roughest estimate of additional revenue per new employee
2. Divide your total revenue or sales by your revenue-generating employees only – these employees may be your production workers or your total employees minus your administrative employees
3. If you know how much revenue a specific team can produce, divide your total sales per team by the number of team members – you can even adjust that value up or down based on the expertise or skill level of the new employee in question
4. If you have or develop a more specific calculation of individual employee revenue, use that number

Company Gross Profit Percentage (GP%)

The second question that we are looking to answer is: “If my employee generates this amount of revenue per year, how much of it does the company get to keep?”

Gross profit is defined as “the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services.” 

You can easily calculate your gross profit percentage by dividing your gross profit amount by your sales. This percentage should give you the answer to the question above (when multiplied by your revenue amount). 

If you are interested, after calculating your own gross profit percentage, you can easily benchmark that gross profit percentage against other businesses in your industry using the financials of public companies or by using online resources.

Annual Cost of New Employee (EmpCost)

The third question we are looking to answer is: “If my employee generates this amount of profit for the company each year, how much is left after we subtract his or her cost of employment?”

Your annual cost of this new employee should include your annual compensation to the individual (including expected overtime) plus the full burden of payroll taxes, workers’ compensation insurance, bonuses and benefits. This cost generally represents an approximate 30% to 50% additional cost on top of the individual’s compensation.

Average Years Tenure for Employees at the Company (Yrs)

The fourth question we are determining is: “If we know how much profit is left after each year (including the cost of employment), how many years should we expect this person to be employed by our company (and, therefore, for us to generate this profit stream)?”

Average years tenure is the number of years your quality employees are likely to stay with your company. If you have a sense of historical averages for your company or this division, use that number. The Bureau of Labor Statistics provides a national tenure average (as of 2016) of 4.2 years (Source). 

There is less value in assuming terrible tenure expectations for your new employee, because that is not the type of employee you should be targeting to employ. You can always adjust down this value to see the effects of lesser tenure on your total new hire value.

One-Time Capital Costs of New Employee (OneTimeCosts)

The fifth question we are exploring is: “If we know the total profit generated by our employee over his or her tenure, how much initial cost is there in capital expenses to get this new employee into that position?”

One-time capital costs for the new employee include personal protection equipment, tools and/or any additional equipment that is required to get the new employee set-up to do his or her job. You could also include any one-time training or certification costs in this category as well.

The Complete “New Hire Value Formula”

The actual “New Hire Value Formula” is pretty self-explanatory based on our description above, but let’s walk you through it now in its entirety.

New Hire Value Formula:

(((Additional Revenue Per New Employee x Gross Profit Percentage) – Annual Cost of New Employee) x Average Years Tenure for Employees At The Company) – One-Time Capital Costs of New Employee = New Hire Value

Or using the abbreviations above:

(((Rev x GP%) – EmpCost) x Yrs) – OneTimeCosts) = New Hire Value

How Is “New Hire Value” Useful?

Let’s put it to work!

• If your “New Hire Value” is negative, it means that you are paying too much for the new employee or he or she is not creating enough value. If this is the case, do not hire this person or know that you must reduce your costs (i.e. compensation or upfront costs) somehow. This tool can often help people rejigger their compensation packages, direct costs or their pricing to ensure that they are creating sufficient value.
• In most cases, your “New Hire Value” is positive and much higher than people expect. Growth sometimes seems like a pain to achieve, but it is exciting to see just how valuable it can be. This value is available to your businesses, if your team chooses to pursue it.
• By playing with your company’s Average Years Tenure, you can quickly see through your revised “New Hire Value” how much value is created through better hiring and retention strategies or how much value is destroyed through poor retention and high turnover.
• Calculate your Hiring Return On Investment (HROI) – By dividing your ‘New Hire Value’ by your hiring costs (which may include advertising, internal recruiting costs and outsourced staffing and recruiting services), you can get a feel for what multiple of those costs you can achieve by adding that new hire.

With the formula described above, you should now have the basic tools to look within your company and determine a “New Hire Value” for your various positions.

As is likely, if your “New Hire Value” is positive and represents an attractive value-creation opportunity for your business, get out there and find the extraordinary people that you need to capture that value. While the job market is tight for certain position and skill types, don’t give up. We suggest downloading our e-Guide “10 Steps To Optimize Your Outsourced Staffing Services” to learn how to build an efficient hiring engine to grow your business.

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