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HR Magazine, October 2002 - Cover Story: Accounting for People

By Steve Bates  10/1/2002

HR Magazine, October 2002

Vol. 47, No. 10

HR executives and academics are searching for the 'Holy Grail' of HR measurements of the value of human capital.

Back in high school, science teachers told us that if the human body were reduced to its basic ingredients, the carbon, water, salt and other constituents could be sold for just a couple of dollars on the commodities markets. But every HR professional knows that people are worth more than that. How else can you explain how Bill Gates built a multibillion-dollar software empire or Mother Teresa enriched the lives of so many people? Many businesses are going through the same kind of internal dialog about their assets, particularly in “new economy” firms with relatively little invested in factories and other tangible assets.

Other things account for the value of the enterprise, they are reasoning.

Among these “intangible assets” are organizational capital, such as business alliances; customer capital, the value of branding and reputation for quality or service; and intellectual capital, such as patents and proprietary technology.

But the most important is human capital, the ability of employees to do the things that ultimately make the company work and succeed.

Hard to define, and even harder to measure, intangible assets are becoming increasingly essential to the success of many organizations in the 21st century. Every company has employees. But not every company understands their contribution to the bottom line or knows how to manage them to drive even better financial results, even though they account for as much as 80 percent of the worth of a corporation.

“I can put a value on everything in my office: my clock, my desk. But I can’t put a value on people,” says Jac Fitz-enz, founder and chairman of the Saratoga Institute, a human capital management consulting firm in Santa Clara, Calif. But he and other experts are pioneering the emerging science of measuring the contributions of people to organizations, an effort that has already helped many organizations achieve greater success.

Human Capital Is the Key

“Human capital is the ultimate leading investment,” says Mark Huselid, a professor of HR strategy at Rutgers University in New Jersey. “There is a big potential payoff for managing people.”

Jeffrey A. Schmidt, managing partner of consulting firm Towers Perrin in Chicago, calls measuring and managing human capital the “holy grail” of HR. But there’s no one magic formula, he says. “Consultants and clients are both guilty of trying to find the grand unifying theory: ‘If we just follow this formula, we’ll be world class.’ The science is constantly evolving. There’s a lot more to learn here.”

On a smaller scale, HR professionals are familiar with staffing metrics—for example, measures of cost per hire and time per hire—which document how effectively HR performs traditional job functions. But the emerging movement of human capital metrics is like staffing metrics on steroids—a “big picture” justification of how people and their efforts can increase company profits and shareholder value.

HR is a part of the equation, and it can be a lead player in an organization by using human capital measurement to align HR practices with the strategy of the business, say HR professionals, academics, researchers and consultants.

It’s not easy. Most HR staffs can’t do it alone. But the experts say that human capital assessment presents an opportunity for HR to step up and expand its role, if only by bringing in consultants, statisticians or other experts who can help establish a tailored, scientific system of assessing human capital and enhancing its role in the organization.

Looking at it another way: “If you’re not measuring how well you’re doing, it’s impossible to know whether anything you try is working or not,” says Peter Cappelli, director of the Wharton School’s Center for Human Resources in Philadelphia.

Traditional accounting measures, such as balance sheets and income statements, won’t be augmented with statistics on human capital and intangible assets anytime soon. But many experts say organizations and government agencies should encourage firms to produce measurements of intangibles to complement existing accounting measures and give a truer picture of corporate worth. (See “Reporting Intangible Assets,” right.)

In some ways intangible assets are more significant than traditional accounting measures. While traditional accounting statistics indicate how the company has performed in the past, measures of investment in human capital indicate how the business might perform in the future.

“Accounting reports are lagging indicators” of a company’s success, says David Norton, president of the Balanced Scorecard Collaborative, a Lincoln, Mass.-based management consulting firm. “People are looking for leading indicators,” he says, and human capital investment is one of the best.

A Variety of Approaches

Companies are applying the emerging techniques of human capital measurement in various ways depending on their most pressing needs. Instead of just tracking tried-and-true metrics, leading-edge HR professionals are gathering and manipulating data in novel approaches to reveal and analyze value in ways that were not previously apparent. For example, Dow Chemical has focused on decentralizing authority (see “Dow: Empowering Teams”). IBM Corp. has scrutinized its training budget (see “IBM: Refocusing Learning”). And CIGNA has targeted high turnover (see “CIGNA: Reducing the Churn”).

Consultants and researchers have differing approaches as well. Some encourage organizations to develop comprehensive “maps” that show how people and other assets and internal processes interact throughout the business and with customers. Some experts target a specific business problem or opportunity in an organization with the goal of getting the most bang for the buck. And some focus on generic HR practices and their average return on investment across all business sectors, even though that impact can vary substantially from firm to firm.

For example, Washington, D.C.-based consulting firm Watson Wyatt Worldwide released a study earlier this year grading a variety of common HR practices, such as variable compensation, developmental training and 360-degree feedback. Though most of the practices were found to be linked to increases in stock value of the companies that use them, the study found that developmental training and 360-degree feedback actually decreased shareholder value. (For more information, see the articles on 360-degree feedback and training in the June and August issues of HR Magazine.)

“We’re dealing with averages here,” says Bruce Pfau, Watson Wyatt national practice leader for organizational effectiveness. “They’re not going to provide these results in every case.” For example, he says, the study found that paying people more than the market level in a given industry is correlated with higher stock value. “That doesn’t mean you couldn’t have a counterproductive result if you pay 12 times the market rate.”

Adds Pfau, “I was as surprised as anyone else” to see that 360-degree feedback is a losing proposition overall. In all these matters, he says, “you have to have an open scientific mind.”

Those who take a different approach to analyzing human capital agree with that point.

“We need a broad understanding of what types of intangible assets are valuable in the company,” says Schmidt. “You need to understand what investments have the greatest impact on earnings growth” in a particular organization, he states.

Some human capital investments are ones that “you’ve got to have just to stay in the game,” such as a basic benefits package. But Schmidt says the emerging science of assessing human capital can foster “intelligent decisions about investment tradeoffs” such as whether variable compensation or better work/life programs or some other choice will maximize workers’ drive to improve the bottom line in a given company.

Focus on Business Strategy

The process must start with a thorough understanding of an organization’s business strategy. A strategy is not “let’s make money.” Rather, it’s “here’s how we make money.” Surprisingly, not all CEOs and HR executives can summarize their business strategy in 25 words or less, note consultants who work with them.

A recent survey conducted by the Society for Human Resource Management and the Balanced Scorecard Collaborative, tentatively scheduled for release this fall, found that even though 73 percent of organizations polled believe that they have a clearly articulated strategic direction, only 44 percent of the organizations say that that strategic direction is communicated well to the employees who must implement it.

Once strategy is clear, the process then moves to identifying cause-and-effect relationships driving business success, the experts say. And these aren’t always as obvious or simple as they might seem, either.

Take, for example, bonus pay and profits. Your company might have boosted its compensation for top salespeople five years ago, and you might have enjoyed five years of solid, and perhaps increasing, sales and profits. But did the higher bonuses cause higher sales and profits, or were all factors basically linked to the overall economy?

“Lots of companies are awash with data,” says Dave Kieffer, who heads New York-based Mercer Human Resource Consulting’s human capital strategy practice, “but very few companies have the statistical capability” to demonstrate cause-and-effect relationships that show how profits and stock value are created and, more importantly, suggest how to adjust HR practices to maximize financial results.

“What gets measured gets managed,” says Kieffer.

An Incremental Approach

Not every organization is willing or able to jump into the human capital assessment game in a big way, analyzing multivariate regressions to demonstrate the value of HR programs they use.

Analyzing human capital investments can be an expensive proposition. A one-day visit from a competent consultant can help set up a human capital assessment program for an initial cost of less than $10,000. But bringing in bigger outside guns can cost as much as $100,000, and more for the largest corporations, though some of them are creating permanent in-house human capital assessment teams.

For many firms, especially small ones, the key is to start small, keep it simple and build on success.

“This is a big nut to crack. These things take time,” says Rutgers professor Huselid. “Choose a business unit with a human capital problem, or a group of teams. Use them as a pilot project. HR can begin the process with line managers,” he says. “What are the jobs that create the most value? Then, how can we differentially invest in and promote those employees?”

 “Start with the idea of taking action that is going to improve your business,” says Theresa M. Welbourne, a professor at the University of Michigan Business School and CEO of eePulse, an Ann Arbor, Mich., survey and consulting firm.

“Every business, regardless of size, is a good place for HR measurement,” says Garrett Walker, director of learning investment and performance for IBM Corp. in Armonk, N.Y.

A Change in Philosophy

In addition to budget implications, starting down the path of measuring and managing human capital requires a change in philosophy for some organizations.

For too many years, say some experts on human capital, HR and managers in general have focused too much attention on costs connected with the workforce. Even when HR has used finely honed staffing metrics to show that it has reduced expenditures to hire or train employees, it has inadvertently reinforced the notion that HR and the workforce are an expense to be limited or reduced, not an asset to be leveraged for profit.

“If you believe that human beings are just an expense, forget it,” says Fitz-enz of the Saratoga Institute, noting that recent research from highly respected academics concludes that HR creates value rather than dragging down a firm as a cost center.

“Even if you’re a small company, to change the mindset is a major step forward,” says Mercer’s Kieffer. HR should endeavor to “move away from managing expenses to creation of value” by asking questions like:

  • What is the real size of our investment in HR?
  • What is the return on this investment?
  • Can we reallocate some of this investment to get a better return?

Adds Wharton’s Cappelli: “Be clear about what the goal is you are trying to achieve for each (HR) practice. Then think about some outcomes that are measurable, even if only subjective, because at least then you can look at trends.

“The hard part is having measures that are meaningful, and that should be generated from good performance management,” says Cappelli. “If you don’t have clear, meaningful outcome measures, don’t bother. It will be garbage in, garbage out.”

HR Under the Microscope

One of the implications for HR in championing or implementing new systems to measure and manage human capital is that the effort might expose some past or existing practices that don’t add value.

“It puts a burden on HR managers,” concedes Jack Phillips of the Jack Phillips Center for Research in Birmingham, Ala.

“There certainly is a risk that you will find that what you’ve been doing isn’t worth much,” agrees Cappelli. “But better you find out that for yourselves first when you’re controlling the process and can make changes than have someone higher up do it for you.”

“It is more threatening for us as HR professionals,” says Huselid. “We’re held accountable for things over which we have only partial control.” But HR professionals should not focus too much attention on past programs and who is responsible for them, he says. Nor should HR spend too much energy crowing over successes.

“The goal is not to give HR or anyone else a pat on the back. It’s about allocating resources.”

Involvement with human capital assessment “leads to a different kind of role for HR,” says Norton of the Balanced Scorecard Collaborative. HR executives can help a corporation build a strategy map, and “suddenly they start talking a different language,” one that puts HR at the table and helps senior management view the complex roles of HR and human capital in a different light.

As the knowledge base about human capital grows, says Norton, top executives “can no longer say to HR, ‘get me good people,’ and to marketing, ‘go sell it,’” he says.

When HR arms itself with sound analysis of the practices that drive success in organizations, says Fitz-enz, “we are the driving force.” 

Steve Bates is senior writer for HR Magazine.  

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