Human capital represents a major part of a company’s value – but how can it be measured?
Mobile phone giant Nokia has fixed assets of just 5 per cent. The remaining 95 per cent of its worth is tied up in intangible assets such as skills, talent and know-how.
Not surprisingly, then, investment analysts are starting to look at a company’s human capital before they value the company. Time is running out for the old-fashioned approach of judging private sector employers on the strength of their tangible assets and strategy. The days when the human resources director carries more clout than the finance director could be fast approaching. The simple fact is that there is money to be made from spotting the companies that are better than others at human resources management.
The question currently taxing everyone from analysts to HR consultants is how can human capital be measured? It may not be possible to use precise figures, but some form of measurement is needed as a guide to help both investors and HR professionals.
Last week, international consultant Watson Wyatt launched the European version of its Human Capital Index, in an attempt to do just that (News, 31 October).
“A major part of Watson Wyatt’s business is advising investment analysts,” says Steven Dicker, partner at the consultancy and co-author of the report. “Three to four years ago there was a real focus on environmental concerns; now it is what companies are doing on human capital.
“A lot of what an analyst is doing is trying to get a feel for how a company is managed, how it works. If you take Nokia, 95 per cent of its worth is intellectual capital; only 5 per cent is the buildings, desks and other fixed assets. So as an investment analyst to spend all your time poring over the 5 per cent is pretty strange. And they are not going to be doing that.”
Analysts know that most of the intangibles refer to personnel matters, but they have struggled to identify what distinguishes the better firms from the rest.
With its new model, Watson Wyatt makes the bold claim that significant improvement in the 30 HR disciplines it has identified will add up to 30 per cent to shareholder value.
This is based on research looking at the links between recruiting, training and communicating and the bottom line. It attaches a score on the index after completion of detailed questionnaires and the consultancy has found that companies with a high ranking on the Human Capital Index also show consistently higher three-year and five-year returns to shareholders.
Watson Wyatt’s research echoes findings from Sheffield University and the CIPD, the London Business School and academics such as Mark Huselid and Jeffrey Pfeffer in the US.
And what are these elusive factors? There is little in the research that has not been touched on before (see box), and Doug Ross, co-author of the report and a Watson Wyatt partner, freely admits that much of it is common sense. But getting top management to accept common sense has not always been possible without data.
Ross describes a common experience. “Marketing will tell the board, ‘Here’s a proposal, with a marginal cost, this is the return and here’s a set of assumptions. We need funding.’ Then R&D will come in and say the same. Then HR will say ‘We have a great idea’. The board agrees that it’s a great idea but it has run out of money.”
Ross stresses that practices identified in the index must not be used as some sort of crude benchmarking tool. Copying an example of good practice in isolation is unlikely to be much use. “You can have the latest fad and have read the book of the day, but if you have a very hierarchical organisation, then installing 360-degree appraisal into a system where it is only going to be used as a punitive measure does not make any sense.
“Similarly, the concept of team-driven management in an organisation that is very controlling is not going to work. If an HR initiative is not aligned with what the business needs, it can take away shareholder value.”
This emerged clearly in the Watson Wyatt US survey, published a year ago. General training programmes and 360-degree appraisals appeared to cause a weaker business performance.
Instead, the index is diagnostic: it gives an opportunity to look at all personnel policies to ensure they actually support what employees need to be doing.
The development is not all in the laboratory. Some Watson Wyatt customers have indicated they will use the new index and the measures that underpin it. Dicker says a handful of companies have already put in requests, including a UK life assurer and a Geneva-based multinational company. Swiss Life has also begun to use the approach.
Independently, Scandinavian insurance company Skandia has developed its own method of calculating intellectual capital. The scheme, known as Navigator, put a value on the company’s intellectual capital at a cool £10bn. Skandia’s Leif Edvinsson was the world’s first director of intellectual capital and is now an author and speaker on the issue.
Watson Wyatt’s tool may or may not be a breakthrough in measuring the relationship between personnel policies and the effect on the business, but it is an invention that needed to happen. If it does not work, it will be amended until it does and rivals will appear. Sheer economic forces will dictate it.
Features that better performing companies tend to exhibit
* Recruiting excellence
* A collegial, flexible workplace
* Clear awards and accountability
* Clear and honest communications
* Prudent use of resources
Those that score highly on these measures have a high Human Capital Index and a higher return to shareholders than others (see graph).
By Philip Whitely