The practice of human capital management

by 19 Aug 2009

Human capital management provides solid evidence about how much a HR strategy is actually worth in terms of market value. Paul Kearns looks at the business case for measuring your number one asset and how it can be achieved

You have probably become inured to the cry of ‘wolf’ heard so often these days in HR circles. Demographic timebombs, HR re-engineering and business scorecards are just some of the many examples of much-vaunted topics, which are heralded with great fanfare but usually fail to disturb HR departments unduly, or leave any lasting impression.

Rather than give the impression of doing HCM, it is probably much easier to just face up to the fact that HCM is a new discipline for all of us. After all, it’s also a new discipline for financial and investment analysts, as well as accountants. That saves you having to make any excuses for lack of progress. Don’t forget, the reason there is so much interest in HCM is that the accounting profession failed to measure the things that really do drive exceptional organisational performance over the past 20 years or so. Moreover, at a time when conventional accounting and auditing practices are in turmoil as a direct consequence of the debacle over the black holes found in the accounts of organisations such as Enron, WorldCom and Parmalat, the HR profession – for once – need make no apologies.

So being alarmist about the latest big idea, human capital management (HCM), will probably serve no purpose. In fact, there is a distinct whiff of déja vu in the HR air from those who think this is just HR measurement in new clothing. Not so. A sober review of some rather startling facts might make you wake up to the latest opportunity, or enormous challenge, that HCM represents.

How about this for starters? Which organisation would win the ‘world cup’ for getting the best value out of its human capital? Microsoft? Motorola? Tesco? Actually there’s no contest – the answer is Toyota and has been for some years now. This does not necessarily mean that it has the best HR function though. It means it literally gets more dollars returned on its investment in people compared to its competitors. How do we know this? Well, the results speak for themselves. Toyota’s market value (share price x number of shares) of more than $166 billion is more than the combined value of Ford, General Motors and Daimler Chrysler (based on figures for January 2004). And Toyota is much more profitable as well. Toyota can produce a car for almost $5,000 less than its competitors in the US, for instance.

When it comes to HCM, shareholders and investment analysts are the key people drawing their own conclusions from such figures and it is their views that count. Share prices are based on the confidence they have that organisations like Toyota will continue to deliver best market value. Moreover, once this level of performance is seen to be achievable, it becomes the benchmark for the industry. So HR needs to be thinking how it convinces them, not its internal customers. HCM asks whether your ‘best’ is good enough and what real market value it brings in terms of money.

Consequently, HCM is based on much tougher success criteria than we are, perhaps, used to in HR. Rates of sickness and absenteeism, staff turnover and even employee attitude surveys will cut no ice if there is no clear, causal connection to a corresponding improvement in market value. The currency of HCM is added value per employee (in terms of money) – not their number of training days per year or even how much of your salary bill is committed in the training budget. Not unless you can show the return on investment on this spend.

One problem with current thinking on HCM is that it is regarded as an ‘intangible’. However, some academic estimates suggest that intangibles account for up to 75 per cent of the difference in market valuations of companies. In the US, this has led to many HR practices designed to influence such intangibles (hence the focus on ‘employee satisfaction’). But maybe they are missing the point? What Toyota does is all very tangible indeed and involves a great deal more than just trying to keep its employees satisfied. Toyota believes in developing its supply chains as partners. It shares knowledge and expertise in return for lower supplier prices, which in turn necessitates open-book accounting. This is, of course, in addition to all its other HR practices of developing staff in the philosophy and practice of kaizen (see box). It is also very tangible in the results it delivers.

So, if you accept that you are going to start out on a new journey towards HCM, where might those first, tentative steps take you?

Step 1 Check whether your board even knows about the subject. HCM needs board commitment. You will not secure the requisite commitment unless they really understand the potential value that HCM could bring. Take along the figures shown above comparing Toyota with the rest of the automotive manufacturing industry, and ask your finance director to explain how this can be so when they all have access to the same capital markets and technology?

If this gets them interested but no clear explanations are forthcoming, suggest that part of that value gap can be created from managing people as human capital – with the emphasis on the ‘human’ more than the ‘capital’. HCM is meant to be a very mature way to run an organisation, so the last thing you want is a debate about whether we call people ‘resources’ or ‘capital’. What we are looking for is the best monetary value from human potential.

Now, ask what your organisation is planning to do to leave your competitors as far behind as possible. For a harder edge, you could suggest that if you do not embrace the principles of HCM, then maybe the board’s reputation will suffer accordingly.

Of course, HCM is only for the ambitious. If the board is quite relaxed about the current market position and isn’t looking for significant value gains maybe you need to go elsewhere to get your HCM experience. As a parting shot, you could also mention the possibility that in future they might have a legal obligation to produce an operating and financial review with this type of data in it.

Step 2 Signal that HCM is a radical departure from conventional HRM. Step one is to check understanding and, if necessary, to whet the board’s appetite. Only then can you suggest that, if it wants all the benefits to be had from HCM, it has to adopt a completely fresh approach to the way the organisation manages people. The board will, of course, ask for examples of what this might mean, so here are a few to start the discussion:

• There should be no fixed training budget. If people are being seen as value-adders then the board should be prepared to sanction any spend that aims to add value through training and development. In return, you will have to start demonstrating the return on investment (ROI) on that spend by using the same financial calculations used by the finance and operational departments.

• All the talk about performance management has to be finally made a reality. HCM might be about getting the best value out of people, but that does not mean you should shy away from dealing with areas of under-performance. How can you talk about maximising human capital while you tolerate passengers? This again means you have to have a robust employee performance measurement and management system in place.

• On the reward front, there are basically two options: you agree to pay market rates and then really concentrate on employee engagement, motivation and retention (the Toyota option); or you take the lid off your rewards policy on the basis that you have to be prepared to put your money where your mouth is for those who generate the most value. However, there’s no room for fat cats in HCM.

• It’s also about time you wrapped up many existing HR policies and practices under the one umbrella of talent management and put someone in place who has clout and really knows what they are doing. The head of diversity will have to go, because this will now be under the auspices of the head of talent management – which is where it should have always been, anyway.

This should be enough for the board to start noticing the difference between HCM and HRM. The old HR practices will start looking decidedly jaded by comparison.

Step 3 Get a board sponsor. This step is quite obvious. Really, the only sponsor to give HCM the weight it needs is the chief executive, so you should perhaps have advised them of this before embarking on step one. But then any HR director with political nous will have already realised this. You will also coach the CEO never to use the phrase ‘our people are our greatest asset’ again. From now on, the mantra is: ‘we aim to maximise the value of our people – their individual value and our value are one and the same’ – or something along similar lines.

You should also point out to the sponsor that there will be plenty of resistance along the road to HCM: from managers who have never managed performance before; from those who like training courses with no clear business objective; and anyone who thinks ‘hitting target’ is the only thing they have to worry about.

Developing the full potential of people is now the name of the game, and what better way to set an example than starting at home, with the HR team.

Step 4 Develop your HCM people. The biggest problem for HR will be finding HCM professionals. They do not currently exist, so there is no point going out into the market to look for them. The only option is the homegrown variety, and these are unlikely to be readily found among existing HR ranks.

HCM is a new discipline requiring new skills. For example, who in your present team can analyse a balance sheet or a profit and loss account and come to some conclusions about what is required from an HCM perspective? Who can look the financial director in the eye, after looking at the existing cost base or revenue stream, and suggest ways of making a significant, measurable impact through HCM practices?

The HCM professionals will need to have an unusual blend of high numeracy with great people skills. They are likely to come from an operational background, but will already have a reputation for getting the best out of the people they have inherited. They will be high performers themselves, who will see that bringing the same level of performance throughout the organisation will require structural changes and fresh perspectives.

Step 5 Start producing some HCM figures now. Probably the most immediate, practical step of all, is to start producing the sort of data required for a future operating and financial review. Talk value, not cost. Look for outputs, not inputs. Don’t measure staff turnover in terms of recruitment and training costs – instead, measure lost revenue opportunities through losing experienced people. Look at customer service level changes that are directly connected to customers meeting too many new faces.

While you’re doing this, stop measuring HR inputs such as training costs, training days and time to recruit unless you have a corresponding measure of output – that is, the performance levels of those you have trained or recruited.

Draft your first HCM report – what would it look like, and what information should be included to represent the value of people in your organisation? If you are surveying employee attitudes or satisfaction, make sure you have a corresponding chart tracking what they bring to the organisation. If this is difficult, then maybe you need to revisit the design of such surveys.

Get ahead of the game. HCM is coming, whether you like it or not. It is much better to shape it to what your organisation needs, than have it dictated to you.

Toyota staff provide 75,000 reasons for using kaizen

Kaizen is a simple, Japanese philosophy defined as continuous (kai) improvement (zen) through gradual, systematic change. It avoids the pitfalls of throwing money at organisational problems by encouraging a thoughtful approach. Masaaki Imai in his book, Kaizen: Key to Japans Competitive Success, defined it as: “A means of continuing improvement in personal life, home life, social life, and working life. In the workplace, [it] means involving everyone – managers and workers alike.” Kaizen promotes making small improvements immediately to encourage active employee participation. Toyota has used kaizen processes since the late 1970s. At one of its US plants 7,000 employees made more than 75,000 suggestions in 1999 and amazingly, 99 per cent of them were implemented.

HCM v HRM

- HCM (human capital management) specialists need to know the difference between the book value and market capitalisation of their organisation

- The most important stakeholders in HCM are external not internal

- HCM is about value not cost. People are value adders not overheads, as in HRM (human resource management)

- HCM has to show the value generated by people management in the annual operating and financial review

- HCM means demonstrating a clear and causal link to organisational performance, not just following best HR practices

- HCM is about measuring organisational outputs (profit, revenue, service levels) while HRM tends to concentrate on input measures (eg, recruitment costs)

Courtesy of Personnel Today