What is the true cost of an employee?

Global expansion is a time-consuming, difficult and, above all, expensive endeavor. With the costs of setting up a legal entity in a new market, the wages and salaries of the expansion team, and the service fees charged by compliance experts who provide legal advice, expenses quickly sum up.

A major cost center businesses must remember when planning their international expansion is the cost of hiring and employing local talent. In fact, employee cost varies so significantly between different countries that it might even influence a business’s decision of where to expand next.

In order to optimize their budgeting and choose the best countries for sourcing talent, businesses need to know exactly how much an employee will cost them in a certain location. But how to calculate the true cost of an employee? What factors do businesses need to consider when determining the cost of an employee?

The true cost of an employee is the total sum of different hard and soft costs. Let’s take a look at the different cost components that fall under both categories.

Hard costs of an employee

Hard costs (also known as direct costs) are costs that represent a specific expense which can be quantified in an exact amount. When talking about the true cost of an employee, hard costs include:

• Direct compensation: base salary, overtime pay, bonuses, and commissions

• Statutory benefits: PTO, sick pay, employer-paid social security contributions, and more

• Voluntary benefits: additional benefits and perks, such as gym memberships, company cars, and supplemental insurance coverage

• Payroll taxes: payroll taxes as part of an employee’s gross pay

• Onboarding costs: employee training, wages and salaries of HR and payroll team for time spent on paperwork, workplace set-up, and more

• Employee expenses: reimbursement claims for business trips, equipment, and more

• Work equipment: laptops, headsets, software tools, etc.

• Additional employee-related expenses: company retreats, group workations, and more

• Hiring costs: job posting fees, referral bonus costs, salaries of the hiring team, and external recruitment costs

Soft costs of an employee

In contrast to hard costs, soft costs are indirect costs that cannot be attributed to a specific expense. Businesses need to keep these indirect cost factors in mind if they want to calculate the true cost of an employee. These costs include:

• Overhead costs: rent for office space, utilities, cleaning fees, and more

• Cost of employee-centered business functions: cost centers like payroll and HR

• Cost of employee turnover: indirect costs like drop in productivity, time spent on training new hires, and more

• Employee absenteeism: absent employees cost money without generating revenue for the business

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Direct and indirect employment costs are subject to variation, especially when comparing employee costs across different markets. Variables that influence the true cost of an employee include:

• Industry: Different industries are subject to different regulations that impact the cost of an employee. For instance, certain industries have higher minimum wage rates than others.

• Employee location: Businesses that opt for a location-based global compensation strategy will find that employee location heavily influences how much they owe in payroll.

• Company location: Paying all the members of a globally distributed team the same salary regardless of their location usually means setting salaries and wages in accordance with the compensation standards that apply in the country or region where the company is headquartered. Depending on where the company is based, compensation levels can vary greatly.

• Company size: Company size is another factor that influences the cost of an employee. Cost structures in big companies are different from the cost structures found in small businesses. Big companies typically offer higher starting salaries and also have higher overhead expenses.

• Competition and market situation: Labor market conditions strongly impact the cost of an employee. In a market where demand surpasses talent supply, businesses are forced to offer higher salaries and more attractive compensation packages.

• Employee turnover: Many businesses underestimate the impact of employee turnover on the total cost of an employee. Research suggests that the cost of replacing an employee equals between 1.5 and 2 times the employee’s salary.

• Employee position and experience: The higher an employee’s position and level of experience, the higher the salary a business will have to pay if it wants to win the candidate. Another aspect to consider is the fact that employees gain more experience as they work for the business meaning that their compensation level will rise over time.

Knowing the true cost of an employee allows for better budgeting and enables businesses to make most of their available funds. But how to actually calculate the cost of an employee? Unless they have an employee cost calculator at hand, businesses need to go through the following steps in order to determine what the actual cost of hiring a new employee is:

1.Determine the employee’s hourly pay rate and annual salary

The first step is to determine what the employee’s hourly and annual pay would be. This includes researching local pay standards for the employee’s position and level of experience while taking into account additional industry regulations and competitive margins.

2.Calculate mandatory payroll taxes

Next, you need to add payroll taxes to determine the employee’s gross hourly pay (and gross annual salary). Also, don’t forget to factor in mandatory employer contributions to social security schemes.

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3.Add the cost of providing additional benefits

If you want to offer additional benefits and perks to your global team, you need to include the cost of these non-mandatory benefits in your calculation. Your international benefits strategy should outline what additional benefits are offered across geographies, but the actual cost may vary depending on the location. For instance, a gym membership in country A might cost less or more than in country B.

4.Estimate the hiring and recruiting costs

Costs for hiring and recruiting can be difficult to estimate upfront, especially when hiring talent abroad. You can get an idea of how much you should expect to pay by checking out the fees of some local recruitment agencies. If you want to take the direct sourcing approach, then you can use your internal cost-per-hire-ratio and add a buffer for using local recruitment channels.

5.Add expected overhead costs

Where will your new hires work? Will they work exclusively from home or will you provide an office space? If the latter is the case, you will need to factor in rental costs, utilities, costs for office supplies, and more.

6.Determine employee cost per year, month, and hour

Adding up all the costs associated with an employee over the course of a whole year delivers the total annual cost for the business. The sum can then be divided into a monthly and/or hourly rate to get an even better understanding of the expenses.

Labor costs represent a significant share in a business’s overall expenses. Although the general consensus is that payroll expenses shouldn’t make up more than 15% to 30% of a business’s revenue, there are companies whose payroll expenses reach up to 50% of what they generate in revenue. In order to maximize profits, organizations need to know how to reduce employee cost. Here are a few tips:

Allow remote work

Can a business actually save money with remote work? This question is commonly brought up in the discussion about remote work and cost savings. There are, in fact, different ways to cut costs with remote working arrangements.

For example, letting employees work from home means saving money on real estate and utilities. Additionally, the proven positive impact of remote work on employee productivity increases the business’s revenue stream.

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Leverage automation

Automation and AI are changing the way businesses operate. Automating manual tasks increases efficiency and reduces the risk of errors, including in the hiring and recruiting process. Online bots and AI can be used for assessing a candidate’s skills, experience, and qualifications. As part of an automated Applicant Tracking System (ATS), they can further reduce the time hiring managers need to spend on managing the recruitment process.

In short, the use of AI and smart technologies brings down the cost of hiring an employee, which ultimately reduces the total employee cost. The same goes for payroll. Payroll automation can significantly decrease an organization’s global payroll costs, which are among the soft costs of hiring an employee.

Hire talent where it’s cheaper

Remote-first businesses that are open to the idea of building a globally distributed team can significantly reduce their workforce expenses. Not being limited by geographical barriers when recruiting candidates for open positions allows an organization to choose hiring destinations where they can find talent at a price that matches their hiring budget.

Since wages and salaries are usually based on a country’s cost of living, hiring in markets where life is cheap brings down the total cost of an employee. Businesses just need to make sure to have a location-based global compensation strategy in place that outlines how salaries are set for international employees.

Follow a streamlined approach to international benefits and compensation management

Streamlining business processes is always a good strategy to increase efficiency and cut costs. Following a streamlined approach to managing international benefits and compensation allows for better budgeting and stops employee cost from going through the roof. This can best be achieved by developing an international compensation and benefits strategy.

With a firm compensation strategy in place, overspending on salaries and other compensation elements can be avoided. Additionally, a comprehensive benefits management framework is the basis for creating competitive benefits packages that improve talent retention and thus save the business from having to pay the cost of losing an employee.

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