Overview: Staff Training & Development Return on Investment (ROI)

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When a gap or deficiency exists between the actual and the desired performance levels, our attention turns to a cost-benefit calculation in examining a training and development program intended to reduce this deficiency or “What is our return on our investment?” (ROI) To determine the priority of the economic value of training to overcome a deficiency, we can examine an equation for assistance. 1

𝑃 = 𝑉𝑁

𝐶 where,

P is the priority of specific training V is the value of overcoming a deficiency N is the number of people that can be trained

C is the cost of the specific training To determine if the training program was successful or did it improve performance, we can conduct a statistical test to see if the average performance ratings are statistically significantly higher for the trained group than for the untrained group. This may be the group before training (untrained) and after training (trained).

Step 1: Calculate the average performance ratings over the six months following completion of the training program.

a. Calculate the average (mean) performance scores for the untrained group. b. Calculate the average (mean) performance scores for the trained group.

Step 2: Conduct a statistical t-test to see if the average performance ratings are significantly higher for the trained group than for the untrained group.

If there is a statistical difference between the trained and the untrained groups, conclude that the training program was a success.

To determine the economic impact or value in dollars and the percentage increase in worker output of overcoming a deficiency through a training program, several steps assist us. 2 Step 1: Determine the size of the performance gain in standards deviation units. This tells us how large the performance increase was.

standard deviation (SD): a deviation from the mean or average

a. Divide the difference between the average or mean ratings of the trained and untrained groups by the average of their standard deviations. This value (d) represents the difference between their performance ratings average of the two groups expressed in standard deviation units.

Overview: Staff Training & Development Return on Investment (ROI)

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Example: Suppose the mean or average of performance ratings for a trained group of individuals was 55 and for an untrained group was 50. Now, suppose that the standard deviation within both of the groups (average of their SDs) was 10. Step 1 would be:

𝑠𝑖𝑧𝑒 𝑜𝑓 𝑔𝑎𝑖𝑛 𝑜𝑟 𝑑𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑑 = 55 − 50

10 = .50

Therefore, the size of the performance gain was .50 or ½ of a standard deviation unit. This is equivalent to moving performance from the 50th percentile or average performance to the 70th percentile.

(Note: .50 for 𝑑 is in line with values reported in research studies on training)

Step 2: Determine the economic value of the increase of the standard deviation in job performance. This tells us what the trained individuals can be expected to produce in dollars more in output per year as long as the effect of the training last.

a. Returning to our example of an increase of .50, we now need an estimate of the standard deviation in dollars (SDy). SDy usually ranges from 16 to 70% of wages, with values most often being in the 40 to 60% range.

Conservatively, this can be estimated as 40% of salary. If the average salary of an individual is $50,000, then 40% of is $20,000.

b. The increase in performance is .50 or ½ of a standard deviation. Each standard deviation is equal to $20,000.

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Therefore, the dollar value of the average gain in output for the trained group is:

𝑑 𝑆𝐷𝑦 = 𝑑𝑜𝑙𝑙𝑎𝑟 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑔𝑎𝑖𝑛 𝑖𝑛 𝑜𝑢𝑡𝑝𝑢𝑡 . 50 ($20,000) = $10,000 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

The trained individuals can be expected to produce $10,000 more in output per year as long as the effects of the training last in our example.

Step 3: Estimate how long the effects of the training will last. This tells us what the average trained worker should produce over time.

a. The effects of training probably decline gradually over time. If we estimate that the effects of training will decline gradually to zero over a period of four years, then the estimate of the duration of the effects of training (T) would probably be 2 years (4/2).

b. The dollar value of the effect of training in our example is:

𝑇 $10,000 = 2 $10,000 = $20,000

Therefore, over a 4 year period, the average trained individual should produce additional output worth $20,000 as a result of training.

Step 4: Determine the value of the total increase in output due to the training program. This tells us what the total increase in output is due to the training program.

a. Multiply the average output gain per trained individual by the number of individuals trained. If 50 individuals were trained, then the value of the total increase in output due to the training program in our example is: 50 $20,000 = $1,000, 000

Step 5: Determine the net gain due to the training program after costs. This tells us the net gain due to the training program. We may also tell what the reduction in percentage gain is lost after allowing for the cost of training.

a. Subtract the cost of the training program from the total gain in output. Using our example, if the cost of the training program was $2,000 per individual trained, then the total cost would be:

50 $2,000 = $100,000

If the training was held during work hours, then this cost of lost work time would also be added.

b. Net gain from the training program in our example is:

𝑡𝑜𝑡𝑎𝑙 𝑣𝑎𝑙𝑢𝑒 𝑖𝑛 𝑜𝑢𝑡𝑝𝑢𝑡 – 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑡𝑟𝑎𝑖𝑛𝑖𝑛𝑔 = 𝑛𝑒𝑡 𝑔𝑎𝑖𝑛 $1,000,000 − $100,000 = $900,000

Overview: Staff Training & Development Return on Investment (ROI)

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c. Calculate the percentage decrease of training costs in our example.

𝑐𝑜𝑠𝑡 𝑜𝑓 𝑡𝑟𝑎𝑖𝑛𝑖𝑛𝑔

𝑡𝑜𝑡𝑎𝑙 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑜𝑢𝑡𝑝𝑢𝑡 × 100 =

100,000

1,000,000 × 100 = 10%

Therefore, the cost of training reduces gain by 10%. Step 6: Calculate benefit-to-cost (BCR) and return on investment (ROI) 3

a. Calculate benefit-to-cost ratio (BCR)

𝐵𝐶𝑅 = 𝑝𝑟𝑜𝑔𝑟𝑎𝑚 𝑏𝑒𝑛𝑒𝑓𝑖𝑡𝑠 ($1,000,000)

𝑝𝑟𝑜𝑔𝑟𝑎𝑚 𝑐𝑜𝑠𝑡𝑠 ($100,000) =

10

1 = 10

Therefore, the benefit-to-cost ratio would be 10-to-1 or 10:1. This means that for every $1 invested, you receive $10 in return.

b. Calculate return on investment percentage (ROI)

𝑅𝑂𝐼 % = 𝑛𝑒𝑡 𝑝𝑟𝑜𝑔𝑟𝑎𝑚 𝑏𝑒𝑛𝑒𝑓𝑖𝑡𝑠 ($900,000)

𝑝𝑟𝑜𝑔𝑟𝑎𝑚 𝑐𝑜𝑠𝑡𝑠 ($100,000) × 100 =

9

1 × 100 = 900%

Therefore, the return on investment is 900%. This means that for every $1 invested, you receive $9 after costs.

Step 7: Determine the percentage increase in output (PIO) that the training produces based on job complexity (information processing demands of the job). This tells us the average percentage in output that the training program produces.

a. For medium complexity work, 1 standard deviation difference in performance in percentage terms is 30%. Using our example, the training program increases output among trained individual an average of 15%. 𝑃𝐼𝑂 = 𝑑 (30%)

𝑃𝐼𝑂 = .50 30% = 15%

Low complexity work 20%

Medium complexity work 30%

High complexity work 50%

Steps 1-5 involved in estimating the total dollar value of a training program can be summarized by the

following equation: ∆U = TNdt SDy − NC where,

∆U = The dollar value of the training program

T = The number of years duration of the training effect on performance N = The number of individuals trained d = The true difference in work performance between average trained and untrained

individuals in SD units

Overview: Staff Training & Development Return on Investment (ROI)

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SDy = The standard deviation of work performance in dollars of the untrained group C = The cost of training per individual

Sources: Moore, Michael L. and Philip Dutton. (1978). “Training needs analysis: Review and critique,” Academy of Management Review 3(3), pp. 532-542.

1

Mount, Michael K. (2004). “Utility of performance improvement programs,” Working Paper, Department of Management and Organizations, University of Iowa.

2

Phillips, Patricia Pulliam and Jack J. Phillips. (2005). Return on Investment (ROI) Basics. Alexandria, Virginia: ASTD Press.

3

Schmidt, Frank L., John E. Hunter, Robert C. McKenzie, and Tressie W. Muldrow. (1979). “Impact of valid selection procedures on work-force productivity,” Journal of Applied Psychology 64(6), pp. 609-626.

2