Weighing up the options

There
are many ways of measuring human capital, but which approach is most effective?
In the second part of our ground-breaking research on human capital, Keith
Rodgers explores the challenges

Choosing the best technique to measure human capital value is no easy task.
Human capital is the name used to describe people within an organisation and
the value they create. The most common methodologies adopted by organisations
today were originally developed for a variety of different purposes, and each
brings a different emphasis. From the highly technical, financially orientated
methodologies such as economic value added (EVA) to the more common HR
benchmarking techniques, the initial data requirements and final outputs vary
widely.

Understanding the pros and cons of each methodology is therefore essential.
A major research survey entitled Measuring Human Capital Value, conducted by
Personnel Today in conjunction with Deloitte & Touche Human Capital
Advisory Services, examines practitioners’ experiences with five common
approaches. Here, in the second of our two-part report into the findings of the
survey, we examine the benefits, limitations and effectiveness of each of the
methodologies. We discuss the survey’s findings – based on the views of 460 HR
professionals – with two advanced adopters of human capital metrics: BT and
Royal Bank of Scotland Group (RBS).

The common limitations to human capital measurement

Before embarking on any kind of human capital measurement, practitioners
need to bear in mind that some common issues will impact the effectiveness of
the exercise regardless of what methodology they choose. Measuring Human
Capital Value examined five approaches to measurement: HR benchmarking &
metrics; balanced scorecard; HR practice effectiveness; accountancy-based
models and EVA. Despite the big differences between these approaches, it found
that three limitations were prominent in each.

Getting the right data

Data accessibility and collection problems were cited as big limiting
factors by 60 per cent of respondents for HR benchmarking & metrics, and 54
per cent for balanced scorecard. To an extent this is an information technology
issue, but more broadly it points to a fundamental issue in human capital
measurement.

As Brett Walsh, head of Human Capital Advisory Services at Deloitte &
Touche, points out, even companies that have implemented the latest versions of
major software application suites can struggle with the data collation process.
While they may have the core databases required, they may not have the
necessary framework to measure their own efficiency and performance. As a
result, if they want to measure something relatively simple such as training
days per employee, they may have to draw the data down manually, recast it and
then compare the ratios with the relevant benchmark.

"The data they have is designed to deliver services – for example, what
training needs to be supplied – not to measure the efficiency of the delivery
of those services," says Walsh. While some organisations have gone down
the data mining road for HR and finance, he adds, most have not.

Doubts over whether HR’s metrics can really deliver

That fundamental issue may also partly explain the second common limitation
– doubts as to whether these measurement approaches can really identify where
the value of the organisation’s human capital lies. This was identified as an
issue by 27 per cent of respondents in relation to HR benchmarking, 40 per cent
for balanced scorecard, and was higher still in accountancy-based evaluation
(47 per cent) and EVA (43 per cent).

As Walsh points out, unlike finance, HR doesn’t have a small group of core
metrics, standardised internationally, to demonstrate the precise value of
human capital.

"If you ask 10 people the most important metrics, they’ll come up with
25," he says. "It’s painting a picture, but it’s still not in proper
focus."

As a result, some of the metrics that have evolved will be incomplete – for
example, it’s not uncommon for HR departments to omit outsourcing fees when
they come to measure their departmental costs.

In addition, some metrics will be unique to individual HR departments.
Financially-orientated valuation methods such as EVA are corporate measures –
as they’re prepared and analysed across the company, the same language is
spoken in marketing, finance or any other department. "Maybe," says
Walsh, "because there are no standard HR metrics, the measurements
available today are in a language only HR professionals can understand and
perhaps communicate between themselves."

Lack of resources

The third problem common to all methodologies is lack of resources.

Resource shortages here don’t just apply to HR. They also affect IT, which
is typically pulled in different directions and finds itself under pressure to
tackle the projects with the biggest impact on the bottom line.

This becomes a self-perpetuating problem. If HR is unable to show that
investment in valuation methods has delivered tangible results, as the survey suggests,
then it becomes hard for IT to justify devoting time to analytical projects.

The different approaches to human capital valuation:

– HR benchmarking and HR metrics

The most popular of the five methodologies examined was HR benchmarking,
which compares HR policies and practices across organisations and sectors, and
HR metrics. Ironically, however, while this approach is used by exactly half of
the respondents to the survey, it’s not viewed as the best technique.

Only 5 per cent of those who adopted the methodology rate it as ‘highly
effective’, while some 44 per cent of respondents see it as ‘less than
effective’ or did not respond.

– Benchmarking

BT Group HR director for HR strategy, policies and organisational
development Margaret Savage argues that these findings do not reflect her own
experiences, and suggests the key problem may lie in poor benchmarking
comparators.

Organisations need to recognise the different drivers within their
businesses – so as well as choosing the right comparators at a corporate level,
it’s important that each business group is free to adopt the benchmarks that
best suit their own operations, particularly in companies that carry out a
range of diverse activities.

Others stress that on its own, benchmarking will not help HR get creative or
innovative.

Head of HR strategy and planning for RBS Greig Aitken acknowledges that
benchmarking methods can be useful, but also cautions that applicability is
everything, and there can be a ‘so what?’ issue about them if they’re used in
isolation. Benchmarking might throw forward a variable – but that’s not the end
of the story. The key issue is ‘is this right or wrong?’ and ‘what do I need to
do to correct it?’

– HR metrics

In terms of HR metrics, one of the limitations to successful business
analysis is lack of standardisation. BT, for example, historically allowed its
business units considerable autonomy in developing their own HR indicators:
recently, it has spent some three months working with line of business managers
to build a set of 14 corporate metrics. These range from wealth, profit, and
revenue created per full-time employee, to average remuneration, absence rates,
voluntary resignation rates and executive stability.

Savage stresses that adoption of these metrics has to take into account
broader corporate issues. Eighteen months ago, for example, BT was in survival
mode – downsizing and divesting as it battled with a massive debt mountain. At
that point, the HR metrics that really counted to senior management were those
focused on cost. Today, investment in HR metric development is one of several
major measurement initiatives.

Despite the limitations, HR metrics can provide the platform for
extraordinarily detailed insights into operational and strategic effectiveness –
insights that can transform the way organisations view and manage their human
capital.

RBS has embarked on a ground-breaking human capital study that takes basic
HR metrics to a new level, using them as a vehicle for an ’employee engagement
model’.

Studies undertaken by the group demonstrate that increases in employee
engagement with the company lead to improvements in customer satisfaction and
reductions in staff turnover.

To measure engagement, it now pulls data from a wide range of sources into a
central data warehouse – information such as employee opinion surveys,
standardised information drawn from both joiners and leavers, feedback from
potential recruits who turned down job offers, and core information from
central HR management systems.

Now, the group is able to track engagement in all its forms – from what
engages highly motivated employees, to the problems aired by those who may be
about to leave. Like the best business metrics, this data is forward-looking as
well as historical: by comparing different engagement levels in similar call
centres, for example, RBS can predict potential attrition problems and act to
prevent them.

– Benefits and limitations of HR benchmarking and HR metrics

According to the survey, the two most common limitations of HR benchmarking
& metrics were data accessibility/collection – a major problem identified
by 60 per cent of respondents – and the level of resources required (52 per
cent).

No single benefit stood out significantly, although six main advantages were
identified. Three were also highlighted in relation to the balanced scorecard
approach – improving business performance, demonstrating a link between HR
activities and business performance, and informing strategic business planning.
The others comprise measuring internal HR efficiency, comparing HR efficiency
against comparators, and informing budgetary decision-making.

Balanced scorecard

In terms of popularity and effectiveness, attitudes towards the balanced scorecard
methodologies are very similar to HR benchmarking & metrics. The second
most popular approach, it’s been adopted by almost one third of respondents (32
per cent) – of these, however, 43 per cent rank it as ‘less than effective’. As
the Personnel Today/Deloitte & Touche report says: "The two main
methodologies used in the marketplace do not consistently deliver what
businesses require in terms of human capital measurement. This indicates that
in many organisations, a significant amount of resource is being utilised with
only a limited benefit in return."

Part of the problem is that the balanced scorecard, based around a suite of
people-related key performance indicators, is not appropriate for every
environment. RBS used to deploy the technology across every part of the group
prior to its acquisition of NatWest. Subsequently, although balanced scorecard
information is still available to all areas, it is supported by other
measurement approaches. Aitken believes it’s an appropriate tool to link HR information
to business performance, and as a result, it’s heavily used in areas where
business performance measurement is strong, such as the bank’s retail arm and
its manufacturing divisions (the operations that provide group support services
in areas such as procurement and technology).

BT’s experiences bear out several additional points. First, the
effectiveness of the methodology will be influenced by how well divisional
scorecards are tied into corporate metrics – the company has recently been
through an exercise with line managers to determine which localised metrics
will form part of the corporate scorecard.

Second, not all metrics provide hard criteria for action. BT has been
debating which metrics should be ‘hard-wired’ and automatically trigger bonus
payments when they’re hit, while others are ‘soft-wired’ and require the CEO or
HR director to make a decision as to whether individuals contributed to the
successful attainment of the target.

Finally, as Savage puts it, "it’s as effective as you make it".

"The value is in the balanced picture it paints," she says.
"It allows you to weigh the impact of other critical success factors on
people and HR contributions or outputs – the scorecard forces you to accept
your piece is not the only piece in the story."

Benefits and limitations of the balanced scorecard

Once again, respondents to the survey cited data accessibility and the high
level of resources required as major limitations. In addition, 40 per cent
argued that it does not locate human capital value in the organisation.

In terms of benefits, respondents rate the balanced scorecard particularly
strongly in improving business performance, demonstrating a link between HR
activities and business performance, and informing strategic business planning.

HR practice effectiveness

While the most commonly adopted metrics come under fire from practitioners,
the more specialist approaches to value measurement receive far better ratings.
HR practice effectiveness, a methodology that examines how well the HR function
and its processes contribute to business performance, has been adopted by a
mere 4 per cent of respondents, yet of these, 76 per cent believe it’s an
‘effective’ or ‘highly effective’ approach.

As the Personnel Today/Deloitte & Touche report says, one benefit to
this approach is that it regularly monitors and evaluates HR processes and
policies, tracking changes over time and helping analyse resource and budget
requirements. There are, however, limitations. To begin with, while it develops
a correlation between HR practices and business performance, that link doesn’t
prove causality. In addition, its scope is somewhat limited – not a single
survey respondent believes the approach informs strategic business planning.

At BT, Savage is embarking on a major overhaul of the group’s HR policies,
and describes this area as "exciting", particularly in terms of its
ability to provide detailed cost analysis and ultimately, end-to-end metrics.

Given that much of BT’s transactional activities are outsourced, this will
give it a far greater insight to cost than the broader, pricing data currently
supplied. The number of policies has been cut from 206 to 90, and BT is
attempting to put metrics around what the policies actually set out to achieve,
and how effective the processes are that underpin them.

Benefits and limitations of practice effectiveness

Data accessibility and the level of resources required are the key
limitations. In terms of benefits, respondents who use the approach single out
three key areas: directing HR investment strategy; demonstrating a link between
HR activities and business performance; and measuring internal HR efficiency.

Economic Value Added (EVA)

EVA and similar approaches, which measure overall corporate performance
against the total cost of capital employed or investment made, also score a
high rating from users, but again, adoption is low – just one in 10
respondents. However, 73 per cent of those rate the approach as ‘effective’ or
better.

The Personnel Today/Deloitte & Touche report suggests there could be a
very practical explanation: like HR practice effectiveness, EVA is technical in
nature, so tends to be used by specialists with specific training, who are more
likely to get the results they seek.

When effectively deployed, EVA can lead to some stunning results, as BT
discovered when it piloted a ‘human investment ratio’. This ratio allows
managers to assess, for example, the relative impact of cutting back on
operational costs or headcount, versus the extra revenue gained by investing in
additional staff. In one live instance where revenue streams were under
pressure, this analysis allowed local management to reverse a proposed
headcount reduction of five and instead justify a decision to recruit three
more individuals and so generate additional revenue.

That said, adoption of this approach is not easy, primarily because
decisions about human capital value are subjective. When it is adopted, EVA is
likely to be driven from the top down, and the decision to implement this
approach will often be outside HR’s hands.

Benefits and limitations of EVA

Survey respondents say the main limitations are that EVA doesn’t locate
human capital value (43 per cent) or evaluate the effectiveness of HR
activities (36 per cent). Lack of user-friendliness is also an issue (30 per
cent).

The prime benefits identified by respondents were informing budgetary
decision-making (61 per cent), informing strategic planning, improving business
performance and setting productivity measures.

Accountancy-based valuation models

In terms of take-up and effectiveness, the final metric – accountancy-based
valuation models, such as activity-based costing – loses both ways. It’s been
adopted by just 3 per cent of respondents, of whom more than half (53 per cent)
rate it as ‘less than effective’.

One of the major limitations here is that valuation is based on cost, which
fails to reflect a wide gamut of factors that constitute human capital value.
Not surprisingly, survey respondents are critical: three out of five say this
approach fails to evaluate the effectiveness of HR activities, almost half
argue that it doesn’t locate human capital value in the organisation and 40 per
cent say it doesn’t link HR activities and organisational performance.

Nevertheless, the approach has its supporters. BT, for example, is
attempting to build a balance sheet of human capital, taking traditional
corporate financial measures such as gearing and applying them to employees.
The analysis allows it to examine and compare corporate employee value in terms
of fixed or variable costs, overtime, agency spend and so forth. The results
can be startling. By one measure, the group is spending just under £4bn on
employee capital, against a limit of £3bn on capital expenditure.

The drill-down from this kind of analysis can also provide highly-valuable
data. On average, employee absence at BT is 13 days a year, equating to £89m –
by contrast, those employees who take advantage of the group’s flexible work
life balance arrangements for part-time and home working average just three
sick days per annum. That kind of analysis provides a highly effective
assessment of HR policy.

RBS is also embarking on a finance-based initiative to develop employee value
metrics. The company has undertaken extensive analysis of recruitment and
attrition costs, for example, to establish the impact of key employee
departures. Starting with a detailed analysis of recruitment and initial
training costs, it’s able to determine a ‘break-even’ point – measured in both
financial outlay and time passed – which becomes a key metric for profit
generation. If an employee leaves before generating sufficient profit to cover
these upfront costs, the organisation has clearly lost heavily on its
investment.

At the same time, RBS assesses a wide range of charges relating to employees
quitting – lost productivity as their motivation slips while they consider
resigning, the cost of gardening leave, the costs of temporary replacements and
so forth. Combined, the power of these statistics is immense. Telling a senior
manager what percentage of new hires has quit before the break-even date – and
then quantifying the financial impact – provides an entirely new, measurable
perspective on the whole issue of key employee retention.

Benefits and limitations of accountancy-based valuation models

As well as its inability to evaluate the effectiveness of HR activities,
locate human capital value and link HR activities to organisational
performance, lack of user-friendliness is cited as a limitation by a third of
respondents.

Not surprisingly, the key benefits of accountancy-based evaluations were in
setting workforce productivity measures and calculating return on investment.
Again, no respondents saw them informing strategic planning or directing HR
investment strategy.

Failing to change management behaviour

The relatively low effectiveness of the most popular measures is reflected
in the fact that only four in 10 respondents (39 per cent) could identify a way
in which management behaviour had changed as a result of using any of the
approaches. Ironically, the most frequently cited change was ‘an acceptance of
HR as a key business area’, acknowledged by 11 per cent of respondents,
followed by improvement in management skills such as communications, identified
by 8.3 per cent.

The Personnel Today/Deloitte & Touche report suggests several key
reasons for this, including the possibility that HR departments, even where
they have useful measures, may struggle to produce an output that has a
meaningful impact on the organisation. It also speculates that HR departments
may see these approaches more as compliance-based record keeping tools, rather
than instruments to drive performance or change.

This picture, however, is likely to change. As Walsh points out: "The
current economic environment is going to drive companies towards taking metrics
more seriously. The percentage of users will increase because of the
requirement for HR to demonstrate its value."

In addition, the report points to political factors – comments by UK
government ministers and initiatives within the European Commission suggest
that measurement and statutory reporting on Human Capital could become
compulsory.

"I see every organisation needing to get comfortable with HR
benchmarking, and then progressing to more sophisticated methods of
measurement," says Walsh. "But this is generally driven by forces
outside HR – and maybe there’s not enough pressure being applied."

Ultimately, most organisations will end up deploying a combination of
methods – BT, for example, has deployed all of the five techniques. As Savage
says: "You don’t want just one type of measure – but you can also end up
with too many. You want to prioritise, work out what you’re trying to prove;
what do you need to know at any point in time? Allow for diversity within the
organisation. I envisage a portfolio of selective metrics that will change over
time to reflect changes in business and HR strategy and with progress in delivering
our people agenda over time."

To get involved in our Delivering HR Strategy series contact us on personneltoday@rbi.co.uk

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