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Three ways to measure human resource costs—and what to do with the numbers.
Although Colin Adams, GPHR, calls on his corporate finance colleagues less frequently these days, when he does, he finds that the discussion flows quite naturally. “We use our finance organization to help understand everything that goes into the cost of each of our HR shared service functions,” says Adams, an East Aurora, N.Y.-based human resource manager for Moog Inc.’s industrial division in the global manufacturer’s Americas Region.
Adams and his HR colleagues have made many calls to their corporate finance colleagues in recent years for help calculating HR costs. The investment in these discussions delivers returns. “I can look at what our staffing shared services model will cost vs. using an external recruiting solution,” Adams adds. “Knowing these costs strengthens the decision-making process.”
Like a growing number of HR professionals, Adams invests more time thinking like a finance manager: calculating the cost of delivering HR services, making efficiency decisions based on those costs and evaluating HR effectiveness in tandem with HR efficiency.
Today, measures such as HR costs per full-time employee are routinely used to assess how, and where, HR resources are deployed. While cost-related metrics are useful, they represent only part of the complete HR performance picture.
Strike a balance between efficiency and effectiveness in delivering on company strategy, says Pete Sanborn, global HR effectiveness practice leader with Hewitt Associates, based in Lincolnshire, Ill.
Apples to Apples?
Moog, a manufacturer of aircraft precision controls, has a fairly strong handle on internal HR costs. The next step in putting this information to use, Adams notes, would be to purchase external benchmarks to see how company HR costs compare to competitors and companies of similar size and structure.
These measures are available from researchers and consultants such as The Hackett Group, PricewaterhouseCoopers Saratoga, Hewitt and Towers Watson, among others, as well as from organizations such as APQC and the Society for Human Resource Management (SHRM).
Most researchers calculate HR costs differently, and the impact remains up for debate.
Several, including Hackett’s practice leader Harry Osle, describe the approaches as fairly standard—with nuanced variations. For example, many researchers calculate training costs differently; some exclude technical training costs in industries where this type of training—as opposed to management training—can be a cost of doing business.
Other HR experts disagree. “There are no standards,” reports PricewaterhouseCoopers Saratoga Director Scott Pollak. “Everyone uses different formulas.”
That could change, thanks to an endeavor to create technical standards for HR metrics, notes John Dooney, SHRM’s manager of strategic research. The Society was designated a Standards Developing Organization by the American National Standards Institute in 2009, allowing it to oversee creation of national standards in the HR sector. These standards are authored by HR professionals, experts and vendor representatives from several organizations and then submitted to the institute for designation as American National Standards.
“The ways APQC, Hackett, Hewitt, Saratoga and others calculate HR metrics are not completely different, but they are different,” Dooney explains. This process will “ensure that apples-to-apples comparisons can be made.”
Filling Your Cost Bucket
Most calculations of total “HR costs” take one of three forms. HR costs:
HR costs per HR full-time equivalent are less common. “We are not big fans of HR headcount ratios,” Pollak explains, because automation, outsourcing and shared services models affect this metric independent of overall HR resources.
The components that determine overall HR costs within an organization are relatively similar, with some exceptions. Most computations of total HR costs include the following:
Some benchmarks, including those produced by Hackett and APQC, feature calculations of the time spent by managers—other than HR managers—on HR activities. For example, the time a supply chain executive invests to interview, select and onboard a new supply chain manager would be included as an HR cost.
Leaders in “more astute organizations are trying to understand the total cost of delivering HR services, and that means going beyond the traditional walls of HR,” says Osle, who allows that these calculations are more complex, “but with complexity comes greater accuracy.”
Karen Piercy, a partner in Mercer’s human capital consulting practice, embraces this activity-based costing approach that Osle describes but insists that it is better applied only within the four walls of HR. “Outside of HR, it takes a lot of work to get that information, and I’m not sure how much value it adds.”
Piercy says that HR professionals should ask: “What do you want to do with the data and what are you trying to measure?”
The Hackett Group, APQC and Saratoga, among others, offer detailed HR-cost taxonomies, arranged by functions, processes and sub-processes. For example, Saratoga’s taxonomy includes 16 sub-
functions of HR, including talent acquisition, compensation and workforce mobility. Hackett’s HR taxonomy includes four process categories, nine process groups and roughly 20 individual processes. These detailed breakdowns help HR professionals and other clients accurately measure, compare and manage costs within their areas of responsibility.
Clearly define the scope of benchmarking, says APQC’s Rachele Williams, program manager of research services“Identify exactly what activities and processes are included as well as what is excluded.”
Failing to do so can cause pitfalls, warns Pollak: “We’ve seen companies start to make dramatic changes when they compared their numbers to external benchmarks before they understood that a large part of the difference in cost is caused by something as simple as not including the payroll function in the benchmark.”
Pollak’s point underscores the importance of understanding that these metrics often serve as grist for budget decisions or transformation planning. Dooney reports that more than half of the HR professionals who request cost metrics from SHRM say they need the information to defend their cost structures and identify potential process improvements. Such decisions can lead to the creation of HR shared service centers, HR outsourcing arrangements or implementation of HR information systems.
Nancy Emerson, a director in Buck Consultants’ human capital management practice, recently worked with utility executives using external HR cost benchmarks to inform cost reduction. The executives compared their HR costs to those at other utilities as well as at companies with similar revenue and headcounts.
Then senior HR executives “socialized” the impact of various cuts. “Before the cost-reduction decisions were made, they made sure the right people understood how their areas would be affected,” explains Emerson, who notes that the metrics helped HR executives illustrate the pros and cons of different scenarios.
Other Buck clients, hospital executives, used external HR cost metrics to support a business case for investments in compensation. When compensation benchmarks showed that the hospital could be viewed as less than competitive when hiring picked up, HR professionals used the metrics to make a business case for gathering more information on certain HR disciplines, including compensation.
At Moog, Adams and his HR professionals recently used internally developed HR cost metrics to debate with their colleagues the pros, cons and costs of restarting a global orientation program for newly hired and promoted managers. Each department that sends a manager must pay the training costs. “Some managers ask, ‘Well, why can’t HR provide that?’” Adams relays. “And we explain, ‘That’s not the model. If we did that, then your HR allocation would change.’ It’s been an eye-opening discussion.” Moog’s HR cost calculations include salaries, benefits, overhead and the corporation’s “charge” for HR information systems.
Integrating quantitative evidence into discussions with top leaders can heighten the quality of these exchanges. The numbers create the business case, Osle explains.
And the most effective business cases are supported by cost measures as well as effectiveness measures.
“Anybody can drive down costs,” Osle adds. “You can say, ‘HR is overstaffed by 22 percent, so I’m going to take out the training function.’ But by doing so, have you really driven any value for the organization?”
Time Equals Value
Determining value ultimately requires more than a cost calculation and a focus on efficiency. “HR expense and resource-related metrics are good indicators of HR efficiency; however, they are not good indicators of value,” Pollak explains.
So, what indicates HR’s value? The time HR professionals spend achieving strategic objectives.
Look “at the company’s strategic priorities and mission and compare those to where HR is spending its time,” says Piercy. Often, those are not aligned. “For example, revenue growth and the development of talent may be very important but HR is spending most of its time on administrative and transactional activities in other areas.”
Showing where the HR department spends its money helps HR professionals and other executives throughout the organization see where HR professionals also invest their time. That understanding represents a first step. “If you focus too much on costs, you are going to be perceived as an administrative cost center,” notes senior consultant Michael Benyamin of New York-based Towers Watson.
That explains why Adams and other metrics-savvy HR professionals use benchmarking data as a way of discussing value with their operational colleagues. “We’re helping our operating groups make better HR-related investment decisions,” says Adams. “Our operating groups make the decision, for example, of whether or not they want to invest in a learning management system based on a sound business case.”
HR leaders should work to understand where top executives want the business to go, Benyamin adds. “Are you going to grow by acquisition? Are you going to go into new markets? Are certain workforces aging faster than others?”
By answering questions like those, HR professionals can identify the talent needs that support strategic objectives, and then create measures that track how well the function delivers on these talent needs. “To do this,” Benyamin adds, “you have to start speaking their language.” And numbers are the language of business.
The author is a business writer based in Austin, Texas, who covers human resource and finance issues.
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