People profit … and how to measure it

A company’s employees are typically its largest expense, but often the least measurable when it comes to productivity and profit. Craig Donaldson looks at how HR can help a company measure what an employee is really worth

As is the case with most initiatives, some organisations measure employee prof itability well; some don’t do it at all; and most are somewhere in between – mak ing good-natured attempts, but often not following through consistently or measuring only bits and pieces without getting the full picture on employee productivity or profitability.

Michelle Smith, president of the US Forum for People Performance Management, says that while many organ isations measure and evaluate an abundance of employee- related constructs such as output, efficiency, satisfaction and engagement, few companies have systematic ways of assembling them into a formal process that calibrates the long-term relationship between people and organi sational performance.

Anastasia Ellerby, managing director for Infohrm in the Asia-Pacific Region, says it is relatively easy in certain industries to connect people input to business outcomes, while in others it is far more complex. The industries that are able to measure the value of their people suc cessfully are retailers, banking and energy, she says.

“A lot of organisations find it difficult to identify and agree on an accepted method of connecting people to business outcomes and provide a key input to decision- making. For some companies, connecting people to busi ness outcomes is put in the ‘too hard basket’; for other organisations it is the ‘holy grail’ and the rest fall some where in between,” Ellerby says.

Debra Eckersley, a partner in PricewaterhouseCooper’s performance improvement practice, says the ability to meas ure profit per employee varies depending on the size and sec tor of the organisation. Process-and-sales-driven businesses have greater potential to establish metrics that monitor employee performance against key events, and are likely to be better positioned to understand rel ative productivity, she says.

“However, for more ‘knowledge’ or ‘innovation’-focused organisations, meas uring an individual’s profitability and pro ductivity is more difficult. Without strong information and a clear sense of what is being measured, it can be difficult to draw meaningful conclusions to aid decision- making,” Eckersley says.

Metrics and formulas

There are a number of formulas for measuring productivity and profit per employee. Rainer Strack, Europe leader for The Boston Con sulting Group, says that companies need a supe rior productivity metric, similar to a value-added per-person metric, which measures output.

“This metric is not profit per employee, but more about productivity, because in profit per employee you include personal costs and it is better to separate input from output,” he says.

“So in our metric, you divide personal cost by capital- related costs, such as depreciation, add the cost of capi tal and multiply by capital employed (for more detail see The Boston Consulting Group report, Creating People Advantage: How to Tackle the Major HR Challenges Dur ing the Crisis and Beyond). Most companies, even in the old economy, are involved in people-intensive work and have ratios of 3:1, 4:1 or 5:1 (people cost compared to cap ital cost), so this clearly indicates value creation is more on the people side than on the capital side.”

The Forum for People Performance Management has developed another formula for calculating Employee Lifetime Value (or ELTV), a long-term metric that provides insights on measuring the financial value of an employee to an organisation.

Its white paper, Employee Lifetime Value: Measur ing the Long-Term Financial Contribution of Employ ees, reviews the concepts, metrics, and applications of ELTV so that employees can be viewed as contributors to the cash inflow of organisations, says Smith.

“The overall goal is to demonstrate how ELTV – much like the parallel customer/lifetime value framework – fits into a strategic approach to management that considers employees and their behaviours the primary drivers of success,” she says.

Generic productivity levels are usually tracked using metrics such as remuneration/revenue and remunera tion/costs, according to Eckersley. “Both methods pro vide clear indications of whether sufficient revenue is being created to justify the level of the remuneration bill and whether it is reasonably controlled against the busi ness’s total costs,” she says.

Additionally, organisations often look at revenue/full- time employee (FTE), profit/FTE and cost/FTE. “Organi sations that achieve a competitive revenue per FTE and high profit per FTE, with costs per FTE under control, are likely to possess a workforce with the right numerical strength, delivering competitive levels of productivity,” Eckersley says.

PricewaterhouseCoopers uses a methodology called Human Capital Return on Investment (HC ROI), which provides a comparative measure of added value per FTE. HC ROI compares the pre-tax profit generated before employment costs, with the investment in compensation and benefit costs.

Eckersley says this ratio determines how much pre-tax profit or earnings are produced for every unit of currency paid to an employee. “HC ROI is a measurement all HR executives should understand as it covers all major elements of an organisation’s potential contribution – including revenues produced, costs incurred and investment in reward structures,” she says.

“Importantly, HC ROI can also help management understand how to improve each element relative to an organisation’s competitors.”

Working with finance

A key aspect for finance and HR is to understand the rela tionship between their people and the value they create for the bottom line, according to Ellerby. Once this understanding is reached, both then need to agree on consistent measure ments, report on these measures and act on the outcomes. “HR can show finance the value creations gained by influ encing the bottom line through attraction, retention or engagement strategies,” she says.

Practising workforce composition modelling is another way that finance and HR can work together to improve profit and productivity per employee, Ellerby says. “Looking at the proportion of contracted professional and technical positions, as well as temporary adminis tration and service staff, can affect the cost of the over all workforce and is a trade-off between cost and flexibility – this process is one way that organisations can demystify the value of people.”

Smith says that what is ideally needed is a set of met rics that can be incorporated into standard financial statements that take into account an organisation’s intan gible assets. “Or, if the value of these assets is deter mined independent of the financial evaluation, the establishment of a model that is universally accepted and recognised,” she says.

“In order to achieve this goal, HR should campaign for additional research to be conducted on the direct link between employee engagement and corporate finan cial performance, and encourage that these metrics are incorporated into their financial statements”

HR should be proactive in working with finance to create the measurements and then getting them into the hands of senior management and helping them to under stand the implications of the data, Smith says.

Most HR departments are still in their infancy when it comes to evaluating human capital, according to Strack. “When it comes to measuring and managing investment capital, there has been 500 years of double- entry book keeping and balance sheet accounting, but when it comes to human capital I think we are still at the very beginning,” he says.

“So if HR is going to work closely with finance, it needs to think about how to increase productivity, under stand who the key people are in the organisation and how to further develop them, keep them engaged and motivate them to improve leadership, engagement and performance.”

Making a start

Quantifying employee value and profitability provides an important opportunity for HR professionals to play a much broader, more valuable role in the future success of their organisation.

Smith says HR should become an important part of strategy development because of the importance of human capital in the ability of the firm to carry out its strategy. “HR specialists, along with financial man agers, should be in charge of measuring employee value,” she says.

“Aside from the more traditional roles of HR, the new role of HR practice should include determining appropri ate organisational structural changes and developing strate gies to improve employee performance. With the increased role of people in today’s knowledge-based economy, the HR department should be included in the strategic business planning process and top management of a company – rather than merely serving as a support function.”

Companies should get started with some very sim ple metrics, according to Strack. “Play with them, get some experience at using them to learn about the process,” he says.

“I think a lot of HR people are reluctant when it comes to analytics because they come from a world of soft measures. As the old saying goes, ‘What gets meas ured gets done’, so if HR doesn’t have metrics in place it will never live up to its full potential in business.”

Eckersley says that without strong information it is difficult for organisations to effectively monitor this area and generate real improvements.

“Creating a successful measurement program requires clarity around how productivity will be tracked (and this may need to involve some subjective supporting indicators) and ensuring robust data exists to support managerial decision-making,” she says.

Jac Fitz-enz on measuring people profit

When it comes to measuring profit and productivity from people, most companies are hardly on track, let alone up to speed, according to Jac Fitz-enz, an expert in human capital analysis and measurement and author of The ROI of Human Capital.

He knows of only a few companies, such as Hewlett Packard and Microsoft, which are seriously doing something in this space. “They have some simple formulas like revenue per FTE, and compensation as a percent of revenue,” he says.

Two formulas he recommends for measuring human capital are:

Human capital ROI = Revenue - (Operating expense - labour cost) ÷ labour cost

and

Human capital Value Added = Human capital ROI ÷ number of employees

For companies starting out in this area, he advises thinking human capital and not human resources. “Understand HR’s mission is to help management optimise the ROI of people,” Fitz-enz says. “Look for root causes for human capital changes and improvements.”

The people business at Blackmores

The great failure of business around the world, according to Marcus Blackmore, executive chairman of Blackmores, is an inability to define the value of employees.

“Maybe it’s driven by the accounting profession, but we see with great repetition chairmen’s reports saying: ‘Our people are our greatest asset’. Then, when you look through the balance sheet of the financial statements, nowhere in there can you find any value on the people in the organisation,” he says.

“I’ve got a very simplistic view about that. If I go to a bank and borrow a million dollars, at the moment they’ll charge me about 6 per cent, or about $60,000 a year. Now, the least-paid people at Blackmores are on about $45,000 a year. The on-cost of employing those people is something in the order of $15,000 a year. So the least paid person at Blackmores costs the company in the order of $60,000.

“That’s the same amount of money that I can go and borrow a million bucks for. So therefore, from my perspective, is it unreasonable that we should suggest that the least-paid person at Blackmores is a one million dollar investment to this company - an investment in people capital if you like?

“Now if you want to go and buy a new forklift, your operations people will give you pages of forms to justify it, but they will put on an extra person in a flash. It’s just amazing, and I think it’s the great failure of modern business because we might appreciate how much people cost but we don’t appreciate how much they’re worth.”

Tips for starting out

1. Understand the relationship between people and business performance

2. Find a simple and consistent way to measure value and report it

3. Spend time analysing results rather than arguing about the data

4. Act on the outcomes to improve bottom-line performance

Source: Anastasia Ellerby, managing director, Infohrm, Asia-Pacific Region