When it comes to recruiting metrics, Cost Per Hire (CPH) seems to be the go-to metric for tracking talent acquisition investment. I contend, however, that for professional services organizations, such as consulting and law firms, there is a better recruiting money metric – “Earn Out.”
In simple terms, Earn Out (EO) is the time it takes for a new hire to recoup their recruiting costs in their billable hours. EO is a step past your CPH – it relates your recruiting costs back to your business.
Before I start throwing math all around, I want to sidetrack for a few moments. In professional services, people are the product. But people are not products. They are amazing living beings that contribute much more than billable hours. They bring culture, innovation, creativity and a whole host of other unmeasurable qualities to the firms they work for and the clients they serve. So I beg that you do not read too much into the “Earn Out” metric. It is by no means a measure of an employee’s full contribution to your company. It is just simply a method for better understanding recruiting investment.
Ok, plea over. Let’s do some math!
How to Calculate Earn Out
1. Calculate your CPH. I’m using fake numbers for purposes of illustration and easy math…
2015 Recruiting Spend = $1M
2015 Hires = 200
CPH = Recruiting Spend / Hires = $1M / 200 = $5000/hire
2. Identify your Onboarding Costs. In addition to recruiting costs, your new hire will have ramp up costs such as HR onboarding, laptop allocation, benefits administration, etc. This number can vary widely depending on how efficient or elaborate your new hire onboarding process is. You may not know this number for your organization (I don’t). It’s fine to wager a guess as long as you are generous.
Onboarding Costs = $4000/hire
3. Identify your average client bill rate and average loaded employee cost rate. Once again, ballpark numbers are fine as long as you err on the side of generosity. Go low on bill rate and high on employee cost.
Average Bill Rate = $150/hr
Average Cost Rate = $70/hr
4. Calculate the average profit margin.
Average Margin= Average Bill Rate – Average Cost Rate
Average Margin = $150/hr – $70/hr = $80/hr
5. Determine your Earn Out.
EO = (CPH + Onboarding Costs)/Avg Margin = ($5K+$4K)/$80 = 112.5 hours
In this example, a new hire will need to bill for about 3 weeks before they “Earn Out”.
So why is Earn Out better than Cost Per Hire?
For starters, it helps determine which projects are more viable. If your EO is 4 months, it may not make sense to bring someone on for a 3-month project.
EO is also important when we talk to retention. The larger the span between EO and average tenure the better. For example, if your EO is 6 months and your average employee stays 3 years, you have 2.5 years of potentially billable time. Pretty good. However, if you tenure is only 9 months you will only see about 3 months of billable time. Not as fiscally good. And, not to mention, you likely have some serious organization culture issues to deal with (see earlier note about this not being all about the money).
Finally, and most importantly, it helps you justify the additional recruiting spend. A short EO means that you see a return on your recruiting investment quicker. Should you choose to invest more in recruiting, your CPH will raise and subsequently will your EO. But as long as that EO is still within your tolerable range, it will likely be worth it. The billable upside is typically factors larger than the budget increase (and that’s a topic for another article!)
For professional services organizations, the Earn Out metric is more closely aligned to the business model than Cost Per Hire. Earn Out is important to know, but not necessarily to dwell on. It helps justify recruiting expenses and make better staffing decisions, but it is only one of many inputs that go into talent acquisition planning. The true impact of the people we recruit and hire goes far beyond any money metric.