Human capital can be a risky business. Jim Matthewman and Rema Sood give some pointers on avoiding the pitfalls

Current economic conditions are placing CEOs and CFOs under increasing pressure to deliver against projected forecasts and improve operational performance.

When it comes to human capital issues, companies typically want to achieve the following:

  • Execute new strategies faster
  • Raise productivity and profitability
  • Reduce costs
  • Ensure the right people are retained when downsizing
  • Align the people strategy to changing business strategies
  • Become customer-centric
  • Prioritise human capital investments
  • Measure the return on investment in the reward programme
  • Cascade goals and objectives more effectively.

    For most organisations, human capital cost is significant, equating to between 50% and 80% of operating income. So, even a small change in labour productivity through better human resource management will yield material bottom-line returns.

    In the past, human capital measurement proved difficult because HR systems were inadequate, and it was difficult to make causal links between financial, operational and people data. Not only is the data more available now, but new diagnostic tools can go beyond correlations to pin-point the key drivers of human capital.

    Linking human capital to business challenges
    In the '80s and '90s, CFOs spent a lot of time making tangible assets more productive. Now they are beginning to turn their attention to the intangible assets – such as human capital.

    In the past, most companies' boards have paid scant attention to understanding how human capital can be used more effectively. But now companies will need to recognise the importance of acquiring, understanding, and acting upon the human capital knowledge within their organisation. Accumulating data on pay, staff turnover and training spend will reveal useful information and enable companies to make decisions on people investments with confidence.

    Stakeholders increasingly require HR departments to answer questions about the effectiveness and productivity of the organisation's human capital. More sophisticated and complex methods for measuring HR's programmes, policies and people practices are being introduced. For these methods to be effective it is key that business, financial and human capital knowledge is viewed together.

    Leveraging human capital value
    There are usually three stages required to leverage human capital value. The first involves explaining to customers and employees how they will be affected. It is relatively easy to outline a strategy on paper; it is much harder communicating it to line managers and employees. The key is to explain what staff are expected to do differently.

    The second stage involves assessing how capable of driving change the business leaders are and how skilled and motivated employees are. Workforce metrics and human capital tools provide hard data about what, how and when things need to be done.

    The third stage is to review HR and business processes to ensure employee behaviour is aligned to the new objectives. If the reward mechanism, performance management and career development programmes do not change, it is unlikely the behavioural shift will happen.

    Positive and negative
    Human capital measurement is about identifying the critical factors which drive corporate performance. The components can have positive and negative effects – in fact, our studies have shown the results are, more often than not, counter-intuitive.

    In one case, a manufacturer was suffering a series of flawed product launches, product defects and waste escalation. Senior management believed the issue was exacerbated by leadership churn and was in essence a reward issue. But our diagnostic review of how the internal labour market really worked showed that the issue was actually a talent management strategy which encouraged managers to seek new moves every 18 months to two years. This in turn encouraged ambitious managers to introduce change initiatives to gain attention and set up their next move. For a company based on total quality manufacturing, these mini-change initiatives had a devastating impact.

    So, human capital can be risky business, but there is significant upside in terms of value creation in identifying the real ROI of people investment.

    Customer research showed a thriving retail bank that significant growth depended not only on acquiring new customers but also on expanding services to existing customers. This led to an aggressive hiring programme to build broader skills in its workforce. While the bank conducted extensive research, it did not appreciate how to create value from its single largest expense and cornerstone of future success – its human capital.

    Employee, financial, operational, and market data were compiled to quantify the impact of various human capital practices on revenue, market share, and profitability. This revealed that the rapid acquisition of new skills from outside the bank was having some unintended consequences. Analysis showed that locations with the most seasoned employees performed better over all productivity and customer value measures. However, such employees felt they were not being rewarded sufficiently. Instead, the company was paying a premium for new hires.

    We recommended strengthening career paths for high performers, enhancing incentives, and introducing new training plans to deliver the required skills without damaging the valuable people assets already in place. Significant short-term savings have been achieved, and the resulting increase in customer service has had a direct impact on performance.

    In conclusion
    An organisation's context is everything; understanding and measuring the drivers of human capital is critical and discrete or reactive decision-making often results in unintended consequences at odds with the needs of the business. Perception and reality are often very different.

    Jim Matthewman and Rema Sood are consultants, Mercer Human Resource Consulting, Tel: 0207 488 4949