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."
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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.
HRmetrics measured, p22
