Is HR measuring up

It
is frequently claimed the effective use of key HR practices increases
shareholder value. Fierce competition is driving management to use every lever
it can to win business advantage. Now is the time for HR to prove its strategic
worth. Tom Lester reports

Measuring
the effectiveness of the HR function has taxed the best business brains for
many years. The aim has been to prove the contribution of "people
assets" to corporate success, and the HR processes needed to increase it.
But the new interest in the subject in the last couple of years begins at the
other end – from the perspective of 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, and how can
they be made more effective?

It
may seem that the difference is a semantic one, but in practice, it could
transform the old question of HR measurement. If, as claimed, a 26% increase in
the value of companies’ shares correlates closely with the effective use of a
number of key HR practices then this is a message no chief executive can
ignore. If, further, it can be shown that one company is deriving more value
from its human resources than another, these points can help HR prove its
strategic worth.

These
are big ifs. But increased competition and the growing emphasis on shareholder
value are driving managements to use every lever at their disposal. The similar
rise in the relative value of knowledge, experience and goodwill compared to
physical assets depends on the quality of staff. Further, in the leaner
organisation there can be few passengers, and the value added by each
individual is critical. If such vital dimensions remain unmeasured, however
crudely, the chief executive is relying on hope rather than verifiable fact.

The
Swiss banking group UBS, like all firms in the financial sector, depends
utterly on the quality and deployment of its staff, and has recently taken
radical new steps to measure them consistently across the group. Earlier this
year it set up a central Human Capital Performance Team (see box above).
"Very few companies can say, as we can, that metrics are right at the
heart of what we do," says the team’s founder and head, John
Mahoney-Phillips.

It
will take time before the disciplines implied by the metrics are universal, and
used effectively by management. Like all the big banks, UBS has to span the
cultural differences between retail banking and the more entrepreneurial asset
management and corporate finance (it embraces Warburg and Paine Webber).
"But we now have a single group-wide core framework", claims
Mahoney-Phillips.

Attaching
financial values directly to intellectual capital remains elusive, however.
Back in the 1960s, the well-known US academic Rensis Likert tried it with
research workers, but he found that the obvious difficulties outweighed the
advantages. In the 1990s, Gerald Kaplan and David Norton produced the balanced
scorecard which added HR and other measures to the conventional financial ones.

At
about the same time Leif Edvinsson, when working for Skandia (the Swedish
financial services group) published an analysis of the group’s intellectual
capital (IC) with the annual report. His concern was to demonstrate to managers
and shareholders alike what really made for success in financial services.

Skandia
still uses Edvinsson’s analysis of IC, which it plans to include in its next
annual report after a three-year gap. Human capital is defined as the
competence and capabilities of the savings bank’s employees; organisational
capital cover systems, databases and so forth, plus customer capital, the value
of its relationship with customers. The group’s reward came this year when it was
ranked number 8 in the world’s top 20 most admired knowledge enterprises –
above McKinsey and Cisco.

Conventional
metrics generally range from the very basic staff productivity and turnover,
through talent acquisition and retention to leadership, innovation and other
qualities. Which ones you choose, says Carolyn Nimmy, a director of the global
HR practice at consultants Cap Gemini Ernst & Young, depends on the answer
to the question, "What does winning entail for your company? Innovation?
Brand strength? Quality? Globalisation? You then ask, what are the things we
can measure against these?"

A
number of consultancies are picking up the metrics baton. They see that linking
HR practices to business success can make sense providing you allow for
economic and stock market fluctuations and different capital structures. PIMS,
the specialist in benchmarking all aspects of corporate performance, uses its
worldwide database supplied by over 5,000 managers to calculate a client’s
expected return on capital employed based on a profile of its business.

HR
characteristics such as an open management style or the number of days managers
spend training per year are then assessed for their impact on the actual return
on investment.

Watson
Wyatt, being an HR consultancy, uses a much smaller database than PIMS, but has
developed what it calls its Human Capital Index (HCI). This is a rating of a
company’s HR practices on a single scale of 1 to 100. It has shown that those
scoring highly are on average more likely to have built up greater intellectual
capital (as measured by the ratio of market value to tangible assets at
replacement cost, known to economists as "Tobin’s Q").

They
also deliver more shareholder value. The IC ratio is, of course, susceptible to
market fluctuation, but is used as a means of comparison. Partner Steven Dicker
claims it to be "a robust method for determining whether you’re managing
your 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 own HR staff), and most make no claim to have
isolated a causal relationship with the bottom line. PIMS comes nearest, with
its long-standing contention that 15 per cent of a company’s profit performance
"is driven by HR strategy", and it singles out nine of the
characteristics of HR policy as having the most significant impact (see above).

Watson
Wyatt says its European list accounts statistically for 60 per cent of the
difference in size of intellectual capital from one company to another, and 26
per 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 of
staff and job security, actually decrease market value. Companies with high
HCIs, 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 management
to act," says Nimmy, "Then the managers’ reaction is likely to be, so
what?"

Laurence
Handy, professor of international business at Tilburg University near
Eindhoven, makes a similar point. The need, he believes, is for "HR to
identify the business problems and the gaps, and address itself to the HR
component of these." Benchmarking may prove nothing more than that successful
companies can afford good management.

Still,
what gets measured gets managed. In the case of one client, ABB Power, although
"nothing surprising came out of it [the Watson Wyatt analysis],"
according to commercial manager Ian Funnell, "what it did do was point to
specific action we could take – or stop doing – to enhance shareholder
value."

Eric
Senesi, European HR director of Agilent, the two-year-old Hewlett-Packard
spin-off that specialises in electronic components and test equipment, sees
that "the metrics you put in place depend on the maturity of HR in the
company. Most companies are still in the lower quadrants." He did a
detailed study of ways of linking HR to results, and found that the Watson
Wyatt analysis was the most relevant.

He
uses a lot of process measures at present, such as the attrition rate of
newcomers and the percentage of managers whose variable pay is on track and can
therefore be assumed to be performing well. He claims to have a "minimum
but robust system" in place now, but "we’ll use higher levels of
metrics in the future. It’s a way to mobilise people and focus attention on the
issues that matter."

On
a practical note, Senesi warns that metrics will only work if the
infrastructure is suitable: comparability of data, ease of access and rapid
response demand a high degree of standardisation and good IT systems. It
remains true that the value lies in the use made of the information rather than
the sophistication of the system itself. If it helps to improve corporate
performance, and the status of HR, it will be a sound investment.

UBS
Banks on metrics

UBS,
by some measures the 7th largest banking group in the world, essentially
consists of three businesses: commercial banking in Switzerland, the UBS
Warburg and UBS Paine Webber investment banking operations, and asset
management. It employs in all some 70,000 people with a broad mix of
nationalities, competences and temperaments. They form a large proportion of
the group’s intellectual capital, and as a step towards maximising the return,
a Human Capital Performance Team was set up in January 2001 as part of the
group’s education, resourcing and development function.

The
team’s head, John Mahoney-Phillips, admits there are still sceptics, "and
we still have 100 miles to go, but we’re picking off the easy targets first and
we’re getting there." The role is to stimulate and co-ordinate throughout
the group: performance management; assessment and management development; staff
surveys and succession planning. It provides a central "human
capital" database to hold, among the usual details, annual appraisal
results of all staff so that the key talent – and the gaps – can be
highlighted.

There
is a strong emphasis on developing talent early on, says Mahoney-Phillips, and
training programmes are carefully assessed. "We talk to line managers to
ask them whether they’ve seen an improvement, so we’re able to show a clear
correlation between, say, the junior leadership courses and subsequent
performance." Later, he finds a close correlation between assessed
competences and subsequent salary performance. And because of the leadership
standards that have been established, "we attract top investment bankers."

Pims

15%
of profit performance driven by the following HR factors:

–
Management participation
– Use of knowledge and contract workers
– Open management style
– Take some risks, but not too many
– Top managers spend 20% time with customers
– Around 20% outsiders in top management
– The importance of management training
– Incentivising top managers
– Succession planning
– Good appraisal system
– Getting employee feedback

Watson
Wyatt

26%
increase in market value (in 2000) driven by the following HR factors:

–
Recruiting excellence
– Consistent pan-European HR practices
– Good union-management relations
– Lack of hierarchy, clear leadership
– Teamwork, 360 feedback
– Customer-focused environment
– Remuneration and "Me plc"
– Sharing information with employees

Addresses…

PIMS:
www.pims-europe.com