Measuring human capital crucial, ROI isn’t, says new think-tank paper

Simple metrics demonstrate value of human capital better than complex ROI math

They are questions that still perplex many organizations: If human capital is the most valuable asset, how much is that asset worth, and what is the value of investing in that asset?

The answers may seem elusive, but organizations can and should find them, because pretty soon, investors are going to demand it, say experts on human capital management.

The problem is that many HR professionals have been looking in the wrong places and doing the wrong math when trying to calculate the value of human capital, according to a new position paper from the Washington D.C.-based Human Capital Institute, a not-for-profit organization committed to promoting best practices in talent management.

Simple big-picture human capital metrics, like employee engagement, absenteeism, turnover and retention, are essential and an example of human capital metrics HR departments need to be tracking.

But calculating the return on investment on isolated initiatives, a popular topic of discussion in HR circles in recent years, is for the most part a waste of time, says David Creelman, the Toronto-based consultant who authored the paper, Return on Investment in Talent Management: Measures You Can Put to Work Right Now.

Talking about ROI is still important, but the actual methodologies developed to put definite numbers on the value of talent as an asset are too complicated to be relevant for most observers. And they are not always accurate anyway.

The truth is ROI doesn’t work well in most areas of business, Creelman wrote.

“A near universal practice in using ROI is to do the calculation then go back and change the estimated cash flows until a suitable answer is derived. Managers do this not because they are incompetent or dishonest, but because they don’t believe the textbook approach is giving them the right answer,” he wrote in the paper. “This reality check can keep us from chasing Holy Grails.”

While the methodologies for human capital ROI may have little practical use in most workplaces, HR professionals still need to do some “rigorous thinking” to prove the value of investing in talent.

“There is a pro-measurement school that argues, ‘If you can’t measure it, you can’t manage it.’ That is nonsense — unless it is merely a rebuke to those who refuse to look at any numbers at all,” he wrote.

Management decisions are made all the time based on limited, ambiguous, and qualitative information. Qualitative assessments can support good decisions on investments in talent, especially when backed up with some simple quantitative measures. Creelman calls these “semi-quantitative” methods.

Many important business decisions are made using semi-quantitative methods, he says. The objective is not to capture all of the costs and benefits, but to “get a handle” on some key impacts in a quantitative way to support qualitative evidence.

A training initiative doesn’t have to have a clear ROI, but participants in the initiative can be tested for knowledge retention. That is the quantitative data that can lead to informed decisions about whether the training makes sense.

Eventually human capital measures of some form — employee engagement, for example — will be as important to investors as financial numbers, says Creelman.

It is widely recognized that intangibles drive value, and when it comes to intangibles, human capital is one of the most important, he says.

“Markets can’t operate without good information and right now they are not getting good information on intangibles.”

Consequently, investors have it wrong when it comes to evaluating companies based on costs associated with human capital. Studies have shown that companies that invest the most in training are penalized by the market because those investments only show up as a cost, even though those companies out-perform competitors in the long term, he says.

“Right now investors are not very good at using human capital measures to make decisions,” he says. But as organizations get better at demonstrating the connection between human capital and bottom line performance, investors will take more notice.

“It is just a matter of time before investors will be knocking on the door saying they want to see numbers,” he says.

Interest in human capital measures is definitely on the rise, says Curt Coffman of the Gallup Organization and author of the seminal 1999 book, First Break all the Rules.

Traditional financial numbers are an indicator of past performance, but reliable measures of human capital are much better indicators of future performance, and therefore growth, and therefore shareholder value, he says. For four years now, Denmark has required publicly traded companies to provide numbers on the “human dimension” of the business to give investors a better sense of the value of human capital. The European Union is looking at some type of human capital reporting measures and it’s inevitable similar requirements will come to North American markets, he says.

The reason for the increased interest in human capital is straightforward, he says. Many organizations have re-engineered everything, processes and products have been reviewed and improved, and yet still they aren’t seeing any organic growth — growth without acquisition.

“It is because everyone else has achieved the same thing,” he says. “If the product isn’t a differentiating factor, what is? It is the human dimension.”

Gallop has developed a model it says clearly shows improvements to human capital, as measured by employee engagement, improve shareholder value. According to Gallup, engagement can be assessed through a simple 12 question framework (see “Gallup’s engagement index” below).

The most recent numbers for Canada show just 24 per cent of employees are engaged, 60 per cent are not engaged and 16 per cent are actively disengaged, said Coffman.

In any organization the ratio between engaged and actively disengaged is a key indicator of company performance.

CFOs showing more interest in HR

A 2003 report from CFO Research Services and Mercer Human Resource Consulting looked at how and why financial executives are more interested in human capital.

Though most of 180 CFOs surveyed now see human capital as a value driver instead of a cost, just 16 per cent said they knew to a “considerable” or “great” extent the return on investments in human capital.

The survey revealed CFO opinions of HR are improving, but they want to play a greater role in decisions about human capital investments, which may include designing HR metrics, adding a financial perspective to HR decisions and helping link HR policy to corporate strategy.

Some CFOs are interested in ROI calculations; others still don’t put much faith in ROI methodologies, and yet others suggest there is “an intuitive understanding” that investments in human capital create value.

Nearly one-half of respondents said investors are beginning to ask about human capital issues to a “moderate extent.”

Gallup’s engagement index

•Do you know what is expected of you at work?

•Do you have the materials and equipment you need to do your work right?

•Do you have the opportunity to do what you do best every day?

•In the last seven days, have you received recognition or praise for doing good work?

•Does your supervisor, or someone at work, seem to care about you as a person?

•Is there someone at work who encourages your development?

•At work, do your opinions seem to count?

•Does the mission/purpose of your company make you feel your job is important?

•Are your associates (fellow employees) committed to doing quality work?

•Do you have a best friend at work?

•In the last six months, has someone at work talked to you about your progress?

•In the last year, have you had opportunities at work to learn and grow?

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