The spin-off brain drain, when it is [and isn't] worth it
By Lexi Bounds
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Executive Summary
A McKinsey survey finds rapid talent reallocation to be positively associated with returns to shareholders, on a self-reported level. But the question should be, on an individual level, does the revenue gains achieved by retaining key company knowledge through this redeployment exceed the additional costs of hiring their replacements?
Research published in the Strategic Management Journal suggests redeploying certain employees from a parent company to individual business unit comes with predictable gains to unit revenue, whereas redeploying from unit to parent comes with predictable losses to unit revenue.
Analyzing your own firm's data on how redeployment affects business unit revenues will help enable more efficient and informed decisions about moving key personnel between parent and spin-off to optimize profits across both entities.
Bottom-line implications of shifting employees (beyond just HR)
A McKinsey survey of “flow-to-work” practices showed respondents who considered themselves dynamic talent reallocators (ie those that believe they quickly shift talent to new projects) were twice as likely to report total returns to shareholders that were higher than their competitors (“The key role of dynamic talent allocation in shaping the future of work", McKinsey, April 2021). This is of course somewhat nebulous impact - what specifically, in talent reallocation direction and skill set, has the biggest impact and on what financials?
Granularly, you might consider the positive returns on profits (revenues less costs) between a parent company and its spin-off as a natural place to start. A company may have many such spin-off units at one time, and the decision to hire anew for those units or shift existing staff (who transfer valuable knowledge and skillsets) will be a constant debate.
Hiring new employees often involves direct costs including recruiter fees, interview travel expenses, pre-employment screenings and exams, and employment costs such as signing bonuses and relocation fees. There are also opportunity costs due to employee training and short-term reductions in productivity. Collectively, hiring a new employee typically costs 33 percent of the position’s annual salary. In contrast, retaining existing employees usually involves a 10-12.1 percent increase in annual salary. Given that salaries comprise a large proportion of operating expenses, fluctuations in hiring and employee retention can significantly impact profit margins.
Yet minimizing personnel costs is only one side of the profit equation - knowledge and skill transfers also bring the potential for greater revenue success as well, so balancing the hiring and internal movement of different types of employees against revenue benefits must also be examined. But how can that return be predicted?
Research: when retaining knowledge via redeployment has impact
Transferring employees to new areas can minimize resource use and retain key company knowledge. Yet how human capital redeployment is leveraged in such cases can also come with performance costs as well - these potential impacts on performance have remained relatively unexplored in research. To this end, a paper published in the Strategic Management Journal explored the effects of redeploying human capital in multi-business firms on unit revenue using data from 9,248 spin-offs (newly incorporated for-profits with their own management but under the ownership of a corporate parent company) spanning 179 industries in Norway between 2004-2015.
The study tested how the direction of movement (employees moving from a corporate parent to its subsidiary business unit or from a subsidiary business unit to the corporate parent), the type of employee (specialist or generalist), and industry relatedness, affected business unit revenue. The study defined generalists as having an “on-the-job” knowledge base without necessary prior education (e.g., factory worker trained on a specific machine) whereas specialists as having completed extensive education (e.g., PhD) with a greater level of expertise in specific area(s) not idiosyncratic to the operations.
The study found the redeployment of generalists in either direction was not associated with revenue change at the business unit level, but parent to unit redeployment of specialists was statistically correlated with total unit revenue change. Specifically, every 10% increase in parent to unit redeployment of specialists increased total unit revenues by ~1.5%. In contrast, every 10% increase in unit to parent redeployment of specialists was associated with ~2.4% decrease in total unit revenue. Redeployment of specialists also showed a lesser association with industry relatedness compared to generalists. Thus, the authors concluded that specialists can be redeployed to new expertise areas and boost unit revenue even with units that are less related to the parent firm whereas generalists’ unit-specific knowledge limits their transferability between industries. Specialists redeployed to a unit firm also likely contribute management experience from within the parent organization that generalists lack.
Now, consider a “base case” business unit with 100 employees and $50,000,000 in revenue. The effects of having redeployed just one additional employee between the business unit and parent firm, taking into account retention and rehiring costs, are summarized in Table 1. Redeploying specialists in both executive and non-executive roles from the parent to business unit leads to a net gain whereas redeploying a generalist leads to a net loss. Redeploying all types of employees from the unit firm to the parent company results in a net loss, but moving a specialist back to the parent company would have a significantly greater loss (>$150,000). Importantly, these net changes are calculated with respect to just the first year after redeployment and do not account for protracted year-over-year changes in business unit revenue.
Table 1. Estimated gains/losses from retaining and redeploying human capital between parent company and business unit.
Table 1. Estimated costs of redeploying human capital from parent to unit firms (P -> U) or unit to parent firms (U -> P) for specialist and generalist employees. Additional salary costs to retain employees are estimated as 33% of annual salary, and other additional costs to retain the deployed employees are estimated as 10.7%-15.2% of annual salary (“HR Benchmarking Reports Launch as a Free Member-Exclusive Benefit,” SHRM.org, April 2022; “The Real Costs of Recruitment,” SHRM.org, April 2022).
A rubric to understand the entirety of costs and benefits for staff movement
Managers interested in replicating a similar analysis for their own company should assess the TRUE total cost of retaining and/or redeploying employees by first collecting internal recruitment cost and past business unit revenue data similar to the actual study.
Day One: Calculate the true total cost of recruitment for a given year versus promoting and/or redeploying current employees to determine whether subsequent changes in productivity are worth the cost. Note that during times of rapid growth or shrinkage, this data may be less relevant and provided more distorted results.
After: Focus any conclusions on vertical resource allocation of personnel as the analysis may not directly transfer to horizontal resource allocation.
Finally: Prioritize specialists over generalists as their redeployment is associated with increased business unit revenue and their skillsets are less reliant upon parent-unit relatedness. As always, the specific resource should always be considered (i.e. star performer), as well as redundancy in personnel, as these can impact salary, training duration, and overall productivity.
When redeploying resources across an organization, business leaders should keep in mind the decision is not solely strategic nor HR related but rather best done in combination of the two.
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Lexi Bounds is a PhD candidate in Biomedical Engineering at Duke University. The research applications proposed in this article are solely the views of the author and do not necessarily reflect the views of the original academic journal article authors nor any individual member of our Editorial Board.