CEO's Guide to Human Capital Value
Accounting says human capital is an expense, but human capital is also an investment generating predictable top-line growth.
The undeniable fact is that human capital is your only live asset. All physical assets are immobile. There is no return on a billion dollar factory until you staff it with skilled, motivated, high-potential employees. The point is, you have a business model, but do you have a human capital management model?
The Value Transformation
In 2007, with the sponsorship of companies such as Accenture, Blue Shield, Ceridian, Fidelity, Monster, Oracle, SuccessFactors, Target and others, we built out the Predictive Management model (PM). The operating model is divided into four phases or steps:
- Comprehensive scanning
- Capability planning
- Process optimization
- Predictive measurement
Strategic Planning Scan
The annual strategic planning exercise has two problems. First, each function usually ignores data from the other functions. Second, data from each silo is seldom correlated, thereby breaking down alignment.
In predictive measurement all functions contribute to a master list of external and internal forces that might affect your company’s human capital, structural capital or relational capital. While it sounds like an impossible task, it is not. The top 40 managers of a 35,000 employee, multinational engineering company worked through it in just two days. Once completed they set a record pace in building a leadership development and succession plan. "[In just six months] we identified our high-potential employees. We developed the high-potential employees' career paths and identified their training, learning and development needs. We were also able to identify potential successors, and now we are working on their training, learning and development needs." Compare that with many companies who cannot even generate an accurate head count!
Workforce Planning Base
Workforce planning is an industrial-era, gap-analysis exercise focused on positions and procurement, not value. Predictive measurement’s central question is, which capabilities will we need to fulfill our business planning goals?
Capabilities can be divided into four categories regardless of departmental boundaries:
- Mission critical—necessary for survival
- Unique and differentiating—provide competitive advantage
- Operationally necessary—keep the machine running
- Movable—can be retrained, transferred, eliminated or outsourced
Once completed, succession planning can begin. Our research of 714 companies in 2007 discovered that there is a connection between succession planning and top line revenue if:
- A senior executive is responsible and accountable for managing the succession plan.
- High-potential employees are identified and development plans designed.
- Training and development plans are directly aligned with corporate strategy.
- HiPo plans are reviewed, modified and reinforced at least annually.
- Performance of the group is correlated with top line revenue growth.
The research showed that when at least 75 percent of mission critical and differentiating positions have a fully qualified replacement, top-line revenue begins to increase.
Processes should be judged on their ability to "return more money to the firm than they cost in terms of invested capital."1 Processes must be treated in two ways:
- Applied statistical analysis. Example: Divide the hiring process into inputs (sources of job applicants), throughputs (selection and induction methods) and outcomes (new hire performance, potential, turnover predictability, etc.). Predictive measurement identifies the most value generating combination of inputs and throughputs to optimize outcomes.
- Integrated delivery schedules. Operations done in a silo are inward looking and inefficient. They conflict with each other when they touch their customer, the manager or employee.
High-value process management synchronizes service delivery. How can you have a staffing strategy before you have a capability plan, or a development plan before there is data on labor pool quality? The synergy within human resources processes is minimal to nonexistent.
Accounting data is lagging information. It is not predictive, and putting it in a dashboard does not change its nature. Benchmarking also lags and seldom is comparable across companies. The solution is to adopt a three-part system tying together strategic, operational and leading metrics.
1. Strategic—You want the big picture quickly. A half dozen human capital metrics do it:
- Revenue per FTE
- Human Capital Value Added (HCVA): Non-human expenses divided by number of employees. This is more precise that revenue per FTE, which ignores the effects of nonhuman investments
- Human Capital ROI (HCROI): Same as HCVA except divide by cost of pay and benefits. This yields a ratio of 1:1.xx
- Human Capital EVA: EVA per employee; the ultimate human productivity metric
- Turnover of mission critical and differentiating personnel
Beyond these you might have specific human capital metrics unique to your needs.
2. Operational—These are the typical lagging indicators:
- Cost per unit of product or service: hiring, training, paying and benefits processing, etc.
- Timeliness: time to fill jobs, deliver training and leadership development, respond and solve problems
- Quantity: volume of output over input, numbers hired, trained, etc. with a given commitment of resources
- Reaction: satisfaction of employees and managers with human resources services
3. Leading—These intangibles are directly related to strategic level metrics:
- Readiness:percent of mission critical and differentiating positions with at least one fully-qualified replacement
- Leadership: employee survey results indicating degree of commitment to corporate leadership; these directly correlate with employee engagement and turnover
- Employee Engagement: employee surveys indicate willingness to give more than the basic effort, correlates with revenue per FTE
- Employer Brand: correlates with the cost to hire and retain top talent
- Employee Retention: percent of mission critical and differentiating positions not losing employees; reverse engineering retention uncovers the reasons for turnover
As operational or leading indicators change you find correlations with strategic metrics.
There is no question that business success is a function of human capital performance. The time-worn idea that labor is only expense is no longer serviceable. To make major improvements, sustain growth and gain competitive advantage you need a positive and practical human capital management philosophy coupled with an operating model. Investing in tools is sub-optimized unless there is knowledge about the potential of human capital investments. The PM system yields comprehensive intelligence, aligns functions and provides future-focused measures tied to business goals. 1Peter G. W. Keen, The Process Edge, Harvard Business School Press, 1997, p. 16