More than just a number

strategy might be gaining credibility in the business world, but more has to be
done to convince hard-nosed City analysts that the human factor has a bearing
on company valuation. Over to you, HR…

Every morning at around 6.30am, somewhere in the City, a chief executive and
his team will be huddled around the table putting the finishing touches to the
day’s schedule of briefings, interviews and presentations ahead of the
announcement of the company’s latest set of results.

Those at the CEO’s side will generally include the finance director,
director of investor relations, managing director and the financial public
relations adviser. Often the chairman will be there to add his weight to the
proceedings and, occasionally, if there’s a specific announcement or initiative
in the pipeline, the operations director or marketing director will be present

After an early round of media interviews and, with the markets now open and
trading, the financial team will head off for perhaps the most critical meeting
of the morning – the analysts’ presentation. While the journalists will be
looking to make snap judgements designed to catch the headlines and set the
day’s news agenda, the analysts will be asking tougher questions.

During the meeting, the analysts will work their way through the profit and
loss account at the back of the statement, scribbling quick calculations in the
margins and generally sucking on their pens as they work out what they should
be recommending to their clients when they return to their desks. Questions
will be fired back and forth.

Yet, throughout these proceedings, for the vast majority of companies, the
HR director will be nowhere in sight. And despite the recognition that one of the
key drivers of competitive edge is the quality of people in an organisation,
the company report will probably contain just a couple of paragraphs on HR. The
"people strategy" will inevitably consist of little more than a few
platitudes hidden in the chief executive’s operational overview.

This is because analysts are primarily concerned with bottom-line financials
that allow them to form a quantitative judgement about a stock, argues
Alexander Campbell, head of HR for investment bank UBS Warburg in London.

While analysts are expected to take a view on the personnel at a company,
particularly its senior executive management, this by its nature, will be a
more qualitative reckoning.

Yet there is a growing realisation that human capital is an essential part
of the valuation equation. Take software giant Microsoft – no analysis of the
software giant would be complete without consideration of the quality of its
software development teams. Analysts will look at things such as labour
turnover, spend on research and development and compensation and benefits

"But the fact of the matter is that, at the moment, most company
reports do not include anything of great value in those statistics," says

"It is a lot easier to get hold of the financials," agrees Jim
Wood-Smith, head of research at stockbroker Gerrard. "The numbers are
there to grasp and it is much harder to grasp the quality of the staff through
the business."

But, as he admits – in the no-nonsense speak favoured by the City – it is
impossible to get a proper understanding of a business without understanding
the people side, particularly the senior management. "If it is run by
morons you will soon know about it."

Tim Huddart, head of research EMEA at investment bank Merrill Lynch, adds
that the HR picture largely comes from looking at the operational highlights
and having discussions about work practices. But, he concedes, "It is not
something we would get an obvious insight into."

In the normal run of things, the only time the issue of human capital tops
the agenda is when a company is reducing the head-count, argues Marc Thompson,
research fellow in employee relations at Templeton College.

Nevertheless, issues such as brand capital, intangible assets and
intellectual and human capital are all gaining ground among City observers.
Models such as those put forward by international HR consultancy Watson Wyatt
and insurance firm Skandia (see box) are being talked about more widely.

But with only 5 to 10 per cent of HR directors at board level there is a
sense that, when it comes to presenting to the City, it is the finance director
who will talk about HR issues, Thompson suggests.

The difficulty for analysts in making an assessment of human capital is
that, for people who spend their days looking for concrete evidence, it can
seem a nebulous and intangible affair – and so unattractive – argues Simon
Barrow, chairman of People in Business. For instance, who could have foreseen
the implosion of Marconi, which prided itself on having a "values
driven" management, he says. "I don’t believe that HR is yet an
integral part of any formal review by analysts."

Even when looking at companies such as Tesco, analysts will tend to focus on
its growth plans, purchases, margins and its performance in Europe rather than
how its HR strategy has helped to grow the business.

Analysts will more often look at the quality of management and the strength
of the brand when making a judgement, agrees veteran retail analyst Nick Bubb
at SG Securities, but human resources itself is less of an issue.

"The brand tends to say something about the staff. Carphone Warehouse,
for instance, has great brand strength and that has something to do with the
quality of its staff," he says.

It’s a question of getting a feel for the firm, the vibes of the place.
"Take John Lewis, it apparently has a fuddy duddy way of not opening on
Mondays and weird hours, and so on, but it is very good at staff motivation. I
think it is just bound-in with people’s judgement of the brand and the

So, what is to be done? The solution, argues Lynda Gratton, professor of
organisational behaviour at London Business School, lies fairly and squarely at
the feet of the HR profession. "The fault is ours," she says.

Up to now, HR has not made a very good case for it to be measured, she
argues. "If HR has got anything to say, then it will be listened to. The
problem is that there are not the models there."

Analysts will do "whatever they can" to get a decent valuation of
a firm and will use HR as a measure just like any other, if they can. At the
moment, though, the only way they can do that is the rather ad hoc approach of
listening to proxies and understanding what the CEO is saying, she adds.

"It is very hard for them to get any understanding of the depth of the
people within an organisation."

HR departments, agrees UBS’s Campbell, have been slow to catch on to the
importance of presenting themselves in a quantitative way that can be measured
by the City. "Most HR functions do not have any way of quantifying the
linkage between the initiatives that they are launching and added value,"
he says.

Analysts would, rightly, be sceptical about listening to an HR director who
was unable to back up his presentation with hard numbers. "They must be
able to demonstrate the achievement between HR initiatives and increasing
shareholder value," he argues.

Yet, Campbell adds, "I think that it is inevitable that, over the next
10 years, company reports will include much more comprehensive sections on human
capital provided we can come up with meaningful measurements."

HR directors need to be able to show the City that they have achieved what
they have set out to achieve, in a quantifiable way, adds Steven Dicker, a
partner at HR consultancy Watson Wyatt.

While valuing human capital is important in all sectors, in some it is more
so than others. Watson Wyatt, for instance, is currently working with a retail
chain where to be able to the show the value its customer service adds to the
business is vital. "It’s all about why it adds value for investors,"
he says. "It tends to be a fairly subjective process rather than having a
protocol that they follow. I do not believe there is a standard method,"
he says. HR departments need to make the link between delivery, value and
enhancement of shareholder value.

Yet just as the City is beginning to grasp the need to include human capital
within its valuations, the economic downturn has sent analysts scurrying back
to their spreadsheets. The focus has shifted back to the financial
fundamentals, says Sean Tyson, professor of HR management at Cranfield School
of Management.

Analysts are now much more interested in asking if a company is holding or
haemorrhaging its short-term value rather than looking at the wider HR-led
picture. "Instead of looking at whether the HR strategy fits the business
strategy they are increasingly looking at whether the company has credible
resources simply to enable it to survive."

In the current climate it looks as if it will be even harder for HR
directors to get their voices heard in the City. But it is a battle they must

Tools to measure HR’s impact on the bottom line

Devised by insurance firm Skandia in 1996

Navigator is a "future-oriented
business planning model" trying to provide a more balanced view of the
company than the simple financials. It aims to put a value on the company’s
intellectual capital in relation to its more conventional operational divisions
and strategies.

Human Capital Index
Devised by international HR consultancy Watson Wyatt in 1999

The Human Capital Index is designed
to gauge how a company’s management of its human capital – its staff,
management and talent – affects its financial performance.

It uses a questionnaire to determine how the company carries
out its HR practices. The responses are matched to objective financial
measures, 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.

The relationship between HR practices and value creation is
then assessed and HCI scores created, with results on a scale of 0 to 100 –
where 0 represents the poorest human capital management, and 100 the ideal.

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