Beyond Employee Engagement: Understanding Employee Lifetime Value
By: Julius Uy
Tags: Employee Engagement, Leadership, Software Development, Human Resources, Startup

Quantifying the return on investment (ROI) of a software engineer is a science this lifetime is likely insufficient to solve. The amount of factors that comes into play in measuring overall ROI remains elusive. A gaping hole is likely due to companies in their nascent years having little resource to invest in people analytics. However, as the company grows, so does the factors affecting people operations, hence, the vicious cycle.

Very few studies today are done with a high degree of coverage and even less companies actually apply those results into their day to day people operations. This could be unfortunate.¹ In software engineering, monitoring is of high importance. The earlier a company detects anomalies, the less resource it incurs to recover from failures. However, because monitoring is not easily translatable to the top line or bottom line, convincing the CFO to throw in resource for such tend to fall under the mercy of intuition (and experience) rather than rigorous evaluation. (And to be clear, putting in a lot of monitoring in the first few years of a company may also end up hamstringing the company of valuable resources that could have been invested elsewhere for higher leverage.)

People Analytics come under the same vein. Everyone understands the value of people analytics but very few see it as a priority. This blog is not intended to argue for it. It is simply intended to present what we are missing and leave it to the reader to evaluate its primacy as the organization scales.

Employee Lifetime Value

Employee Lifetime Value (ELTV) is a recent concept that found its origins from Customer Lifetime Value(CLTV). At risk of oversimplifying, the CLTV is computed by subtracting the acquisition cost from the overall revenue generated by the customer.²

Calculating ELTV is far more complex because a lot of factors comes into play in people analytics. In general, we can condense the analysis of ELTV into four data points:

Acquisition — the amount of resource spent to hire the employee. Onboarding — amount of time it takes for the employee to understand the system and work on it productively. Performance — the value the employee generates Attrition — the end of employment

The graph below gives a rough sense of how ELTV looks like post acquisition:

Figure 1 — Employee Value to Cost

At first glance, he who has a keen eye would surface a few questions.

How is employee value derived? The answer is that it is arbitrary. At this point, there is not enough literature nor people analytics technique to convert productivity into a unit of measurement. One could argue that this is easier in sales where a salesperson can directly attribute his productivity to dollar value in sales. The further the staff is from sales however, the more factors are considered. For example, how does one quantify the productivity of a Staff Software Engineer or an Engineering Manager? It becomes more convoluted the further away it is. Hence, the arbitrary value in the graph must be seen in relative measure to (a) staff productivity within the same cohort and (b) employee cost.³ However, do not be alarmed. As you read on, you’ll understand why this arbitrary value remains a very good indicator of subsequent macro-level decision making within the company. What is the staircase increment in employee cost? This is the annual salary increment with an estimated promotion after three years of tenure. Why is there a productivity plateau for the employee? During the onboarding phase, the employee’s productivity increases exponentially. By onboarding, I do not mean a typical one week onboarding process. Onboarding here is defined as the amount of time it takes for the employee to understand the system and work on it productively.⁴ How is the delta between an average staff and a high performer derived? The average performer has an exponential decay in performance over a period of five years whereas the high performer has a linear performance growth.⁵ This is also arbitrary. In essence, certain employees tend to get comfortable and ending up having constant (if not decaying) contribution over time whereas high performers tend to keep challenging themselves hence is attributed with a linear growth projection.

ROI vs. Employee Performance Over Time

Below is an overview of how the relative value an employee generates to the business:

Figure 2 — ROI vs. Employee Performance Over Time

Notice that at the beginning, the ROI is negative for both the average and the high performer. This is because in the onboarding phase, the company is bleeding resource to get the staff up to speed. This must be seen in light of the cumulative ROI over time in the graph below:

Figure 3 — Cumulative ROI Over Time

In essence, it takes about a year for the company to break even.⁶ Moreover, consider Figure 2. Over time, retention of an average performing employee does not yield progressive ROI to the company over time. In general, the value he provide stagnates. On the other hand, high performers continue to grow the delta. This must then be seen in light of several inferences around macro-decision making within the company. In fact, here’s another model showing that even if the high performing employee gets double the salary increment per year compared to the average performing one, (in this scenario, an annual increment of 12% vs. 6%) the ROI he generates remains more than an average performer:

Figure 4 — ROI Impact with High Performer getting double percentage in salary increment per year

Maximizing ROI in light of the Employee Lifetime Value (ELTV)

To reiterate, the graphs above are indicative. While there’s not enough science to generate a succinct perspective, the graphs are good enough signposts to inspire general inferences.

Be Meticulous in Acquisition — Steve Jobs famously noted that A-Players hire A-Players and B-Players hire C-Players and if you don’t get your talent acquisition right, you’ll end up having a lot of B and C players and drive away your A-Players. The people that the company allows to go through the hiring door becomes a self-fulfilling prophecy. What this means is that you would rather hire three high performers than four average performers because over time, the top performers will create a halo effect to the company they’re in. Reward Your Top Performers —Retention of top performers is of vital importance to the company. While it is totally fine to have average performers go through the revolving door of attrition, a company must make every effort to retain their golden geese. These are those that produce a disproportionate amount of value to the company and every feasible effort must be made to retain them. Several articles, videos, and books have already been written around identifying top performers that a repeat discussion in this blog is unnecessary. Retention is a P1 Objective. Always— As shown in the graph above, even retaining an average performer will yield ROI to the company. Hence, a company should continue to strive in extending employee tenure. How this is done is already better discussed in books, videos, and articles elsewhere. Shorten Onboarding Time — The shorter the onboarding time, the better it is for the company, especially at a time when the company is in hypergrowth. During mass hiring, ensuring that people get productive quickly generates exponential value to the company.

Conclusion

There you have it! Beyond simply an abstract perspective on employee engagement is a sense on how acquisition, onboarding, retention, and rewarding generates value to the company. The widening gap between employee cost and the ROI they generate over time must not be ignored. While further studies are still needed to reinforce the current breadth of knowledge, the graphs above should serve as a bunch of viable guideposts towards maintaining a virtuous cycle of value for the company.

If anyone is interested to see the data points in the graph I plotted, he can access it here.

____

¹ I used could because applying people analytics too early may have an adverse effect in resource management. Applying it too late will likewise yield the same. Not enough study has been made to prescribe an ideal timing when and to what degree people analytics must be done.

² Acquisition cost involves amount of money spent on ads, marketing campaigns, etc. Some also consider the personnel cost although of course as the company scales, the personnel cost becomes negligible. Different models apply depending on the nature of the business. Hence, the reader is encouraged to read through the link for a more robust take on CLTV.

³ In essence, salary + equipment + other benefits.

⁴ I am writing this with the context of a software engineer.

⁵ Roberts, Pasha. “Employee Lifetime Value and Cost Modeling.” People Analytics in the Era of Big Data, 2016, 255–81. https://doi.org/10.1002/9781119083856.ch10.

⁶ Of course, a lot of factors come into play that could affect this. The model is simply to give a general sense of how the curve looks like and how people ops should be understood and executed in a company.