JAME: The Journal of Applied Management and Entrepreneurship

Retaining Employees in Small and Medium-Sized Firms:
Examining the Link with Human Resource Management

Terry H. Wagar, Saint Mary's University
Kent V. Rondeau, University of Alberta


Executive Summary

While the 1990s were a decade characterized by downsizing and restructuring, there has been a recent focus on attracting and retaining quality employees. Very little research has addressed employee retention within small and medium-sized firms. This paper uses data from a national study of manufacturing organizations in Canada to investigate the relationship between employee quit behavior and human resource management issues. The results suggest that employee retention is affected by a host of factors that includes the system of human resource management practices, human resource strategy, and decision-making ideology.


Introduction

While researchers are now placing considerable attention on the links between human resource management (HRM) practices and the performance of the firm, most of this research has been conducted in large organizations (Wood, 1999; Wright, Gardner, Moynihan & Allen, 2005). Many of these studies have examined the impact of human resource systems on the financial performance of the organization. However, there is a paucity of research investigating whether the adoption of certain human resource management practices has the potential to affect employee retention rates (Stovel & Bontis, 2002; Batt, Colvin & Keefe. 2002). The current study uses data from small and medium-size manufacturing workplaces to investigate the factors associated with the ability of an establishment to retain employees.

Why should small firms be concerned about retaining employees? There is a strong body of research indicating that employee turnover can be very costly (Griffith & Hom, 2001). Potential costs (Dess & Shaw, 2001) can include both "direct" costs (such as separation, replacement, training and general administration costs) and "indirect" costs (such as lower productivity and reduced customer loyalty). While the loss of quality employees can be devastating for both big and small firms, retaining key individuals may be particularly important for small and medium-size businesses - if a high-quality employee leaves the organization, a smaller firm may be less likely to have a suitable internal candidate or lack the resources to selectively recruit on the external market.

Background

Although most of the research addressing human resource management and firm performance has been conducted in large firm settings, small and medium-size businesses are now adopting human resource management practices with an expectation that these practices have the potential to positively impact firm performance (Way, 2002). Following from Heneman, Tansky and Camp's (2000) observation that there is a shortage of information on human resource management practices in smaller organizations, it is not surprising that there is very little research addressing the link between employee retention and human resource management.

While there is an extensive body of research on employee turnover, almost all of the work by social scientists has been done at the individual (employee) level of analysis (Griffith & Hom, 2001). For instance, Kickul (2001) found that employer breach of factors addressing autonomy and growth (such as providing meaningful work, the opportunity to develop new skills, and recognition of accomplishments) and rewards and opportunities (for instance, providing opportunities for advancement and compensation tied to performance) were associated with a greater intention to quit among small business employees.

However, the importance of studying employee turnover at the workplace or organizational level has been noted (Delery, Gupta, Shaw, Jenkins & Gangster, 2000; Batt, 2002). Shaw, Gupta and Delery (2005) recently investigated the relationship between voluntary turnover and organizational performance using data from employers in the trucking industry and organizations involved in the manufacturing of concrete pipe. They found that there was a negative relationship between voluntary turnover and organizational performance but that the relationship was attenuated as the level of voluntary turnover increased.

Marchington, Carroll and Boxall (2003) examined the retention of drivers in small firms using data from the road haulage industry in the United Kingdom. They noted that recruiting good drivers was challenging and retaining such drivers was also very important. In some firms, two years of continuous service was viewed as long-term employment. In addition to a mix of formal human resource practices (such as the provision of training opportunities and pay-for-performance), employee retention was associated with an "informal" working relationship and a "relaxed place to work". In other words, favorable work conditions, employment security and positive relationships between management and employees were considered important in retaining employees.

Two other studies examine the relationship between employee turnover and HRM practices. Way (2002), using data from the National Employer Survey (Phase II), found that a High Performance Work System (HPWS) was strongly related to lower workforce turnover in his sample of small businesses. Similarly, Batt (2002) observed a very significant association between human resource management practices and quit rates in her sample of call centers.

In addition to the lack of research at the workplace or firm level, many of the previous studies have also failed to differentiate between voluntary and involuntary turnover (Shaw et al., 1998; Shaw et al., 2005). Voluntary turnover occurs when an employee makes a decision to leave the organization (commonly referred to as a "quit"). Drawing from the individual level research on voluntary turnover, it can be argued that the decision to quit a job may be affected by the attractiveness of the current job, the relative fit that a person has to the job, and the availability of alternative employment (Griffeth & Hom, 2001). While an organization can engage in practices and activities to make the firm a more attractive place to work, the availability of alternative employment is not directly controlled by the organization. Consequently, this paper focuses on the impact of human resource management practices in making the firm a more attractive workplace.

According to Barney (1995), the resource-based view of competition suggests that employers can create competitive advantage by means of a highly productive workforce - a valuable source of competitive advantage because it cannot be copied quickly, is hard to imitate, is a source of the firm's competitive advantage, and is somewhat specific to the climate or environment of the organization. Effective human resource management allows an organization to attract, keep and develop higher quality employees that are a relatively rare and valuable resource (Pfeffer, 2005).

It must be stated that there is yet no consensus from the literature as to what specific HRM approach constitutes "high performance" work practice. (Wright et al., 2005; Michie & Sheehan, 2005). As an illustration, Pfeffer (1998), after an extensive review of the subject, suggests that there are seven HRM practices of successful organizations (employment security, selective hiring, decentralized work arrangements, performance-based pay, extensive employee training, reduced status differentials, and information sharing). More recently, Pfeffer (2005:97) listed thirteen practices and observed that "there are interrelated practices – I enumerate 13 but the exact number and how they are defined are somewhat arbitrary – that seem to characterize companies that are effective in achieving competitive success through how they manage people."

The strategic view of HRM implies that an organization's human resources can be "leveraged" to provide a source of competitive advantage. This perspective suggests that the application and adoption of certain "bundles" of HRM work practices have the ability to positively impact organizational performance by creating "powerful connections", or to detract from performance when "deadly combinations" of practices are inadvertently placed in the mix. This "configurational" (as opposed to contingent) approach suggests that "bundles" of HRM practices, rather than discrete programs, act on organizational performance. A firm's selection of which HRM practices to adopt is made so as to achieve "horizontal fit" or internal consistency of HRM practices, as well as "vertical fit" or congruence of the HRM system with other characteristics of the organization, such as corporate culture and operative strategy (Huselid, Jackson and Schuler, 1997; Michie & Sheehan, 2005).

In light of the focus on human resource management "systems" or "bundles" of human resource management practices (Becker and Gerhart, 1996; Wood, 1999, Wright et al., 2005) as a determinant of organizational performance, our major research question is whether such systems are associated with voluntary employee turnover. It is anticipated that firms with a higher use of HRM practices will have lower turnover. In addition, we explore whether decision-making ideology, human resource strategy and the presence of a human resource management professional or department are related to lower quit rates.

Method

Data Collection

We collected our data by surveying senior executives (typically the chief executive officer or the most senior individual responsible for human resource management) in the manufacturing sector. Employers selected to receive the questionnaire were identified and randomly selected using a mailing list provided by Dun and Bradstreet Canada and the study was conducted nationally. Surveys were directed to a specific individual within the firm (with a note asking the recipient to pass the survey on to another member of the organization if that person was in a better position to complete the survey), and a follow-up mailing was conducted. The overall response rate for the survey was just under 31 percent. Data were collected in 2000-2001 and we received 448 useable surveys. Since we were interested in only small and medium-sized workplaces, we removed employers with more than 500 employees from the data set. In addition, a small number of respondents were excluded from our analysis because of missing data on the dependent or independent variables. Overall, 323 workplaces are included in the study.

Dependent Variable

Our primary focus was on employee retention, and we were particularly interested in the factors associated with voluntary turnover (employee quits). Our dependent variable, which we labeled the quit rate, was measured by dividing the number of quits over the past year for the workplace by the number of employees, adding one to remove zeroes, (quit rates have a lower bound of zero), and then taking the natural logarithm. This procedure is similar to that used by Delery, Gupta, Shaw, Jenkins and Gangster (2000).

Independent Variables

Our initial objective was to examine whether employee retention was associated with the human resource activities at the workplace. In light of the focus on human resource management "systems" or "bundles" of practices (Michie and Sheehan, 2005; Wright et al., 2005), we developed an index of human resource management practices. For each of the twenty-four practices, the establishment received one point (thus the minimum score was 0 and the maximum score was 24). The twenty-four practices, which address a variety of issues including communication, team-based programs, training, compensation performance appraisal and employee selection, are outlined in Figure 1. As Pfeffer (2005) has pointed out, there is no magic list of practices that must be included in the "bundle". Our HRM practices index contains many of the practices used in previous research (see, for example, Way, 2002; Michie & Sheehan, 2005) but we acknowledge that our index does not contain every possible practice.

Figure 1: HRM Practices Index

Specific HRM Practice
Communication:
Employee Attitude Survey
Orientation Program
Employee Career Counseling
Information Sharing Program

Protection Programs:
Employee Assistance Program
Sexual Harassment Policy

Recognition Programs:
Employee Recognition Program
Internal Promotion Policy
Employee Suggestions System

Team Initiatives:
Total Quality Management Program
Project Teams
Problem Solving Groups

Training:
Formal Training Program
Employee Involvement Training
Personal Computer Training

Compensation:
Profit Sharing
Productivity Sharing
Individual Merit Pay
Employee Pension Plan
Employee Stock Ownership Plan

Other Practices:
Formal Performance Appraisal System
Flexible Work Hours
Employment Selection Tests
Written Job Descriptions

As a result of some research addressing decision-making ideology (Goll, 1991) and human resource strategy (Bae & Lawler, 2000), we also developed measures of these two constructs. Decision-making ideology was measured from a three-item scale adapted from Goll (1991) that assesses the level of participative decision-making and open communications. Each item was measured using a six-point scale (one = strongly disagree and six = strongly agree) and the scale's Cronbach's coefficient alpha was 0.81.

A firm's operational human resource management strategy was assessed, based on the work of Huang (1998; 2000). HRM strategy was measured using an eight-item scale that addressed human resources and strategic management decisions, the degree of devolution of human resource functions to line management, human resources and long term planning, and human resources and the future mission of the firm. Again, each of the eight items was measured on a six-point scale (one = strongly disagree and six = strongly agree), with the scale's Cronbach's coefficient alpha at 0.87.

Although one may question the use of a scale which was used in research on Taiwanese firms, Huang's (1998; 2000) articles were written in English and the questions making up the scale were grounded in literature from mainstream Western human resource management literature. Respondents to the survey had no problems understanding the questions and the scale reliability was very good. As Huang (1998: 60) states, "The purpose of this research will, it is hoped, not only promote a deeper understanding of HRM practices in Taiwan, but also help determine the extent to which western HRM theories are applicable to oriental social and cultural contexts."

There has been some research on the role of the human resource management department in achieving organizational objectives (Ng & Maki, 1993). One may expect professional human resource managers to be more aware of current issues in the field. Consequently, we examined whether the quit rate was associated with the presence of a HRM professional or HRM department. In the study, the presence of an HRM professional or department was coded as one and absence as zero.

Control Variables

A number of variables were entered into each of the regression equations to control for other factors that were hypothesized to influence quit rates. The control variables included the demand for the establishment's primary product or service (one = substantial increase; six = substantial decline), whether the business had experienced a merger over the past five years (one = yes; zero = no), whether the business had permanently reduced its workforce over the past two years (one = yes; zero = no), the union status of the business (one = union; zero = nonunion), the age of the business (natural logarithm of the number of years the business has been operating), and size of the business (natural logarithm of the number of employees). Previous research (Shaw et al., 1998; Delery et al., 2000; Batt et al., 2002) has demonstrated the need to control for such variables.

As a check on non-response bias, we grouped the survey responses depending on whether the questionnaire was received on the first or second mail out. We then ran a logit model in which we compared early and late respondents with reference to the control variables (product demand, merger, permanent workforce reduction, union status, age of the business, and size of the business) and each of the independent variables (HRM practices, decision-making ideology, human resource strategy, and presence of a human resources department). This approach is based on the notion that late respondents are more likely to be like non-respondents (Armstrong and Overton, 1977). The logit results showed no difference between the early and late respondents.

Results

Respondent Characteristics

While respondent firms varied in size, the average number of employees was 189. The mean number of years a business had been operating was 38 years. About 23 percent of firms reported engaging in a permanent workforce reduction of the workforce over the past two years and respondents reported an increase in demand for their primary product (mean score of 2.57 on the six-point scale). Although there was considerable variation in the composition of the HRM practices index, the average number of practices per workplace was about 16. The mean score for the decision-making ideology scale was 4.43 (out of a maximum of 6), suggesting a somewhat positive approach by the firms. However, the average score for the human resource management strategy scale was somewhat lower (mean of 3.94 out of 6); while some organizations are heavily involved in HRM strategy, other firms have not placed much focus on this approach.

Quit Rate

Table 1 provides information on the quit rate experienced by the participant organizations. As noted previously, the rate is calculated as a percentage of the total workforce. By way of example, a score of 3 percent on the quit rate index would indicate that for each 100 employees, a total of three quit during the past year.

Table 1: Breakdown of Quit Rates

Quit Rate Percentage Cumulative Percentage
0 percent (No Quits) 6.5 percent 6.5 percent
0.1 percent to 2.5 percent 33.2 percent 39.7 percent
2.6 percent to 5.0 percent 24.8 percent 64.5 percent
5.1 percent to 10.0 percent 19.4 percent 83.4 percent
More than 10 percent 16.1 percent 100.0 percent

As observed in Table 1, about 6.5 percent of the respondents reported that no employees quit the organization over the past year. About one-third of participants had a quit rate of between 0.1 percent and 2.5 percent and a little over 16 percent had a quit rate exceeding 10 percent. In times when qualified job candidates are in short supply, there are considerable costs in trying to replace good employees.

Quit Rates and Human Resource Management

We used OLS regression to investigate whether a firm's human resource management activities were associated with quit behavior. These results are provided in Table 2. The first column of results (Model 1) contains the additive scale of 24 HRM practices as well as the control variables. The coefficient on the HRM practices variable was both negative and significant at p < .01. In other words, employers with more HRM practices (as measured by the HRM practices scale) had lower quit rates.

Table 2: OLS Regression Results: Quit Rate and HRM

Variable Model 1   Model 2   Model 3   Model 4
HRM Variables
HRM Practices -0.032***
(0.009)
 
Decision-Making Ideology   -0.121**
(0.054)
 
HRM Strategy   -0.182***
(0.057)
 
HR Professional/Department -0.149
(0.102)
Control Variables
Product Demand 0.045
(0.047)
  0.046
(0.048)
  0.066
(0.050)
  0.060
(0.048)
Merger -0.211**
(0.097)
  -0.253**
(0.098)
  -0.190*
(0.100)
  -0.244**
(0.098)
Permanent Reduction -0.043
(0.108)
  -0.065
(0.111)
  -0.065
(0.112)
  -0.353
(0.092)
Union Status -0.377***
(0.091)
  -0.378***
(0.092)
  -0.379***
(0.094)
  -0.040***
(0.110)
Number of Employees -0.238***
(0.075)
  -0.284***
(0.079)
  -0.263***
(0.078)
  -0.252***
(0.079)
Years in Business -0.073
(0.055)
  -0.087
(0.055)
  -0.070
(0.056)
  -0.088
(0.055)
(Constant) 3.657***
(0.424)
  4.003***
(0.504)
  3.950***
(0.480)
  3.355***
(0.428)
F-Test 10.877***   9.317***   9.514***   8.994***
R-Square 0.195   0.173   0.184   0.167
R-Square 323   320   303   323
*p < .10; **p < .05; ***p < .01

Models 2 and 3 of Table 2 provide the results for the decision-making ideology and HRM strategy variables. In both models, the coefficient on the relevant variable was negative and significant (p < .05 for decision-making ideology and p < .01 for HRM strategy). In short, firms with a higher decision-making ideology score and a greater focus on HRM strategy had lower quit rates. These findings, in conjunction with the results from Model 1, indicate that human resource management is associated with employee retention (as measured by quit behavior).

Does having an HR department or HR professional result in a lower quit rate? As indicated in Model 4 of Table 2, the coefficient on the HR department variable was negative but not statistically significant. This suggests that the presence of HRM professionals is not significantly associated with employee quit rates.

Although the focus of this paper is on human resource management and quit rates, a few of the results relating to the control variables merit discussion. First, and consistent with past research (Delery et al., 2000; Batt, 2002), quit rates were significantly lower (p < .01 for all four models) in unionized organizations. As Batt, Colvin and Keefe (2002) observe, the presence of a labor union provides employees with a voice in issues relating to their employment (such as the right to appeal management decisions or grieve a disciplinary penalty) and a higher level of compensation relative to similar nonunion jobs. Second, quit rates were also lower when there was a merger and among larger firms. It may be that workers experiencing a merger feel that employment opportunities are limited and are thus unwilling to simply quit their job. Furthermore, larger firms may provide greater benefits and opportunities for promotion and advancement so employees do not have to quit in order to advance their careers.

Quit Rates and Specific HRM Practices

Earlier, we examined the effect of a "bundle" of HRM practices on quit behavior. While acknowledging the importance of such "bundles" or "systems" in the literature (Wood, 1999; Pfeffer, 2005), we were also interested in examining the effects of individual practices on voluntary turnover. Obviously, caution must be exercised in the interpretation of these findings; as the result on "bundling" shows, it is often the synergistic effect of practices that affect performance outcomes rather than the effect of any one practice (Michie and Sheehan, 2005). Still, for practitioners, it may be useful to have some information on specific factors associated with reduced quit rates.

We ran a set of 24 regressions (one for each of the 24 practices comprising the HRM practices index) with a full set of control variables included in each estimation. We discuss these results using the seven broad headings provided in Figure 1.

Communication with employees (in the form of conducting of employee attitude surveys and the presence of an information sharing program) was associated with lower quit rates (with both variables significant at p < .05). It appears that employees want to know what is happening in the organization and seek a sense that management is listening to them (the notion of "employee voice").

Not surprisingly, both protection-type programs (an employee assistance program and a sexual harassment policy) were strongly associated (p < .01) with lower quit rates. Although merely instituting such programs is not enough, programs such as an EAP or sexual harassment policy send a message to employees that the employer cares about them and the workplace environment. People may be more likely to quit when confronted with intractable personal problems or with a workplace that does not respect their dignity. By contrast, none of the recognition programs was related to the quit rate. It may be that such programs are not as valued among workers.

In recent years, there has been a growing focus on the use of team-based activities. For all three of the team initiatives (Total Quality Management, project teams and problem-solving groups), there was a significant association with lower quit rates (p < .05 for the TQM variable; p < .01 for the variables addressing project teams and problem-solving groups). Employees may feel a greater commitment to a team and a preference for working with others. It may be more difficult for employees to quit a job when peer associations and group responsibilities prevent them from doing so. Similarly, the presence of a formal training program was also related (p < .05) with employee retention. The practitioner literature and popular press reports indicate that employees are seeking more challenging work and an opportunity to further develop their skills. The current study underscores the importance of employee training in retaining workers.

Obviously, fair compensation is necessary in the retention of employees. Our results suggest that retention is associated (at p < .01) with the presence of a productivity sharing programs, an employee pension plan, and an employee stock ownership plan.

Among the other practices, employee monitoring activities such as performance appraisal systems and written job descriptions were not significantly associated with quit rates. The only variable that was significant (and only at p < .10) was the use of employment selection tests. It may be that rigorous selection of employees should lead to better hiring decisions and fewer quits. Firms that expend more resources and time on matching job applicants to actual jobs might expect less turnover.

Conclusion

The major purpose of this study was to examine whether human resource management practices were associated with employee retention in small and medium-size manufacturing employers. Overall, about 40% of the organizations had an employee quit rate of 2.5% or less per year, while 16% of firms had a quit rate in excess of 10%.

Our results show that retention of employees is related to human resource management activities. A lower employee quit rate was associated with a greater use of HRM practices (as measured by an additive index of 24 practices). While a number of small and medium-size firms may lack the resources to have a highly-sophisticated human resource system, Pfeffer and Veiga (1999) note that even among large organizations, only a small minority have effectively implemented such a system.

Although a number of the individual HRM practices were associated with lower voluntary employee turnover, it is likely that such practices bundle together (at least under related themes) and play a role in reducing employee quits. By way of example, the findings suggest that communication practices, protection programs (such as an EAP and sexual harassment policy), team-based work, investment in employee training, and selected forms of compensation help reduce employee turnover. In managing human resources, firms seek (or should seek) to keep quality workers while removing less productive workers. While poorer performers may quit, in some instances it may be necessary to terminate such individuals. As Griffith and Hom (2001) note, voluntary turnover can be both functional and dysfunctional; firms want to retain quality employees and have poor performers leave the organization.

An important finding with implications for small and medium-size firms was that a lower quit rate was associated with a higher score of the decision-making ideology scale and greater attention to HRM strategy issues. Decision-making ideology addresses the use of participative decision-making and open communication while HRM strategy focuses on the importance of linking human resource needs with the strategic plan of the business - a firm concerned with employee retention could aim at increasing its performance on both of these constructs without having to undergo the costs of implementing a full battery of HRM practices.

Way (2002) has noted that introducing a battery of HRM practices can be very costly. In small and medium-size firms, the presence of formal human resource practices may be less important and the workplace climate can be a major factor in an employee's decision to quit or stay with the employer. In short, organizations with a more developed human resource management system and an environment in which employees feel that the business is "a good place to work" are more attractive to employees and thus fewer workers quit such firms.

Some research (for instance, Guthrie, Spell and Nyamori, 2002; Michie and Sheehan, 2005) has shown that the adoption of HRM practices and the relationship between human resource management systems and performance may be associated with the business strategy of the organization. Depending on the strategic perspective of the firm, some organizations may be more willing than others to accept high employee turnover. Although it has been estimated that the cost of hiring and training a new worker to replace one that has quit is about 50% of the employee's yearly salary (Stovel & Bontis, 2002), this cost varies between firms. Consequently, some organizations may do a cost-benefit analysis of the effect of high turnover and conclude that the benefits may outweigh the costs.

There are several avenues for future research. For instance, while this study used a sample of manufacturing firms, it would be important to see if the results generalize to employers in the service sector. In addition, how does a firm's corporate culture and operative strategy affect the relationship between HRM practices and employee turnover? It would also be advantageous to examine the association between retention and human resource activities using longitudinal data rather than relying on cross-sectional studies. Furthermore, there is need for considerably more work on the measurement of HRM systems; for example, what practices should make up the index and to what extent are subsets of practices associated with employee retention? Simply adopting more practices, without understanding their impact and relation to other existing practices, may not be beneficial. Given the costs of termination and the importance of making appropriate labor force adjustments, it is in the best economic interests of the firm to effectively address employee retention issues.

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About the Authors

Terry H. Wagar is Professor of Human Resource Management and Industrial Relations at Saint Mary's University in Halifax, Nova Scotia. His current research interests include human resource issues affecting small firms, organizational downsizing, and dispute resolution.

Kent V. Rondeau is Associate Professor of Health Policy and Management at the University of Alberta in Edmonton, Alberta. His current research involves the link between human resource management and organizational performance and human resource issues in health care.