Key Takeaways
1. Employee cost is the complete amount that it costs a company to hire an individual employee.
2. Employee cost includes base salary, benefits and apportionment of the overheads of the business.
3. To reduce employee cost it is worthwhile considering how you can improve retention processes and more efficiently outsource certain tasks.
Total employee cost means all the expenses incurred by a company due in hiring an individual employee. It goes beyond the simple calculation of salaries and wages, and also covers the direct and indirect financial impacts on a business, such as benefits, taxes, training, and overhead costs associated with employees.
This cost is a major concern for businesses. According to 2024 statistics, 9 percent of small business owners listed the cost of employment as their number 1 concern, second only to labor quality.
In this article, we explain exactly how employee cost is calculated and look at what you can do to reduce employee cost.
What Are the Components of Total Employee Cost?
We can break down total employee cost into the elements listed below.
1. Salaries and wages
Salaries and wages represent the fixed and variable cash compensation that employees earn for their work. It is usually calculated on an hourly basis (wages), monthly basis or annual basis (salary) and paid according to established pay periods.
2. Equity compensation
Sometimes (usually in more senior roles) employees receive equity compensation, which is non-cash compensation. This could be in the form of stock options (the right to buy company stock at a predetermined price), restricted stock, or some other class of stock.
This can be one of the trickier elements of employee cost to calculate, as it depends partly on a vesting schedule (the point at which the individual can exercise their stock option). In principle, this can be calculated by dividing the current valuation of the company by the employee’s ownership interest.
2. Benefits
Employee benefits include medical insurance, dental and vision coverage, life insurance, and disability insurance. These are indirect costs that enhance an employee’s well-being and job satisfaction.
3. Taxes
Employers are responsible for certain taxes and compulsory contributions. In the United States, this includes Social Security, Medicare, Federal and State Unemployment taxes. These are often collectively called payroll tax.
Where both the employee and the employer pay a component, only the employer component needs to be added (as the employee contribution is already included in their salary/wages).
Employers in most jurisdictions also hold back tax as employee income tax withholding. As this is deducted from employee salaries, it is not an additional cost to be added to total employee cost.
Employers are also often required to pay for workers’ compensation insurance.
4. Retirement plans
Retirement plan contributions are a part of total employee cost. This includes employer contributions to 401(k) plans, pensions, or other retirement savings programs designed to provide financial security for employees in post-retirement life.
5. Training and professional development
Investments in training and professional development are pivotal for workforce competency. These costs can include on-the-job training, upskilling courses, workshops, or any educational programs that contribute to the professional growth of the employees.
All these programs have a cost that needs to be added to the total cost of employment.
6. Recruitment costs
When you carry out recruitment in-house, it has a significant cost, in both employee time and costs associated with advertising. There is also the cost of recruitment software to be considered.
Where you have outsourced recruiting you may pay an additional commission of 15% to 30% of the employee base salary.
7. Onboarding costs
This includes:
- Employee paperwork, including tax forms and requirements for internal policies.
- Relocation and visa costs, where the employee needs to be relocated either nationally or internationally.
- Equipment costs, especially for employees being set up anew for remote work.
8. Business overheads
In addition to costs that can be directly attributed to individual employees, there are also business overheads to be considered. The most common overhead costs include:
- Office space. Whether the company pays commercial rent or for co-working spaces, or whether the company owns the building, there is a cost that can be apportioned to employees.
- Utilities. This covers heating, water, air-conditioning, electricity and internet.
- Office equipment. This covers workstations, printers, photocopiers, and more.
Some of these costs, or some portion of these costs will be fixed, and won’t increase per employee. However, at certain thresholds, hiring more employees will increase these costs.
Which factors drive employee cost?
Clearly, the cost hiring an employee differs in different locations and industries. More specifically, employee cost depends on:
1. Location
Salary expectations and minimum wage laws vary significantly across different regions and countries, influenced by local economic conditions. High-cost cities (e.g., New York, London or Hong Kong), often require higher salaries to maintain a standard of living, affecting employee costs.
Furthermore, the supply and demand for specific skills in an area can drive salaries up or down. Areas with a surplus of talent will se lower average wages for certain positions, whereas in regions with a talent shortage, employers may need to offer more competitive packages.
3. Market conditions
In times of economic growth, wages may increase as businesses compete for talent. Conversely, during downturns, wage growth may stagnate. For roles that can be filled remotely, global competition can impact local salary expectations, especially in fields with a large remote workforce.
4. Company size and type
Larger companies often have more resources to offer competitive salaries and benefits, driving up the cost per employee compared to smaller businesses. When it comes to sector, companies in high-margin industries might offer higher salaries and more benefits than those in low-margin sectors.
5. Regulatory environment
Regulations regarding minimum wage, overtime, benefits, and workplace safety can vary by location and affect employment costs. Similarly, tax rates and structures, both for employers and employees will influence net compensation and the cost to the company.
6. Social and cultural expectations
In regions or industries where work-life balance is highly valued, companies might need to offer more flexible working conditions or additional benefits. The norm for certain benefits (like healthcare, retirement plans, and paid time off) varies by region and can significantly impact total employment costs.
How Does Employee Cost Differ Between Sectors
The data below released by the US Bureau of Labor Statistics at the end of 2023 shows how employee cost, and its make up, differs across sectors. Note:
- Benefits make up about one third of total employee cost in the United States.
- Benefits are a bigger component of employee cost in the public sector than in the private sector.
- While leave entitlements are stable, it is health insurance and retirement plans where public sector workers are much better off, receiving twice the amount in health insurance and nearly five times as much in retirement contributions.
How to Calculate Employee Cost
To calculate the cost of hiring an employee, we recommend you take the following steps:
- Calculate the base salary. This should be appropriately benchmarked for the industry, seniority, and any specifics of the job.
- Estimate the cost of equity/stock options.
- Add the employer contribution to payroll taxes.
- Add the cost of supplemental benefits, including health insurance, retirement contributions and paid time off.
- Add training, development and onboarding costs.
- Calculate the cost of equipment, tools, and supplies for that indvidual
- Apportion overhead either by dividing by the number of employees or finding a way to allocate based on space/resources used.
- Add any miscellaneous costs, including any other perks or bonuses.
How to Reduce Employee Cost
Calculating employee cost accurately is very important, but so too is finding ways to keep those costs down. Here are a few possible ways to do that:
- Optimize Recruitment Processes. Enhance your recruitment process to better match candidates to roles, reducing turnover and the costs associated with hiring and training new employees. This might include leveraging technology or outsourcing recruitment.
- Increase Employee Retention. A meta-analysis of the 11 most important studies on the cost of employee turnover found that it costs around 20 percent of an employee’s annual salary to replace them. To improve retention you could improve employee engagement and ensure you offer competitive compensation:
- Implement Flexible Work Arrangements. This might include remote or hybrid work: Save on office space and related costs by allowing employees to work remotely, at least part-time. It could also be about ensuring more flexible working.
- Outsource Non-Core Functions. For example, you could outsource payroll or back office functions. Or you could engage a PEO to acquire better rates on employee health insurance and benefits through economies of scale.
- Utilize Part-Time or Freelance Workers. Hiring a contingent workforce can save significantly compared to hiring fulltime employees. Note, however, that care must be taken to avoid employee misclassification.
- Invest in Training and Development. Investing in your current workforce can fill skill gaps more cost-effectively than hiring new full-time employees. Similarly, filling higher positions internally can reduce recruitment costs and improve retention by offering career progression.
- Review Benefits Packages. Analyze Benefits Usage to see which benefits employees value and use the most, and consider cutting or replacing underutilized ones.
- Renegotiate Vendor Contracts. Lowering the costs of goods and services your business needs can reduce the overall cost of employment. For example, getting a better rate on an office commercial lease.
Employee cost — get help from the experts
Whether looking to accurately calculate employee costs in a given location, or looking at ways to reduce your costs, an international hiring partner like Horizons can be invaluable. Horizons will be able to explain how you can best save on hiring costs, and which hiring solution is best for you.
Frequently Asked Questions
The concepts of employee cost and labor burden (also known as ‘payroll burden’) are similar, but distinct. Labor burden only covers the cost of salaries, compulsory contributions and benefits. Employee cost also includes a portion of overheads associated with hiring.
A good place to start is with a payroll calculator. This will tell you the precise cost of hiring in different locations.
