The people equation: cost versus value

by 08 Jun 2007

HR is often perceived as a cost centre within organisations. Melissa Yen speaks with Wayne Cascio about the economic and financial impact of HR initiatives and people investments, and what HR can do to capitalise on return on investment

Companies around the world are finding it increasingly necessary to invest more resources in their people in order to remain successful, sustainable and competitive. As the pressures of today’s labour market intensify, the claim often made by organisations that ‘“their people are their most valuable asset’”demands more factual and financial evidence.

Wayne Cascio, professor of management at the University of Colorado, Denver, has been studying the financial costs associated with employees, and is set to publish The Financial Impact of Investing in People, writtenin conjunction with John Boudreau and Pete Ramstad.

Considering people accounting

Cascio believes that while many organisations and executives are recognising the financial value and benefit that people can bring to their businesses, the view that people are merely costs to be cut,– rather thanas assets to be developed ,– still exists. This has seen the importance of accounting for the financial costs of employees become an essentialas part of the HR function, and a new responsibilityof companies have to their investors.

Suggesting, tongue-in-cheek, that employees are sometimes viewed as getting in the way of business, Casciorefers to a quote quotes from Kurt Vonnegut’s 1952 book, Player Piano, : “If only it weren’t for the people, all the [blankety blankexpletive deleted] people, always getting tangled up in the machinery. If it weren’t for them, earth would be an engineer’s paradise.”.” Even less extreme views are quickly becoming a thing of the past, and ways to measure the value of employees are becoming more sophisticated.

From a pure cost perspective, standard ratios such as the cost per hire, wage-and-benefits costs, cost per incident of absenteeism, or cost per incident of voluntary turnover are popular, Cascio says.

“Of course, there are also costs associated with mis-managing people, such as those associated with lawsuits alleging unfair discrimination or the costs associated with resolving industrial disputes. Other costs include those associated with resolving industrial disputes.”

Ultimately, the role of HR becomes inextricably linked to accounting for such human capital costs as much as other operating expenses, includinge those associated with ending the employment relationship –, so-called severance pay or employee buy-outs. In fact, as Cascio points out, in labour-intensive businesses, such as consulting firms, law firms, or universities, labour costs may account for as much as 80 per cent of total operating costs.

“This figure is much lower in airlines or banks (roughly 30 per cent of total operating costs) or oil refineries (about 10 per cent),” he says.

As a result, the challenge for HR lies in its ability to shift its people investment approaches away from models that focus purely on the investment, as opposed to the outputs that can beproduced gained through that investment or human resource.

In Cascio’s view, the greatest challenge for HR is to move from a compliance model, in which the focus of HR is on maintaining compliance with laws and regulations and the policing of management processes such as staffing and compensation, to a service model where HR provides services at reasonable costs to help line managers manage their operations. In effect, he claims there is a movement towards a decision-oriented model, in which the main focus is on decisions around talent, and on the relative strategic importance of different talent pools in the organisation provinges pivotal. “Focusing on decisions that affect the deployment and use of talent is likely to yield far greater payoffs than simply remaining in a compliance- or service-oriented mindset.” As compliance and service are the traditional roles of HR, he adds that focusing decisions on talent and the people-related impacts of strategic business decisions will guarantee HR a much more strategic role in the future.

What to capitalise on

Companies as a whole, and in particular HR,HR find it difficult to prove the return on investment when it comes to their human capital. Whether it be for various benefits, training and development, paid time off or anything to do with ensuring work- life balance, providing and arguing the facts and financial returns is the ultimate challenge. For HR it is all about capitalising onwhat which practices create the highest value, and identifying those that will contribute to the overall business strategy and maximise business performance.

According to Cascio, while it might appear that it is in an organisation’s best interest to reduce costs across the board, at all levels of employees, this is not necessarily the case. “Think of market segmentation, in this case, segmentation of the talent market. It’s important to begin by identifying pivotal talent, that is, places in the organisation where investments are likely to create the greatest strategic value to a firm,” he suggests.

For instance, dispatchers in a delivery service, or call-centercentre employees who take orders for merchandise, might well represent pivotal talent. “It makes sense to focus investments on things such as staffing and training because they are so critical to the success of an organisation.”

Core quality eCritical to success means refers to those employeesthat are vitally important to the survival and growth of the firm, as well as to achieving its strategic objectives, effectively generating benefits that may far outweigh their costs.

Cascioprovides an example using describes a research and development operation as an example wherewhere innovationis is critical to the future success of a firm, andmeaning where high employee turnover, especially among high- performers, may be disastrous. “It therefore makes sense to hire carefully, to pay well, and to provide lots of opportunities for personal growth and development for employees in research and development.”

Cascio says that while the direct costs of doing these things may be apparent, the benefits are no less important, but may be less obvious. Benefits might include reduced cycle time from concept to production, an increased number of patents, andthe a higher percentage of revenues derived from new products or services (for example, those that are fewer than three years old).

“Henry Ford recognized this in 1914 when he decided to pay workers in his automobile-assembly factories $5.00 a day, when the ‘going rate’ was half of that. Why did he do it? Because he was tired of trying to hire 50,000 people a year to fill 14,000 positions,” Cascio exclaims.

There is also a side benefit of reducing employee turnover by treating employees well. Cascio refers to his December, 2006 article in the Harvard Business Review, entitled:The high cost of low wages, where. Here,hesuggests argues that organisations can learn something from the operations in the retail industry, where employees are less likely to steal from their employers. “At least among retailers in the United States, ‘shrinkage’ or losses due to employee theft, shoplifting, vendor fraud, and administrative errors comprise approximately 2 per cent of annual sales.”

Casciopoints to the fact observes that for a large retailer, that 2 per cent couldmean represent millions, and in some cases, billions of dollars. “Retailers with very low employee turnover also tend to have very low shrinkage rates, in some cases, as with the retailer, Costco Wholesale Corporation, that number is as low as 0.2 per cent. Yet Costco pays wages or labour rates that average 40 per cent higher than its closest rival.

He claimsit is about there is value in ensuring competitive salary or pay rates. “The costs that it does not incur, in the form of reduced employee turnover (or more positively, through increased retention) or in reduced shrinkage, offset its higher labour rates. As a result, its overall labour costs (as a percentage of sales per employee) are actually lower than those of its rivals.”

The proof is in the people

Currently, many companies are practicing what Cascio refers to as ‘labour arbitrage’, believing the economic model of outsourcing has become far too compelling for companies to ignore.

“Whether it’s Nike, Dell, IBM, General Electric, Boeing, Apple, or Siemens, many companies are practicing ‘labour arbitrage’, in which they seek constantly to outsource non-core activities to cheaper providers of labour. This has resulted in a global dispersion of work, not just to low-wage countries such as China, India, Vietnam, and Eastern Europe, but also to second- and third-tier cities within those countries,.” Cascio says.

He Cascio refers to the trend of the relocation of call-centre operations from more-developed to less-developed countries asthis doing so proves cheaper. The same is true with respect to engineering operations, information systems, assembly of electronic components, and many other types of activities. Cascio cites the work ofIn fact, a recent analysis by Princeton University economist Alan Blinder, whichindicated demonstrates that many more occupationssuch as the following are ‘“highly offshorable’, ”:including bookkeeping and auditing clerks, computer programmers, graphic designers, data-entry staff, financial analysts, tax preparers, and medical transcribers, Cascio adds. All of which represent both high- and low-knowledge work.

“The HR challenge will be to develop the management systems and to identify managers with the skills to coordinate the activities of far-flung workers, for the economic impact of that will be huge. Finding and keeping top talent in every market in which a company operates will provide ongoing challenges for HR.”

It is therefore important that HR identify metrics now that will enable it to tally the value of the economic benefits that it adds to an organisation by making wise decisions about people, says Cascio.