HR’s new ROI: ‘Return on intangibles’

Rating a firm's hidden values

The search for conclusive, indisputable proof that HR departments, practices and professionals have a positive return on investment is never ending.

There is little doubt that investments in HR practices will increase employee commitment and increased employee commitment is a lead indicator of customer commitment, which in turn is a lead indicator of profitability. Firms that invest in some HR practices are more likely to have financial returns than firms that do not. And HR practices shape an organization’s culture, identity, reputation and brand.

But there’s another ROI HR can hang its hat on — not return on investment but “return on intangibles.” Intangibles represent the hidden value of a firm — the shareholder value not determined by financial results. Intangibles are not new to a firm’s overall market value, but they are becoming an increasingly important portion of a firm’s total market capitalization. Below are six actions HR professionals can take to create intangible value.

1. Become investor literate. To deliver value to investors, first learn who the investors are and why they are investing in the organization. Consider the questions below an investor literacy test for HR:

•Who are the company’s five major shareholders and how much does each of them own?

•Why do they own the company? What are their investing criteria (such as dividend stock and growth stock)?

•What is the company’s tangible value? And its intangible value?

•What is the company’s price-to-earning ratio for the last decade? How does it compare to the industry average and to the firm with the highest price-to-ratio in the industry?

•Who are the top analysts who follow the industry? How do they view the company versus competitors?

•How well does the board govern itself?

Few senior HR executives can answer these questions. Yet, these questions form the base of knowledge that enable HR professionals to link their work to investors.

2. Understand the importance of intangibles. Traditionally, 75 per cent to 90 per cent of the market value of a firm can be predicted by financial performance. However, since 1990, this percentage has dropped to about 50 per cent. This means a large portion of the market value is not tied directly to present earnings. It is tied to what the financial community calls “intangibles,” which represent the value of an organization not directly derived from physical assets. Intangibles derive from choices leaders make about what happens inside their firm and from how investors value those decisions.

3. Create a framework for organization and people practices that increase intangible value. The intangibles of organizations and people can be made tangible by identifying how leaders bring people and resources together to accomplish work.

One way to do this is to develop a pattern in the techniques leaders use to increase their organization’s intangibles, beginning with the basic essentials at level one and proceeding upward to more complex concepts:

•Level 1: Keep promises — Build and defend a reputation among external and internal stakeholders for following through.

•Level 2: Compelling strategy — Define growth strategy and manage trade-offs in customer intimacy, product innovation and geographic expansion to achieve growth.

•Level 3: Aligned technical competencies — Provide concrete support for intangibles by building core competencies in research and development, technology, sales and marketing, logistics and manufacturing.

•Level 4: Build value through organization and people — Develop capabilities of shared mindset, talent, collaboration, speed, accountability, learning and leadership throughout the organization.

This architecture is progressive. Keeping promises is what builds trust and delivers credibility, so it has to come first. A compelling strategy builds confidence in the future. This vision of the future must turn into action or the hope will prove false. Leaders must invest in aligning core competencies to fold their future into their present. Yet core competencies are not enough, either. Ultimately, an organization must be sustained by enduring capabilities embedded in its people and organization.

An organization’s capabilities are the deliverables from HR work. These capabilities give investors confidence in future earnings and increase market capitalization. HR professionals who link their work to capabilities and find ways to communicate those capabilities to investors deliver shareholder value. A typical list of capabilities includes: talent, speed of change, shared mindset, accountability, collaboration, learning and leadership.

4. Highlight the importance of intangible value to total shareholder return. At times, HR professionals have trouble talking about HR issues in financial terms that directly connect to the thinking patterns of business leaders. Go through the last 10 or 15 years and plot the company’s earnings and stock price (or total market capitalization) by quarter. This chart will show whether market value is above or below the earnings line and whether the company has a net positive or negative intangible reputation. Then, plot for 10 or 15 years the company’s price-to-earnings ratio against that of the most successful competitor. This trend line offers an overall report card on how investors perceive the company’s leadership versus that of its leading competitor. If the company’s price-to-earning ratio is consistently 20 per cent below that of its largest competitor, that means investors are not as confident in the firm’s management team as they are in the competitor’s.

5. Conduct an “intangibles audit” that assesses where leaders should focus value creation. HR professionals can be the architects of intangible audits that define, assess, invest and improve on each of the four levels of intangibles. Just as financial audits allow leaders to monitor cash flow and leadership 360-degree feedback assesses leadership behaviours, intangible audits allow leaders to turn intangibles into tangibles. An intangibles audit assesses what leaders must do to deliver investor value given the organization’s history and strategy, measures how well each level of intangibles is being delivered and leads to an action plan for improving them.

6. Align HR practices and investors. Traditionally, HR practices focus on what is done inside the organization. However, by focusing on the investors, these traditional practices take on a different focus.

•Staffing. What if investors could vote on individuals hired or promoted in the firm? What leadership and management qualities would they look for? What types of individuals would give them confidence the management team has the capacity to make correct decisions? Or what if investors reviewed competence models used as candidate screens in the hiring process? Would the institutional investor focus on the same attributes as the traditional hiring manager?

•Training and development. If a representative of the largest single investor in the company sat through the last five-day leadership program offered, what would his investment response be — buy, hold or sell — at the end of the week? Do they see participants focusing on real business issues within the firm rather than case studies of other firms, facing their competitive realities in candid conversation with thoughtful responses laid out, leaving with clear and specific actions that would be taken as a result of the training experience?

•Appraisal and rewards. Many firms already tie management behaviours to investor-focused rewards. Putting a larger percentage of total compensation into stock-based incentives — such as grants and options — links management actions to investors. Many claim that CEO pay relative to average employee pay is excessive. Such arguments are less tenable when the CEO pay is linked to stock. The boundary between managers and investors is removed when managers become investors. In addition, the wider and deeper the investment mindset throughout a firm, the more managers act and think like investors.

Dave Ulrich and Norm Smallwood are co-authors of Why The Bottom Line Isn’t: How to Build Value through People and Organizations. This article originally appeared as a chapter in The Future of Human Resource Management: 64 Thought Leaders Explore the Critical HR Issues of Today and Tomorrow. Ulrich can be reached at [email protected].

To read the full story, login below.

Not a subscriber?

Start your subscription today!