Employee Lifetime Value

What employee lifetime value means

Employee lifetime value (القيمة الكلية للموظف), abbreviated ELTV, is an estimate of the net return an organisation receives from an employee holding a particular position, calculated over the whole of that employee’s tenure, after deducting what was spent on the hire and what will be spent on the replacement.

The unit of measurement is a position, not a person. The calculation describes the economics of one seat in the organisation over a period of time; it is not a verdict on anyone and not a ranking of people. Using it for anything else asks more of it than its inputs can support, because three of its five inputs are assumptions, not measurements.

The five inputs to employee lifetime value, and the two taken from records

• Annual surplus. What the position produces, minus what is spent on the person holding it. This is an assumption unless the output of the role can be attributed to one individual.
• The ramp to productivity. What the employee produces in the first year as a share of what they produce once settled in the role. This is an assumption.
• Tenure. Taken from the average length of service for that group of roles, not from the average for the whole organisation.
• Hiring cost. Taken from cost per hire.
• Discount rate. An assumption, decided and then disclosed.

The split is the point to keep in view: two figures come from the organisation’s records, and three are decided. A result presented without that split looks like a measurement when three of its five inputs are estimates.

A full employee lifetime value calculation

Take a position whose annual surplus, once the holder is settled, is SAR 60,000, and in which the holder produces 60 percent of that in the first year, or SAR 36,000. Tenure is 4 years, a hiring cost of SAR 25,000 is paid at the start, and a replacement cost of SAR 15,000 is paid at the end.

Added up without discounting, 36,000 plus three years at 60,000 gives SAR 216,000. Subtracting the SAR 40,000 of hiring and replacement cost leaves SAR 176,000.

Every figure in this calculation, and in the variations that follow, is assumed in order to show how the calculation works. The definition sets no value for any employee or any role, and none of these figures is a benchmark or taken from a source.

Discounting takes about a fifth off employee lifetime value

The amounts fall in different years, so each one is brought back to its value today. At a discount rate of 8 percent:

• Year one: 36,000 divided by 1.08, which is SAR 33,333.33.
• Year two: SAR 51,440.33. Year three: SAR 47,629.93. Year four: SAR 44,101.79.
• From these, SAR 25,000 is subtracted at the start, together with SAR 11,025.45, which is the present value of the replacement cost.

The result is SAR 140,479.94, which is SAR 35,520.06 below the straight sum. The discount rate by itself has a visible effect: at 5 percent the result becomes SAR 152,559.35, and at 12 percent it becomes SAR 126,279.62. When the rate is not disclosed, two results cannot be compared.

Which discount rate suits a particular organisation is a financial decision for that organisation. The figures above show only how far the choice moves the result.

Tenure moves employee lifetime value most in this example

With the same figures, and changing only tenure:

• Three years: SAR 95,496.11.
• Four years: SAR 140,479.94.
• Five years: SAR 182,131.63.
• Six years: SAR 220,698.01.

The fourth year alone adds SAR 44,983.83, and the fifth adds SAR 41,651.69. Each additional year adds less than the one before because discounting is at work, but the addition still outweighs the other changes tested here. Raising the annual surplus from SAR 60,000 to SAR 70,000, an improvement of one sixth, lifts the result to SAR 169,897.51. The increase is SAR 29,417.56, less than the fifth year of tenure adds by itself.

The implication is that spending to lengthen tenure is set against spending to raise productivity using the same calculation, and that in this example the first gives the higher return. That is the proper use of the calculation: comparing two courses of action, not putting a price on an employee.

What a step on the ramp to productivity is worth in employee lifetime value

Change only productivity in the first year, and keep everything else as it was:

• At 40 percent: the result is SAR 129,368.83.
• At 60 percent: SAR 140,479.94.
• At 80 percent: SAR 151,591.05.
• At 100 percent: SAR 162,702.16.

Every twenty points is worth SAR 11,111.11, and the step is the same between any two neighbouring levels, because the whole effect falls in a single year and is discounted once.

That figure can be compared directly with the cost of whatever shortens the ramp, which is the subject of employee onboarding. A programme that costs less than SAR 11,111 per employee and raises productivity in the first year by twenty points covers its cost on this count alone. Spending more than that requires counting some other benefit.

The 60 percent share for the first year is an assumption as well. We found no published measurement of the ramp to productivity for the Saudi market, and the absence of one in the sources we reviewed is not a basis for any conclusion about it.

When employee lifetime value turns positive

The figure starts negative and then turns. With the figures above, the result after one year is minus SAR 5,555.56, and after two years it is SAR 46,913.58.

So in this example the position covers its cost only during its second year. An organisation whose average tenure in such a position falls short of that spends more on hiring and replacement than the position returns to it. This shows up in no single line of its expenses, because the two costs sit under separate headings and are not added together.

This alone is reason enough for the calculation, even though its inputs are estimates: it brings hiring cost, replacement cost and the effect of turnover together in a single figure that can be examined.

Employee lifetime value multiplied across seats

The differences above concern one seat, and at that level they are figures that can be overlooked. They become visible when multiplied by the number of positions filled each year.

Take an organisation that hires into thirty positions of this kind a year. The difference between an average tenure of three years and one of four is SAR 44,983.83 per seat, and 30 multiplied by that comes to SAR 1,349,514.90.

The amount appears on no expense line, because it is not an expense but a return that did not happen. For that reason it is shown alongside the cost of keeping staff, rather than only as an amount set against that cost.

One caution applies here. The figure rests on an assumed surplus, so it should not be carried into a financial presentation as an amount lost. The correct way to state it is that, in this estimate, one additional year of average tenure is worth a stated amount, together with the inputs the estimate was built on.

What employee lifetime value can and cannot be used for

The calculation can be used to compare two courses of action for the same position: whether to spend on shortening the ramp to productivity, on lengthening tenure, or on lowering hiring cost. The inputs stay as they are and one of them changes, and the difference between the two results is a valid comparison even though the inputs are estimated, because any error in them falls on both cases to the same degree.

It cannot be used to say that a particular employee is worth a given amount. The annual surplus is estimated for the position, and in that estimate the current holder and whoever comes next are treated alike. Attributing the figure to a person attributes to them something that was not measured on them, and a decision about that person is then built on it. Decisions about individuals are built on the appraisal of their performance; see performance standards.

We do not take a position on whether an employee lifetime value figure may be used for a named employee, and we do not recommend that use. As explained above, the inputs of the calculation do not support it.

How employee lifetime value differs from revenue per FTE, cost to company and cost per hire

• Revenue per FTE. This divides the revenue of one period by the headcount in that period, so it contains no cost and no span of time. Employee lifetime value subtracts cost and extends over years. The first describes the organisation in a single year; the second describes a position over the whole time it is held.
• Cost to company. This is one of the inputs here, because it enters the subtraction that gives the annual surplus. It stops at what is spent and sets nothing against it.
• Cost per hire. A single figure, incurred once at the start, which employee lifetime value combines with everything that follows. A programme that lowers hiring cost but shortens tenure may lower employee lifetime value while improving cost per hire.

What distorts an employee lifetime value calculation

• One average tenure for the whole organisation. Tenure can differ between roles, and a single average gives a calculation that is correct in form but can be wrong for any position taken separately.
• Leaving out the ramp to productivity. Assuming full productivity from the first day raises the result to SAR 162,702.16 instead of 140,479.94, an increase of about SAR 22,222 with nothing behind it.
• Calculating the surplus on revenue alone. The surplus is what remains after everything spent on the position, not what comes in from it. Calculating it on revenue gives figures that cannot be compared with the cost of any course of action.
• Changing two inputs at once in a comparison. It is then impossible to tell which of them moved the result, and the comparison, which is what the calculation is for, is lost.

The inputs are reviewed on a set date, not when the figure is needed for a presentation. Tenure moves, and so does hiring cost, and a calculation built on last year’s inputs gives a figure today that looks current only because it is being shown today. The date on which the inputs were taken is part of the figure, not a footnote to it.

Before an employee lifetime value figure is used

Four things are written down with every result of this kind: the assumed surplus, the ramp to productivity, tenure and where it was taken from, and the discount rate. A figure presented without these four cannot be compared with another result, because the whole difference between them may lie in an input that was not stated.

The figure is then used as a difference, not as an amount: how much the result changes if the ramp to productivity is three months shorter, and how much it changes if tenure is a year longer. The absolute amount carries every error in the inputs, while the difference between two cases carries less of it, and the difference is the figure a decision can be built on.

This is an explanation of the concept, not legal advice.

Related terms

• Cost per Hire
• Employee Onboarding
• Retention Rate
• Attrition
• Employee Value Proposition