Don't Fear Prudent HR Risks

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Wayne Cascio, Ph.D., Professor and Robert H. Reynolds Chair in Global Leadership, University of Colorado

Wayne CascioWayne F. Cascio holds the Robert H. Reynolds Distinguished Chair in Global Leadership at the University of Colorado Denver. He has published 28 books and more than 185 articles and book chapters. A former president of the Society for Industrial and Organizational Psychology, Chair of the Society for Human Resource Management Foundation, and member of the Academy of Management's Board of Governors, he is an elected fellow of the National Academy of Human Resources, the Academy of Management, the Society for Industrial and Organizational Psychology and the Australian HR Institute. He received SHRM's Losey Award for Human Resources Research in 2010 and SIOP's Distinguished Scientific Contributions award in 2013.

"It seems to be a law of nature, inflexible and inexorable, that those who will not risk cannot win."

—John Paul Jones 

Paradoxically, one of the unfortunate byproducts of employment downsizing—a phenomenon that seems to continue unabated in both good and bad economic times—is that surviving employees become narrow-minded, risk-averse and self-absorbed. This happens at the very time when organizations need their employees to take risks in order to develop new products and services, to penetrate new markets, and to serve their customers better. Yet the term "risk" has come to imply a bad outcome. It may be more prudent, however, to rethink the concept of risk in light of two other considerations: uncertainty and opportunity.

Uncertainty is the degree to which we are unsure about whether an outcome will occur and its consequences, good or bad. Risk refers to an undesirable outcome and its consequences. Finally, opportunity refers to a desirable outcome and its consequences. A prudent approach to human capital risk requires carefully distinguishing these three ideas. Uncertainty is not necessarily a bad thing, but it depends on the balance between downside risk and upside opportunity.

HR Strategy and the Two Faces of Risk

HR strategy refers to the processes, decisions and choices organizations make regarding how they manage their people. Indeed, a firm's competitive strategy and its HR strategy are interdependent.1 Both require a prudent and balanced approach to risk. HR strategy must optimally balance risk-taking and risk-mitigation, in line with an organization's competitive strategy and the role of human capital within that strategy. 

HR strategy requires a focus on planned major changes in an organization and on critical issues such as the following:

  • What are the HR implications of our proposed organizational strategy?
  • What are some possible external constraints and requirements?
  • What are the implications for management practices, management development and management succession?
  • What can be done in the short term to prepare for longer-term needs? 
The Chinese characters for "risk" depict "danger" and also "opportunity." We might call these the two faces of risk. Human capital risks reflect the uncertainty arising from changes in a wide range of workforce and people-management issues that affect a company's ability to meet its strategic and operating objectives. 

They include issues such as talent management and succession planning, ethics and tone at the top, regulatory compliance, pay and performance alignment, and employee training and development. The global accounting firm Ernst & Young described four broad categories of such risks—strategic, operational, compliance and financial—and characterized HR risks as "one of the key business risks of our time."2 

To date, the dominant approach to such risks has focused on risk mitigation (emphasizing danger), not risk optimization (emphasizing opportunity). HR practitioners and academics have generally not adopted systematic approaches to optimizing human capital risks. Consider five key HR risks that many organizations face:

  • What is the risk that we do not attract or retain the right talent to achieve our strategic targets?
  • What are the underlying assumptions about human capital in our business forecasts (are we assuming adequate internal and external supplies)?
  • What is the risk that our company culture does not support our strategic intent?
  • Which HR policies, programs and practices pose potential risks? How do we manage them?
  • How do we ensure that assessing and managing human capital risk is not an HR-only exercise?
Prudent HR Risk Taking: An Example

What might prudent HR risk taking look like? Workforce analytics can help. Workforce analytics is fact-based decision-making. As an example, consider global engineering company CH2M Hill, headquartered in Denver, Colo. The company was facing an increasing voluntary employee turnover rate, especially among female engineers, and it needed to identify the causes and consequences to operations in different parts of the world.

It began by "crowdsourcing" ideas from its current cadre of managers and non-managers about why people leave the company. It generated 78 possible hypotheses, and narrowed that list to 30 hypotheses based on the availability of data, the integrity of the data generated, and the ability to generate actions based on evidence-based findings. 

The master data file contained 472 variables of interest. Using logistic regression (where the dependent variable is binary in nature, such as "stay" versus "leave"), the company identified seven variables that predicted the likelihood that an engineer would leave, with a corrected R2 value of 0.34 that yielded an 80% hit rate on classifying retentions and a 60% hit rate on classifying resignations. The model was derived on the basis of data from 2012, tested on data from 2011 and validated on data from 2013. For proprietary reasons, the company does not disclose the actual seven items in its prediction model.

In using its prediction model, CH2M Hill generated "risk-retention" scores by geography and used "heat mapping" to show results graphically. It then prioritized retention risks by business groups, critical job families, demographic categories and years of service. It also used "what-if" simulations as an aid in annual merit-raise planning. The company was able to generate a "risk-retention" score for each employee and to subdivide the overall employee population by geographic region, country, critical job family, gender, age, ethnicity, job-performance category and pay-grade band.

This powerful model allowed CH2M Hill to manage voluntary turnover more strategically and to give managers an "early-warning" system that might allow them to take actions in a timely manner to prevent some of the voluntary turnover from ever occurring. Of course, the company could have done nothing and simply accepted its voluntary employee turnover rate as "industry average" and a cost of doing business. It would have risked—and gained—nothing.

In managing employee turnover strategically, consider three kinds of circumstances where it might make sense to increase employee turnover: (1) the fully loaded costs (separation, replacement and training) of employee turnover are low, and reducing turnover saves little; (2) those leaving are much less valuable than their replacements; and (3) there is certainty about the availability or quality of the replacements. Sometimes one or more of these considerations outweigh others. 

For example, during the Great Recession as many as 70% of the firms that were laying off employees also added new ones in the same year! They did so because even though the direct costs of downsizing are high (as much as $100,000 per high-tech worker in the U.S. and Europe), those leaving were seen as less valuable than their replacements, because the replacements possessed skills that organizations would need going forward to execute their business strategies. In short, organizations ushered out the back door employees with yesterday's skills, while at the same time welcoming in the front door those with tomorrow's skills.

Conversely, it makes sense to decrease the costs of employee turnover under the following three conditions: (1) when the fully loaded costs (separation, replacement and training) of employee turnover are high, and reducing turnover (particularly in mission-critical positions) can save those costs; (2) those leaving are much more valuable than their replacements; and (3) there is considerable uncertainty about the availability or quality of replacements.

Getting Started: An Action Plan

As a simple framework that might help HR professionals get started in this area, consider identifying and then prioritizing each HR risk that your organization might face. To do this, consider just two dimensions, likelihood and impact. Describe each of these dimensions in terms of a three- or five-point Likert-type scale. Next, with respect to each potential HR risk that you have identified, answer the following questions:

  1. Is it relevant to your organization?
  2. Might it have a material impact on your organization?
  3. If relevant and material, is it an enduring risk?
  4. If relevant, material and enduring, is it addressable?
Here is the message to convey to decision-makers: Focus where it matters most!
 
Endnotes

  1. Cascio, W. F., & Boudreau, J. W. (2012). Short Introduction to Strategic Human Resource Management. Cambridge, UK: Cambridge University Press.
  2. Ernst & Young. (2008). 2008 Global HR Risk: From the danger zone to the value zone: Accelerating business improvement by navigating HR risk. London, UK: Author.
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