Measuring the ROI of Leadership Development

Investing in management and leadership development is costly. It takes out of pocket investment (usually to send people programs or to bring in outside trainers) and it takes time away from working for which there is an opportunity cost. The leads to some key questions: Does leadership development really pay off? How can we measure the ROI of investments made in leadership development?

There are a number of ways to approach this issue. The Cost of Not Investing in Leadership Development = Cost of Turnover One way to get an idea of the value of investing in leadership development is to look at the cost of not investing in leadership development. The cost of not investing in the development of people is an indirect cost; it is the cost of turnover. As a company grows it is likely to outgrow the skills and capabilities of its people. A reasonable rule of thumb is that whenever a business doubles in size as measured in revenues it requires a different set of capabilities. The management challenges and issues of a $25 million dollar business are very different than the management of a business with $50 million in revenues. The same is true of a $100 million business that has grown to $200 million or a $500 million business that has grown to$1 billion. As companies grow form one stage to the next, the so-called Peter principle comes into play. This is the notion that people get promoted to their level of incompetence! What happens is that people are promoted as a company grows: A bookkeeper is promoted to Controller; a secretary become the VP of HR; A sales person becomes the VP of Sales or marketing. A shipping clerk become the VP of manufacturing

Unfortunately, they might not have developed either the advanced technical skills or the managerial skills required of the new higher level position. They begin to experience difficulties in their position. Some are terminated and replaced, while others are simply moved aside and another person is hired to perform their duties. This indicates the opportunity cost of not investing in leadership development! One way to measure this is to use a simple rule of thumb: whenever a person is replaced, the replacement cost of that person.

(Which is the cost of recruiting, selecting and training the replacement) approximates on years compensation (salary plus benefits). 1

Measuring the ROI of Training To measure the ROI of training, we will draw upon concepts and methods from the field of Human Resource Accounting, which was the area in which I did my PhD dissertation at the University of Michigan.2 We can use this to estimate the ROI of training as follows: 1-1 Current turnover (rate or) number of people terminated 1-2 Replacement cost of the position 1-3 Current cost of replacing personnel turnover Pre-training Compared with 1-4 Turnover rate after training 1-5 Replacement cost of the position (same as 1-2) 1-6 Revised cost of replacing personnel turnover Post-training 1-7 Difference between 1-3 and 1-6 divided by Investment in Training For example:3 1-1 Current turnover (rate or) number of people terminated = 100 1-2 Replacement cost of the position (average) =$50,000 1-3 Current cost of replacing personnel turnover Pre-training: $5,000,000 Compared with 1-4 Turnover rate after training =80 1-5 Replacement cost of the position (same as 1-2) =$50,000 1-6 Revised cost of replacing personnel turnover Post-training: $4,000,000 1-7 Investment in Training $100,000 1-8 Difference between 1-3 and 1-6 divided by Investment in Training: ($5,000,000-$4,000,000=) $1,000,000/$100,000=1000%. Use any number you wish! You will see that the potential ROI of training can be very significant! Return Required to Break-Even on this Investment

Source: Eric G. Flamholtz, Human Resource Accounting, Second Edition Revised and Expanded, Jossey-Bass publishers, Inc., 1989. 2 See Eric G. Flamholtz, The Theory and measurement of An Individuals Value to an organization, unpublished PhD dissertation, 1969. This dissertation was co-winner of the McKinsey Foundation for Management Research post-Doctoral Fellowship Award for 1969. 3 For simplicity, I am ignoring present value or discounting, but the underlying principle of this illustration the same.

We can also use this formula to calculate the required breakeven on our investment in training and development. For example, by how much does turnover need to be reduced for us to breakeven on this investment? The answer is 2 people: 1) The average Replacement cost of the position is $50,000 2) The investment required on training is $100,000 3) The breakeven point is to reduce turnover by 2 people: $100,000/$50,000 = 2. If the training reduces turnover by two (2) people, the investment will break even. 4 Be sure to visit our Leadership Training and Development and Coaching for more information on programs offered by Management Systems.

Obviously different numbers will lead to different results, but the ROI method is the same.