Human Capital Metrics – proving HR’s value

Everyone in HR often starts from the intuition that “Good HR” adds value to the enterprise, but as we know – proving it often becomes the challenge. And that lack of ability to convert the intuition into financial language can often create the branding issue for HR within an organization.
The good news is that there has been lots of research over the last couple of years that show that companies that invest in their people perform better in the market. Look for research by Mark Huselid to start learning about the correlation studies – there is a lot more out there- but this is a great starting point.
This also changes the financial conversation during HR budgets. Instead of having to prove from top up that a training program in customer service with increase revenue by 103%, this approach allows someone to explain that companies that invest 2% (making the number up) in training programs have earnings 15% higher than others in that particular industry segment.
Help from Wall Street
What is interesting is that HR is starting to gather what may initially seem like an unusual ally – Wall Street. For the investors there are typically two approaches that they are starting to adopt – and both are fine:
1. Believers – there are some investors that understand and believe the correlation of HR to stock performance and starting to push for more research and also direct their investing dollars to firms that invest in their people.
2. More Data is better. – There are other investors who aren’t going to invest solely on the people data, but in an environment for most other valuation tools are starting to lose their accuracy – adding more transparency about the largest expense on the income sheet for most people makes tremendous sense.


Where we are at today – On the Cusp
If you have ever read the SEC filings for an airline – it is interesting as to the amount of detail provided about their airplane fleet – in terms of mechanical hours, flight time, etc. That same type of approach should be used for the people but sadly – if you read the SEC filings for an industry sector, the amount of visibility into the workforce truly varies as it is a voluntary disclosure.
The challenge is having agreement on what the human capital metrics are, how they should be measured, and then eventually getting them added to SEC filings. This “open source” approach is key as investors will not be able to rely on them if they are not uniform.
So what are we talking about in terms of reporting?
I encourage you to go to the Human Capital Management Institute website (www.HCMinst.com) and they just released a white paper that provides an example of the type of metrics that are being asked for – but you will be surprised that it is relatively simple. It mirrors the normal pro forma today (income statement, asset sheet and a cash flow). It shows your investors the labor dollars of the workforce, the direct cost of the workforce, and produces a metric as a percent to revenue. The asset sheet may initially raise your eyebrows as it suggests breaking out the workforce by role types (e.g. Sales, R&D, etc) by headcount and labor costs.
Imagine if this was in place today!
Imagine for a moment that all of your competitors and you have SEC filings showing the Human Capital Metrics as suggested by the HCMI, and now lets think about some of the potential “proofs” that could be developed to show the intrinsic value of your HR organization.
For organizations that are salesforce intensive, you could show the benefit of the training function by showing your sales teams generate more revenue on a per employee basis than your competitors.
In a very margin thin business, such as retail, you could compare against other competitors on how thin the organization is. Do you have the organization structure just right? 

In organizations where there are high value talent employees (e.g. consulting, financial services, R&D) how does your labor spending look compared to others? Are you attracting and maintaining high end talent. Could you imagine if you had your leading competitor showing that they falling 5% behind you in terms of revenue per employee, but they just increased their headcount in research and development by 100%.

To some extent, some of this data is available via benchmarking reports, but often loses functionality due to concern about the sample size, comparator groups, etc. It is a lot easier to compare your organization against the specifics of one or two competitors that you know.

But isn’t this the secret sauce and should be confidential?
You may be reading this and feeling a bit uneasy- thinking that this gives away your strategic advantages, and that is somewhat true but a wrong perception. Capitalism is built to drive the most efficient use of capital, and capital itself is subject to supply and demand. As a result, one function of a company is to “woo” investors and to show that they are effective consumers of those dollars – resulting in a metric called return on invested capital (ROIC). So if you dig into SEC filings today, you will find that companies provide all sorts of mandatory and voluntary information about their sourcing strategies, real estate approaches, credit instruments, etc – and when all combined gives investors a really good visibility into how a company functions – the last remaining void – is how does a company invests in their people (for purposes of this article I am ignoring long term incentive plans, and/or pension liabilities).

If this information did become standard, not only would investors utilize it, but it would quickly highlight great HR organizations. It would allow CEO’s and Boards to understand when they have a HR department that is truly adding benefit to the bottom line of the company, and conversely – it would help them identify HR functions that are just treading water.

So what can you do? 
This is a fun topic area, as I am hoping that you can quickly apply this approach to your daily job as at least a perspective that you bring to the table. While it would be great if the SEC required the Human Capital Metrics, a lot of the data about your company and competitors is out there – so you can build your own simple dashboard.

1. Take your company, and your immediate competitors and build a table that shows last year’s revenue, Net Operating Profit and the employee count. Most companies publish their employee count in the annual report, and/or you can find it on LinkedIN, Hoovers, etc. It isn’t exact – but it will be close. Now take a look at revenue per employee and net operating profit per employee – does anything jump out at you? This should allow you to start seeing trends and asking yourself questions if a competitor is better in one of the ratios – what do you think they might be doing different and/or are you leading in an area. Lets take a quick example and compare Home Depot to Lowes – as they are similar business types and organization structures:

(Just as a quick caveat – these were pulled from a variety of sources, so take this as an example, and not a specific analysis of Lowes and Home Depot). But in this scenario, it quick becomes apparent that Home Depot employees sell more on a volume side, and create higher profit on a per employee basis. What is even more interesting is that on a enterprise perspective, Lowes has higher margin – so it means that it must be more efficient on other aspects of the operation (e.g. Cost of goods, distribution, retail, marketing, etc.) but on the people side – Home Depot is excelling.

This should be just a starting point – and based on the numbers you are seeing for you company – and competitors, you may need to dig into what geographies are they in, etc. But at the end of the day – it will make you more fluent about how your human capital is performing for the company.

2. Now that you have compared numbers, the next step is to read the most recent 10-K and Annual Report for your company and your top competitors. Key things to look for are:

What additional human capital information is provided? Turnover, training dollars, headcount by geography or business segment? 
Now put on a marketing hat – in comparison to your company’s reports – are any of your competitors using their HR results in their reports? Often you can find annual reports that have sections focusing on employee engagement numbers, training dollars, recruiting strategies, etc. Remember that analysts get assigned to industry verticals – so are they seeing a better “story” with a competitor than with your company?

3. Now what to do with the learnings.
At a minimum, I think every HR person should go through this exercise on an annual basis, and I think Director’s and above should do this on a quarterly basis and hopefully you will have a couple of outputs:

You may find some results that will cause you to look at how you are delivering HR and look for areas of improvement. Even if you are the best, hopefully you are finding something one of your competitors is beating you on – so you can continue to improve.
Make sure to use the results in HR Business Partner meetings, and executive committee. This helps to start to educate others on how HR connects to results, and conveys a strong sense of understand that HR knows financial results are key.
Depending on the results, you may have an opportunity to sit with the CFO and Investor relations and help guide the analyst and shareholder strategy. Your organization may be driving results, and a story, that the analysts and investors don’t know about. 
Aside from strategic workforce planning, this is one of the areas that I am passionate about – so if you have any feedback and/or questions – please do not hesitate to contact me.

(Source: HCMI | Human Capital Management Institute – Workforce Analytics & Workforce Planning Knowledge Leaders)

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