Mounting evidence shows that good HR practice increases shareholder value.But as competition drives management to use every lever it can to win businessadvantage, the time has come for HR to prove its strategic worth beyond doubt.Tom Lester reportsMeasuring the effectiveness of the HR function has taxed the best businessbrains for many years. The aim has been to prove the contribution of ‘peopleassets’ to corporate success and the HR processes needed to increase it. Butnew interest in the subject in the past couple of years focuses on the otherperspective – the company’s value in the market. Given the growing part of HR that is intangible and derived from its people,what HR practices are effective in increasing its value and growth rate, andhow can they be made more effective? It may appear that the difference is a semantic one, but in practice, itcould transform the old question of HR measurement. If, as claimed, a 26 percent increase in the value of companies’ shares correlates closely with theeffective use of a number of key HR practices, then this is a message no chiefexecutive can ignore. If, further, it can be shown that one company is derivingmore value from its human resources than another, these points can help HRprove its strategic worth. These are big ifs. But increased competition and the growing emphasis onshareholder value are driving managements to use every lever at their disposal.The similar rise in the relative value of knowledge, experience and goodwillcompared to physical assets depends on the quality of staff. Further, in theleaner organisation there can be few passengers, and the value added by eachindividual is critical. If such vital dimensions remain unmeasured, howevercrudely, the chief executive is relying on hope rather than verifiable fact. Swiss banking group UBS, like all firms in the financial sector, depends onthe quality and deployment of its staff, and has recently taken radical stepsto measure them consistently across the group. Earlier this year it set up acentral Human Capital Performance Team. “Very few companies can say, as wecan, that metrics are right at the heart of what we do,” says the team’sfounder and head John Mahoney-Phillips. It will take time before the disciplines implied by the metrics areuniversal and used effectively by management. Like all the big banks, UBS hasto span the cultural differences between retail banking and the moreentrepreneurial asset management and corporate finance (it embraces Warburg andPaine Webber). “But we now have a single group-wide core framework,”says Mahoney-Phillips. Attaching financial values directly to intellectual capital remains elusive,however. In the 1960s, the well-known US academic Rensis Likert tried it withresearch workers, but he found the obvious difficulties outweighed theadvantages. In the 1990s, Gerald Kaplan and David Norton produced the balancedscorecard that added HR and other measures to the conventional financial ones. At about the same time Leif Edvinsson, when working for Swedish financialservices group Skandia, published an analysis of the group’s intellectualcapital (IC) with the annual report. His aim was to demonstrate to managers andshareholders alike what really made for success in financial services. Skandia still uses Edvinsson’s analysis of IC, which it plans to include inits next annual report after a three-year gap. Human capital is defined as thecompetence and capabilities of the bank’s employees; organisational capitalcovers systems, databases, and so on, plus customer capital – the value of itsrelationship with customers. The group’s reward came this year when it wasranked eight in the world’s top 20 most admired knowledge enterprises – aboveMcKinsey and Cisco. Conventional metrics generally range from the very basic staff productivityand turnover, through talent acquisition and retention to leadership,innovation and other qualities. Which ones you choose, says Carolyn Nimmy, adirector of the global HR practice at consultancy Cap Gemini Ernst & Young,depends on the answer to the question: “What does winning entail for yourcompany? Innovation? Brand strength? Quality? Globalisation?” “Youthen ask,” she says, “what can we measure against these?” A number of consultancies are picking up the metrics baton. They see that linkingHR practices to business success can make sense, providing you allow foreconomic and stock market fluctuations and different capital structures. PIMS,the corporate performance benchmarking specialist, uses its worldwide databasesupplied by more than 5,000 managers to calculate a client’s expected return oncapital employed based on a profile of its business. HR characteristics such as an open management style or the number of daysmanagers spend training per year are then assessed for their impact on theactual return on investment. Watson Wyatt, being an HR consultancy, uses a much smaller database thanPIMS, but has developed what it calls a Human Capital Index (HCI). This is arating of an organisation’s HR practices on a single scale of 1 to 100. It hasshown that those scoring highly are, on average, more likely to have built upgreater intellectual capital (as measured by the ratio of market value totangible assets at replacement cost, known to economists as Tobin’s Q). They also deliver more shareholder value. The IC ratio is susceptible tomarket fluctuation, but is used as a means of comparison. Partner Steven Dickerclaims it to be “a robust method for determining whether you are managingyour human capital better or worse than your rivals”. There are other attempts being made to link people and results. In essence,all are forced to use a subjective assessment of a company’s HR operations(usually performed by the company’s HR staff), and most make no claim to haveisolated a causal relationship with the bottom line. PIMS comes nearest, withits long-standing contention that 15 per cent of a company’s profit performance”is driven by HR strategy”, and singles out 10 of the characteristicsof HR policy as having the most significant impact (see left). Watson Wyatt says its European list accounts for 60 per cent of thedifference in size of intellectual capital from one company to another, and 26per cent of the increase in market value (in Europe, in the year of the survey– 2000). It finds that a further two practices, the paternalistic retention ofstaff and job security, actually decrease market value. Companies with highHCIs, Dicker notes, have done better financially in the downturn this year,”but a good financial performance does not lead to a better HCI”. How relevant is all this sophisticated measurement to the average company?”Unless it provides information and support that enable senior managementto act,” says Nimmy, “then the managers’ reaction is likely to be,‘so what’.” Laurence Handy, professor of international business at Tilburg Universitynear Eindhoven, makes a similar point. The need, he believes, is for “HRto identify the business problems and the gaps, and address itself to the HRcomponent of these.” Benchmarking may prove nothing more than successfulcompanies can afford good management. Still, what gets measured gets managed. In the case of one client, ABBPower: “The Watson Wyatt analysis,” according to commercial managerIan Funnell, “pointed to specific action we could take – or stop doing –to enhance shareholder value.” Eric Senesi, European HR director of Agilent, the two-year-oldHewlett-Packard spin-off that specialises in electronic components and testequipment, sees that “the metrics you put in place depend on the maturityof HR in the company. Most companies are still in the lower quadrants”. He uses a lot of process measures at present, such as the attrition rate ofnewcomers and the percentage of managers whose variable pay is on track and cantherefore be assumed to be performing well. He claims to have a “minimumbut robust system” in place, but “we’ll use higher levels of metricsin the future – it is a way to mobilise people and focus attention on theissues that matter.” On a practical note, Senesi warns that metrics will only work if theinfrastructure is suitable: comparability of data, ease of access and rapidresponse demand a high degree of standardisation and good IT systems. Itremains true that the value lies in the use made of the information rather thanthe sophistication of the system itself. If it helps to improve corporateperformance and the status of HR, it will be a sound investment. Barometer of human resourcesPims 15% of profit performance driven bythe following HR factors:– Management participation– Open management style– Take some risks, but not too many– Top managers spend 20 per cent of time with customers – About 20 per cent outsiders in top management– The importance of management training– Incentivising top managers– Succession planning– Good appraisal system– Getting employee feedback Watson Wyatt26% increase in market value (in 2000) driven by the followingHR factors: – Use of knowledge and contract workers– Recruiting excellence– Consistent pan-European HR practices– Top managers spend 20 per cent of time – Good union-management relations– Lack of hierarchy, clear leadership– Teamwork, 360 feedback– Customer-focused environment– Remuneration and ‘Me plc’ – Sharing information with employees Previous Article Next Article Is HR measuring up?On 5 Mar 2002 in Personnel Today Related posts:No related photos. Comments are closed.