March 2006

Profitability

The Case for Investing in Employee Engagement: How Turnover Affects Growth Rates

“The secret of success is to do common things uncommonly well,” said John D. Rockefeller. That’s a guy who knew how to turn a profit. Unlike the robber barons of old, though, modern business leaders know that profits aren’t just about driving down costs. Employee engagement is crucial to competitive advantage.

You know those various surveys determining the top “Best Employers” of the year? A new batch of them recently came out—and they provide some very interesting reading for anyone seeking to improve profitability by increasing the quality of their service to clients. The fact is, the quality of client service is directly linked to employee satisfaction. To illustrate, before we crunch some numbers on it, we’ll lead off with a little story.

If you’ve traveled much, you’re bound to have been stranded by an airline in an unfamiliar airport, in an unfamiliar city, when the flight you’re on arrives too late for you to be able to make your connecting flight. For one of us, recently traveling with colleagues, the airport was Airport Schiphol in Amsterdam, The Netherlands. The airline shall remain nameless, for reasons you’ll quickly see.

Now, Amsterdam is a beautiful city, one with incredible, cosmopolitan charms. Unfortunately, it just wasn’t the city we needed to be in on that particular day. One of our traveling companions had a hearing in federal court back home the next day, and she was frantic to get a flight—any flight—back to the States.

For the remainder of what seemed to be the longest day of our lives, we trudged from counter to counter, and from harried airline employee to more harried employees, begging, pleading and, finally, outright demanding to be placed on another plane, all the while competing with the hundred or so other angry people from the delayed flight for the few remaining seats available. To no avail.

Finally, as the sun was setting and it became all too clear that we were not going to get home that day, we admitted defeat and agreed to accept hotel rooms and seats on the first flight out the next morning. All we had to do was go to the airline’s “hotel desk” to pick up the vouchers and get directions to the hotel. This is when things got really interesting.

The directions we received to the hotel desk led to an empty hall filled with unmarked doors. We trudged from one end of the airport to the other and back, dragging all our carry-on luggage and souvenirs, without finding a trace of the elusive desk. No one seemed to know where the thing was, or if it really even existed.

Back in the hallway to nowhere again, hungry and exhausted, we were thrilled to see a man with our airline’s logo on his jacket emerge from one of the countless doors. We eagerly rushed up to him and, as a polite preamble to requesting directions to the hotel desk, asked, “Do you work for X airlines?” To which he smiled and replied, “Not until 8:00 o’clock tomorrow morning.” He then turned on his heel and strode away, ignoring our plaintive pleas for help. He was, clearly, not thrilled with his job.

So, is this how your employees treat your clients? Then you’ve got some serious management issues, but that’s not the purpose of this column. This is about how it’s costing you money.

Where Satisfaction Leads to Cash Flow

Hewitt Associates has developed a concept called “employee engagement” that is not about creating “happy” or “loyal” employees—it is about measuring the emotional and intellectual commitment employees demonstrate for the organization for which they work. According to Chris Howe, “Best employers know that a highly engaged workforce provides a strategic advantage that will benefit them in working through any current and future human resources challenge including attraction and retention.”

It is quite clear that High Employee Engagement = Competitive Advantage. (You were just waiting for us to use some sort of an equation, weren’t you?)

High employee engagement is one factor that shows that an employer is rated highly by its employees. Based on averages from recent “Best Employer” surveys (as reported in The Globe and Mail, December 20, 2005), here is the math on why you should care about increasing your employee engagement:

• The full-time voluntary turnover rate is 8 percent for the best employers versus 11 percent for others.
• The part-time voluntary turnover rate is 12 percent for the best employers versus 23 percent for others.
• Among senior leadership at the best employers, 74 percent believe that their organization is investing enough to develop the next generation of leaders versus 65 percent at other participants.
• Among the best employers’ senior leaders, 64 percent believe that their organizations have an excellent succession planning process for developing leaders versus 46 percent at other organizations.
• The 50 best employers who are publicly traded have an average compound annual growth rate of revenue (averaged over their past five fiscal years) of 16.4 percent per annum versus 6.1 percent at other organizations.
• When looking at average cash flow return (averaged over their past five fiscal years), the best employers come in at 13.7 percent per annum versus other publicly traded participants at 10.2 percent.

Of particular importance to law firms is the finding that employees of these best employers are, on average, 21 percent more engaged than employees of other organizations. In fact, the best employers have an 80 percent engagement score, compared to just 59 percent at other participating organizations, according to Hewitt Associates.

The financial implications of these numbers can be large. Let’s look at the cost of employee turnover as an example.

How the Loss of Employees Reduces the Size of the Pie

Estimates of the total cost of losing a single employee range from 30 percent of the yearly salary of the position for hourly employees (an estimate from Cornell University) to 150 percent (as estimated by the Saratoga Institute, and independently by Hewitt Associates).

According to a Mercer/ CFO Magazine study, corporations spend, on average, 36 percent of their revenue on human capital expenses. Let’s assume that law firms fall within this range (though in our experience, salary and benefits may actually be higher than this in many, or most, law firms because of their higher personal service requirement). Then assuming a 25 percent average rate of employee turnover and a cost associated with turnover equivalent to 1 times salary, the cost of turnover represents on average about 9 percent of revenue!

Using a conservative estimate that the loss of one staff person is equal to his or her annual salary, the negative financial impact of employee turnover on a law firm’s profitability immediately becomes clear. (Other articles have indicated that the actual cost of junior lawyer turnover is much higher: perhaps as high as 3 times the annual salary when you factor in senior partner mentoring time and other costs associated with training and development.)

Now, let’s look at the impact on the difference in annual growth rates.

We noted earlier that the compound annual growth rate of revenue (averaged over their past five fiscal years) was 16.4 percent per annum for the top employers and 6.1 percent for the rest of the pack. Assume that your law firm has current revenues of $1 million.

With an annual growth rate of 6.1 percent, after five years your

annual revenues would be:

Revenues = $1,000,000 x (1.061)5 = $1,344,549.88

However, if your annual growth rate is 16.4 percent, then after five years, your annual revenues would be:

Revenues = $1,000,000 x (1.164)5 = $2,136,805.05

The difference is $792,255.17 in year five alone—and you would have smaller increases in prior years as well (with larger increases yet to come…).

Time to Discuss the Dividends

All in all, the financial case for investing in high employee engagement is persuasive. This does not take into account the ancillary benefits such as enhanced leadership development in your firm, greater interest in your firm from potential new staff members (and your increased ability to easily recruit quality staff) and the overall increase in client and staff satisfaction.

What steps can you take today to make your firm a better place for your employees to work? Sit down and talk to your employees about it. It’s a conversation that will pay dividends—for yourself, your clients and, of course, your bottom line.