Making people count

How can
the value of HR be measured in real terms? Nic Paton looks at a tool devised to
assess the impact of the human factor on company performance  Additional reporting  by Andrew Rogers

The
most well known of the models looking at human capital is international
consultancy Watson Wyatt’s Human Capital Index (HCI).

This
index was designed to gauge how a company’s management of its human capital –
its staff, management and talent – correlates with its shareholder value.
The aim was to prove that superior HR practices deliver higher shareholder
value.

How
HCI works

HCI
uses a series of questions to determine how the company carries out a range of
HR practices such as pay, people development, communications and staffing.

The
HCI also collects a range of objective financial measures to measure
shareholder value, including:

● the company’s market value
● its three- and five-year total returns to shareholders, and
● Tobin’s Q  – an economic ratio
designed to measure an organisation’s ability to create value beyond its
physical assets.

Further
number-crunching then takes place to look at the relationship between its HR
practices and value creation. HCI scores are then created, with results on a
scale of 0 to 100 – where 0 represents the poorest human capital management,
and 100 the ideal.

The
results of the survey

The
company’s first survey in 1999, conducted only in the US and Canada, revealed
that 30 key HR practices were associated with a 30 per cent increase in market
value.

In
2000, Watson Wyatt widened the scope of its survey to take in European
organisations, with similar results. It found 19 key HR practices were
associated with a 26 per cent increase in market value.

Its
2001 survey found that the higher a company’s HCI score, the higher its
shareholder value:

● companies with low HCI scores averaged a 21 per
cent five-year return
● companies with medium scores averaged 39 per cent
● companies with high HCI scores returned 64 per cent over five years.

But
Watson Wyatt claims that the HCI study goes beyond showing that good human
capital management works. Indeed, it claims that the HCI indicates exactly
which HR practices play the biggest part in creating shareholder value.

Value-creating
HR practices

In
its 2001 survey, Watson Wyatt identified 49 HR practices that play the greatest
role in creating shareholder value, grouped into six "dimensions".
From this it concludes that:

● a company making significant improvement in all
practices covered by the dimension "total rewards and accountability"
would see its shareholder value increase by 16.5 per cent
● a company making significant improvement in all practices covered by
the dimension "collegial, flexible workplace" would see its
shareholder value increase by 9 per cent
● a company making significant improvement in all practices covered by
the dimension "recruiting and retention excellence" would see its
shareholder value increase by 7.9 per cent

Chicken
and egg resolved

Watson
Wyatt claims that its latest study proves that HR practices drive positive
financial results, rather than showing that positive financial results simply
provide companies with the luxury to afford good HR practices.

51
companies participated in both its 1999 and 2001 studies. Correlating their
1999 HCI scores against their 2001 financial performance and their 1999
financial performance against their 2001 HCI scores enabled Watson Wyatt to
create a strong case for the argument that good HR practices result in improved
financial performance.

For
the future

Nevertheless
until HR directors become more visible at results presentations and company
visits and talk up their function, analysts are likely to remain highly
sceptical of working HR into their complex financial models and calculations.

For
more information about the HCI, see http://www.watsonwyatt.com/

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