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The ROI of Human Capital

How to measure Human resources’ value added

How to Measure Human Capital's Contribution to Enterprise Goals

Time

Measurement of the return on human capital starts with an understanding of the tasks involved with managing human capital from the workforce planning stage onward.

A Human capital P&L

Human Capital Management Star

  • Like cost reduction, if you can do something faster than your competition, you have a differentiating competitive advantage.

  • Time has other effects as well as direct costs or savings. Delays frustrate people. They affect morale and thereby negatively impact productivity.

  • The hidden effect of time lost can be devastating.

Human capital Enterprise Scorecard

Evaluating

Retaining

  • Evaluating the management of human capital is not a separate task. It is integral to the efficient and effective exercise of the other five.
  • What is worth measuring?

COST

QUANTITY

  • The last step in human capital management game is to retain talent.

  • Employee-relations program, attitude surveys, and various other means are used to learn what it takes to keep talent in the organization.

  • The main measure of retention efforts is the separation rate.

  • Quantity is the third must common metric. It is easy to deal with, because you can physically count the items under consideration.

  • By itself, knowing the quantity processed is not very useful. But it is the starting point for asking the important question.

  • Cost is the one variable that gets management’s attention.

  • You can usually count business issue in monetary terms.

  • The cost of human capital management can be broken down into its major elements to understand where the opportunity for reduction lies

  • There are four costs associated with turnover: termination, replacement, vacancy and productivity loss.

Planning

Developing

  • Before there is effective action in an organization, there must be some amount of planning for human capital.
  • A small and slowly growing number of managers are working with human resources to project human capital needs into the next decade.
  • Effective workforce planning or management can be evaluated along a couple of lines. One of the more common is to look at the percentage of jobs that have been filled from the existing employee population. Goals can be set up to fill a certain percentage of jobs from within.

Having acquired and maintained a viable workforce, the next step is to develop it to its fullest potential.

Human capital is unique, in that it is the only asset that can be developed.

Human capital development is accomplished through various forms of education and training and by on-the-job experience.

If you spend time and money helping people learn and grow, you make a deposit in their loyalty bank.

Training effects are measured best through changes in trainee job performance and the ensuing improvements in productivity, quality or service.

It is axiomatic that all resources should be directed to serving the enterprise's purpose. This purpose can be, should be, and most often is expressed through a combination of economic and human goals.

Sample Corporate human Capital Scorecard

Acquiring

Maintaining

  • Planning and acquiring obviously must feed each other.

  • After there is a work force projection for either the short or long term, the human capital must be acquired through hiring or renting from an agency or contracting with individuals directly for part time or full time work.

  • Some companies have been their own worst enemies in hiring.

  • Effective recruitment is most often assessed in terms of hiring costs and time to fill jobs.

  • The quality of hires can also be evaluated, although it is more difficult.

  • Once the precious human asset is in-house, it must be maintained.

  • This is done principally through pay and benefits – the remuneration system.
  • Nonmonetary reward and recognition is more of a retention and motivational effort than a maintenance program.

  • Notwithstanding that, to keep talent today, stock options, profit sharing, gain sharing, and other forms of cash payouts are becoming common at much lower levels than ever before.

  • Measures of maintenance effectiveness naturally focus on money spent. Wage and salary levels, pay and benefits as a percentage of revenue or expense, and average compensation for non-exempts, supervisors, managers, and executives are all captured and published by different sources.

ERROR

REACTION

  • Human reaction refers to the physical, psychological, or emotional response of individuals to events around them.

  • Error and defect rates became popular with the advent of the quality craze of the early 1980s.

  • An error or defect is simply something that did not meet expectations or requirements.

  • Acceptable error rates are very individual issue.

Human-Financial Interface

For may years, the general practice of matching human and financial variables at the corporate level has been confined to a single gross measure derived from the income statement of corporations.

This metric is revenue per employee.

We need tactical level metrics to measure improvements within the human resources-based functions and to monitor the human capital effects on business unit objectives. We need strategic-level metrics to show the effects of human capital on corporate goals.

Human capital ACCOUNTING

Human capital scorecard

How to Measure Human Capital's Impact on Processes

The

H

in Human capital

The profit lever of a knowledge economy

  • In 1965, Roger Hermanson propsed a method for determining the value of human being to an organization then called Human Resources Accounting (HRA).

  • I can testify that true value of any tangible asset is unknown until someone gives you money for it.

  • A more practical angle is to look at what really happened, as accounting does, and then calculate the value added by human effort after the fact.

  • The Saratoga Institute has work on this issue for two decades. The Human Capital Profit-and-loss statement is one of its latest contributions to that effort.

Human Economic Value Added (HEVA)

  • We can take the concept behind the balanced scorecard and create human capital version.

  • It has four quadrants: acquiring, maintaining, developing and retaining.

  • In fact, the scorecard concept was developed to deal with factors that are ignored in standard financial statements.

  • Each of the quadrants should contain cost, time, quantity and quality measures to extent practical and possible.

  • Across the bottom, a base can be added to cover reaction factors. The reactions of managers and employees to human resources programs are important.

Human Capital revenue Factor (HCRF)

A first step in looking at the human capital aspect of financials is to revise the traditional revenue per employee metric.

We have converted revenue per employee into revenue per FTE (including full-time, part-time, and contingent labor hours). FTE is a surrogate for total labor hours invested.

Workforce demographics

Investment Management

Human Capital Market Value (HCMV)

Human Capital Cost Factor

Enterprise-Level Metrics: The Launch Point

Finding Human Capital Effect

The principal costs of human capital are four: pay and benefit costs for employees, pay costs for contingents, the cost of absenteeism, and the cost of turnover.

It is useful to know things like how many exempt versus nonexempt people you have and what percentage of the work is being done with regular versus contingent personnel or is being outsourced.

1. Exempt Percent

2. Contingent Percentage

The contingent percentage is the number of contingent FTEs as a percentage of total FTEs.

This is the other side of the cost management approach. We know from the human capital value added and the human capital ROI formulas earlier that people do make money for companies. It only makes sense, then, to invest in them and to monitor that investment.

Employee Development Investment:

This is the cost of all education, training, and development programs as a percentage of payroll.

This can be accomplished with a four-step analytic process called process value analysis.

Workforce Movement

Cost management

Although it is good to know about percentages and movement, it is even better to know about cost.

Total labor Cost Revenue Percentage:

This figure is all labor costs as a percentage of total revenue.

Obviously, the workforce is not static. people come and go every day. Some are replacing terminated personnel, and some are taking newly created positions.

1. Accession Rate: is the number of replacement hires and hires for new positions as a percentage of the workforce.

2. The separation rate: is the number of voluntary and involuntary separations as a percentage of total head count.

Human Capital Value Added (HCVA)

Human capital Return on Investment (HCROI)

HCROI looks at the ROI in terms of profit for monies spent on employee pay and benefits.

Step one

Situation Analysis

Step four

Value

1. What are the internal effects on service, quality, or productivity levels?

2. What are the external effects on competitive advantage?

1. What is the business problem: service, quality, or productivity (SQP)?

2. What is the current performance level in terms of SQP indices?

3. How is the current performance affecting competitive advantage?

4. What are the critical work processes in this situation?

ACCOUNTING OF HUMAN CAPITAL

Step two

Intervention

Step three

Impact

1. What is the source of the problem?

2. What is the best solution?

3. Agree on a solution, plan the action, and do it.

Point of Measurement

1. Did performance change? If yes, was the change in a positive or a negative direction?

2. What and how much change occurred?

3. What caused the change? Was it the action we took or extraneous factors?

  • In the closing years of the Twentieth century, management has come to accept that people, not cash, buildings, or equipment, are the critical differentiators of a business enterprise.

  • As we move into the new millennium and find ourselves in a knowledge economy, it is undeniable that people are the profit lever.

  • Leverage is the use of certain fixed assets to enhance the return on investment or sales

  • The stock market has recognized the leverage of human knowledge by awarding a market value for service and technology companies that exceeds their book value by many times.

  • In April 1999, investment bank Goldman Sachs launched an initial public offering (IPO) that drew a market value of $ 36 billion on its opening, a value four times that of its hard assets.

  • Since employee costs today can exceed 40 percent of corporate expense, measuring the ROI in human capital is essential.

Every things that happens in an organization is the result of a process. a process is a series of steps designed to produce an effect. All processes share a common pattern. They consume resources, and they generate a product or a service.

The reason we want to study business processes is that an organization is only as effective as its processes.

  • We must deal with the myth that only standard financial information is accurate.
  • We have practiced double-entry bookkeeping for 500 years, we have come to believe that the numbers on financial statements are truths.
  • We have constructed a system that changes whenever the Financial Accounting Standard Board (FASB) decides to change it.
  • Accounting has ignored human capital.

  • Human Capital ROI analysis uses the same principles, but some data points are not found on corporate financial documents.

  • This is where the barrier seems to be for many people. They can’t seem to get past a mythology that claims that the economic value of effectiveness of people in business can not be calculated.

  • The problem has been that measurement initiatives often applied manufacturing methods.

  • The input to white-collar work is data. The applicable skill is judgment. The output is information and, if we’re lucky, intelligence.

  • We will show how to measure the ROI in human capital and process management, which leads to competitive advantage and economic value at the enterprise level.

Human Capital in Processes

What we are trying to ascertain is how much more value the employee leveraged from other capital investments such as computerization. A basic question is, if we invested in the automation of a process, how well did the worker leverage that investment?

People make the difference through how effectively they employ other forms of capital. In effect, the result is the value added of human capital.

Is a process either

an asset

or

an expense?

Positioning Business Unit Processes

Process Performance Matrix

processes are the link between human capital management and the enterprise's strategic goals. Human capital, often called people, is an asset. through processes, which are activities, assets are put to work.

our agenda is to look at how the role or deployment of human capital in the process affects outcomes in a measurable way. the outcomes will be defined within productivity, service, or quality terms.

References

Anatomy of a Process

Every function should have an ongoing set of operational metrics. Production, sales, and service units normally do. But when we move to staff groups, we often find a lack of metrics that tell us how efficient or effective the unit is.

There is a basic methodology for process management. It is called the performance matrix.

Effects on Organizational Management

Performance Matrix

Service:

Taking care to satisfy the needs of people is service. Usually we think of customers as the prime target of service. Although that is true, we also have to serve employees, people in the community, government agents, strategic partners, and, of course, stockholders. In effect, all relations with other human beings are measurable in service satisfaction terms.

Quality:

The customer also defines quality. But again, there are concrete measures of both product and service quality. The customer usually judges quality in terms of a combination of factors. the cost of the product and its utility and durability are the criteria that underlie a subjective judgement of quality.

Productivity:

The most concrete of all measures is productivity. The most common metric is unit cost.

  • Since employee costs today can exceed 40 percent of corporate expense, measuring the ROI in human capital is essential.
  • Management needs a system of metrics that describe and predict the cost and productivity curves of its workforce.
  • Beyond that and more important, are qualitative measures. Quantitative measures tend toward cost, capacity and time. Qualitative measures focus on value and human reactions.
  • The Quantitative tells us what happened, whereas the qualitative give us some idea of why it happened.

Shahriar Mahmoodzadeh

Zahra Ghasemi

Master of Public Administration

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