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Phillips' Edge

Capturing Cost of Human Resources Programs: Easier Said Than Done

Jack and Patti  Phillips
Posted: 05/14/2009

Many of the ROI articles in this column have focused on the benefits of a particular human resources project or program. After all, developing the monetary benefits is a difficult challenge. Almost anyone will quickly state that capturing cost isn’t the problem. It’s the benefit. Consequently, the current focus of human resources programs should be on the benefits side of the ROI equation. The ROI analysis is leading to an equation where we capture the net benefits, divide it by the cost and multiply it by 100 to calculate the ROI as a percent.

We’ve looked at converting data to money to determine the benefits stream, so that the total monetary benefits are connected to the human resources program. Now, with the benefits comes the denominator of the equation, which is the cost. Several issues with indirect costs of human resources programs deserve attention.

Cost of Participation in a Human Resources Program

There’s an indirect cost for people involved in human resources programs. Regardless of the type of human resources program, it takes time for someone to either learn about the program or use it in some way, and this time away from work can be significant. For example, in a leadership development program, the indirect cost of taking the leaders away from normal work activities is perhaps the largest single cost item. So, how do we develop this cost?

There are three ways to develop human resources program costs:

  1. Use the replacement cost—If we actually hire replacements, we use the cost of the replacement. But in most cases—and certainly in the case of the leadership development program—we would not be hiring replacements. If this doesn’t apply, move to the next possibility.
  2. Calculate the lost opportunity—What did we lose by not having those people on the job? For some, this may be easy to calculate. Take someone in a production environment, for example. We can certainly see what we would miss if they were not there producing. For someone in a sales capacity, we know what we miss by not having them selling. Perhaps, this is the easiest one. However, it’s also a little tricky because when we take a sales representative away from the job, we lose the profit on the sale. After all, there’s a cost of the goods sold that must be considered. So, it’s the operating profit (or the gross profit) that would be lost. We know this amount can be found in the records, and we may use it for the lost opportunity. But not so fast. Suppose the profits are negative, and we’re actually losing money at this point in time. What do we do then? Do we add cost to our human resources programs or take it away? Obviously, it would be absurd to suggest that the company is doing much better to take these people away from work simply because we lose less money. So, while the option of calculating lost opportunity seems the most credible, it is sometimes the most difficult to accomplish and may not be credible. This leads us to the next option for developing the costs of human resources.
  3. Use the cost of fully-loaded compensation (salaries plus benefits)—If we take a manager away from the job for a week, what would we have paid that manager to be there? That’s the fully-loaded compensation cost; salaries, bonuses, plus benefits. It’s easy to calculate or, in some cases, just estimate. We know approximate salaries and can obtain ranges from human resources. We can calculate the cost of participation and be very accurate about it.

Factoring the Cost of the Facilities for a Human Resources Program

Another often omitted indirect cost is the cost of using facilities—when people meet in a conference room, attend training sessions, or use a technology lab, for example. These are legitimate costs of using a facility, so we must include the cost. Here, estimates would be appropriate, prorating the cost of using a conference room on a particular day or for a certain number hours in some cases. The accounting department may be able to provide data regarding the cost. The old fashioned way of asking the local hotel about the cost of a room and refreshment would make the data quickly available and would be a good substitute for a calculation.

Cost of Coordinating a Human Resources Program

Another indirect cost is the cost of people involved in managing, administering, facilitating or coordinating the human resources program. These salaries are often in the records (or can be estimated) and performed by individuals who may do other work. So, a prorated portion of the cost for the time involved in this human resources program is needed. This calculation would use simple estimates for the amount of time factored in with the cost of their time.

Prorating a Human Resources Program Costs

Sometimes costs need to be prorated to the particular group being evaluated. For example, the cost of initial needs assessment (to identify a particular solution); the cost for developing a solution for a particular problem; or the cost of purchasing an existing program would all be initial costs that occur early in the process. These are often called "sunk costs." Sometimes an accountant will tell you "these costs are sunk; don’t worry about them." But we do worry about them because they are a part of the cost for this program. So, we must account for them in our evaluation. For example, consider the development cost for a leadership program that was developed two years ago and that 200 people attend every year. Now, we’re evaluating two groups of 25 to determine the impact, so we need to add the development cost for the 50 people. How much development costs would we include? Perhaps the easiest way to approach this is to think of the life cycle of the human resources program. If the life cycle is five years (in five years either all of the participants have completed the program or a major revision of the program is needed). We have 200 participating each year. We know that 1,000 people will complete the program during this life cycle. We have estimated the $25,000 development costs (or purchase costs if the program was purchased). Estimates are appropriate. Now, we calculate the development cost per person; $25,000/1,000 participants, which is $25 per person. If we are evaluating 50 people, $25 x 50, or $1,250, would be the prorated development cost. This is probably the easiest way to reflect the development costs.

Human Resources Costing Guidelines

Here are some guidelines we should use when developing cost for a particular human resources project or program.

  1. Use fully-loaded costs including the indirect cost. There’s a tendency sometimes to use only the direct cost of the human resources program, what’s actually been spent, and leave any other cost out of it. These indirect costs are sometimes hidden costs, often referred to as "sunk costs." All costs should be included to have a fully-loaded cost profile. This is the credible way. What we’re trying to do is prevent anyone from suggesting that all of the costs are not in our calculation. The total list of costs is in Figure 1. (Click on diagram to enlarge.)
  2. Estimates will be appropriate for many of the cost items—calculating the detailed cost to two decimal places isn’t necessary and isn’t expected. A general estimate of cost from credible sources should be appropriate.
  3. Never present the cost of the human resources program without some knowledge of the benefits; either we know how to calculate the benefits and can do so, or we’ve already calculated them and have them in hand. As you can imagine, presenting costs without concern for the benefits will always lead to the question, "So, what are we getting out of this program?" Be prepared for that. Some organizations have a policy of never reporting a cost unless they’re prepared to discuss the benefits in some way.
  4. The finance and accounting staff is your best friend when developing human resources costs. We need to partner with the finance and accounting community when developing ROI in human resources. Having them involved in the cost standards is an easy way to involved them. You can quickly take a list of the costs and secure input on the standards. In essence, you want the finance and accounting team to agree with your cost categories.
  5. Although we use estimates, let’s ensure that we use as many actual human resources costs as we can, when they’re easily available, and when we use inputs from sources that are very credible. After all, this is an important part of the calculation. (Click on diagrams to enlarge.)

Figure 2 shows the completed example from an absenteeism reduction program. Figure 3 shows a similar set of costs from a leadership development program for first level managers.

Summary

With costs in hand, the next issue is to calculate the actual ROI. The next column will focus directly on this calculation, what it means and what it doesn’t mean.

Jack and Patti  Phillips
Posted: 05/14/2009