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Good
managers know that
measurement is a prerequisite for good management: You’ve surely
heard the axiom that, “What gets measured gets managed.” This suggests
then that the fundamental source of wealth creation—human capital—is
seriously under managed in most organizations. That is because most
organizations’ systems of measurement, shaped in part by accounting
and reporting requirements, are still unduly influenced by measurement
concepts dating back to the industrial era when physical capital
was the primary source of wealth creation. Using these out-of-date
measurement systems to manage today is roughly analogous to steering
a car with the rear view mirror.
This article addresses
the measurement challenges facing enterprises in developed economies
(and by extension, societies). It begins with a brief overview of
economic history and its implications for measurement then provides
research-based foundations for defining the key determinants of
human capital advantage and the implications they have for measurement.
The article concludes with some practical tools and tips on how
to get started.
All of Economic
History in a Nutshell
There have been only
three eras in all of economic history: the agrarian era, the industrial
era, and the knowledge era. Each era has been defined by the factor
of production that has served as the foundation for wealth creation.
Not surprisingly, in the agrarian era, land was the primary source
of wealth. In the industrial era, the primary sources of wealth
were machinery and, to a lesser extent, natural resources. In the
knowledge era, human capital is the source of wealth. [A definitional
note: human capital is the embodiment of productive capacity within
people. It is the sum of people’s skills, knowledge, attributes,
motivations, and fortitude. It can be given or rented to others,
but only on a temporary basis; its ownership is non-transferable.]
The accounting and
reporting systems that have developed over centuries reflect this
evolution, albeit with a lag. In most of the developed nations,
the currently accepted accounting principles and their related reporting
requirements rest on the foundational assumption that physical assets
(land, machinery, buildings, natural resources and inventory) generate
wealth. Human capital does not even appear on the balance sheet.
There is, of course,
a reason for this that transcends history. Unlike all other factors
of production, human capital is the only factor that cannot be owned.
Although that is as it should be, the omission of human capital
from the balance sheet can play mischief in the wise allocation
and management of resources.
One need not look
far back in economic history to find a painful example of this mischief.
As the U.S. underwent major restructuring throughout the 1980s and
into the 1990s, corporations that announced massive layoffs typically
enjoyed dramatic increases in their stock prices. Some of the increase
was undoubtedly the result of the perception (right or wrong) that
fat was being cut. Some of the increase, however, was the tautological
result of the fact that when people are cut, costs decrease and,
as a result, earnings increase, at least temporarily. In other words,
layoffs could be used to drive short-term increases in stock market
prices (and, therefore, senior executives’ compensation). However,
research has shown that the majority of firms that used the layoff
strategy ended up several years down the road with stock prices
below the pre-layoff price. This suggests that the short-term euphoria
of cost cutting is eventually followed by the sobering recognition
that when people costs are cut, so too are the assets that generate
future revenue and profitability.
If investors had
better information available to them, they would be less quick to
reward firms that engage in short-sighted (often excessive) cost
cutting strategies that will have productivity consequences in the
out years. [Remember, for example, Chainsaw
Al?] Indeed, investors finally seem to have caught onto
this fact; layoff announcements no longer generate the same level
of stock price spikes. Alas, both individuals (workers and investors)
and the market endured much pain and suffering before they learned
the necessary lessons.
This information
problem is also apparent at a more micro level. Who among us has
not experienced the tyranny of the bean counters? These people know
the cost of everything and the value of nothing. [By way of full
disclosure I should reveal this is often used as the definition
of economists—of which I am one]. Expenditures associated with the
development of people—education and training being perhaps the most
prominent—are treated as costs even though, in actuality, these
expenditures possess the attributes of an investment (an expenditure
at one point in time that is made with the intention of generating
an increase in capacity at some future point in time).
In fairness to the
bean counters, however, it should be noted that their sometimes-maddening
focus on costs and cost cutting is not baseless. Often the known
costs associated with people and their development, for example,
are but the tip of the iceberg. Precisely because measurement and
accounting practices associated with human capital are remnants
of the industrial era, the measured costs are only a portion of
the total costs. Moreover, because benefits are both uncertain and
unknown, a conservative strategy has its merits. And finally, because
human capital cannot be owned, spending on the development of people
does not meet the traditional accounting concept of an investment,
since employers cannot control the asset, i.e., the people in whom
an investment is being made.
In short, there are
legitimate arguments in favor of the status quo with regard to measurement,
accounting and reporting of human capital development and management.
There are, however, also powerful arguments to be made that change
is necessary.
Alas, there is no
magic formula for solving this dilemma. But the time for serious,
disciplined experimentation is clearly upon us.
The Foundation of
Human Capital Advantage
Economists’ (remember:
the ones who know the cost of everything and the value of nothing)
concept of human capital advantage is embedded in what is known
as “efficiency wage theory.” This theory posits that the way to
get people to avoid shirking on the job and produce the maximum
possible value on their employer’s behalf is to pay them an efficiency
wage. Simply put, an efficiency wage is an above-market wage. And,
certainly if you pay people more than they can earn elsewhere, they
are more likely to exhibit the behaviors necessary to avoid being
fired, but it surely is an expensive way to elicit such behavior.
Moreover, merely exhibiting the behavior necessary to avoid being
fired probably falls far short of what most employers want and need
from their employees. This type of thinking represents little more
than a knowledge era tweak to an industrial era model.
Money is, of course,
one of the things—but by no means the only thing—that people want
through their work. Sociologist’s concept of “mutual gift giving”
probably comes closer to getting at the essence of human capital
advantage. Because human capital cannot be owned (or even transferred),
extracting the maximum advantage from it requires that an organization
first understand what people want and then give it to them.
The trick to creating
human capital advantage is to figure out inexpensive but difficult-to-replicate
ways to give people what they want. Those organizations that develop
a human capital advantage have learned to give people what they
want in a more cost-effective manner than the competition.
Human capital represents
a huge operating cost that must be managed efficiently because of
its sheer magnitude; in the United States, for example, nearly 70%
of all operating costs are ultimately attributable to people. At
the same time—because human capital is also the only asset that
cannot be owned—it must be managed wisely, but also with humanity.
Consequently, a strategy that focuses exclusively on efficiency
and cost containment can, at best, only be successful in the short-run.
This creates a fundamental paradox.
Exceptional management
in the knowledge era is defined by the ability to resolve this paradox
through a “both/and,” rather than an “either/or” strategy. The both/and
strategy requires a relentless focus on finding ways to cut costs
and improve productivity, while simultaneously evoking the passion,
creativity, loyalty and best efforts of the people on whom an organization
relies.
That focus is the
essence of human capital development and management (HCDM). And
embedded in it is a framework for beginning to measure human capital
advantage.
Implications for
Measuring Human Capital Advantage
Given the high cost
of human capital, one major category of metrics must capture a variety
of measures of efficiency, such as sales per employee and unit labor
costs. These “easy” measures are the ones that most organizations
already have in place. They might unkindly be characterized as holdovers
from the industrial era. That interpretation would, however, be
unduly harsh. The more even-handed perspective is that these measures
are, at most, only half the story.
The other half of
the story, and the one much less well developed in most organizations,
might be thought of as “short-run indicators of long-run success”
(where long-run success is measured by the types of efficiency measures
outlined above). This second category of metrics is the one that
organizations must now master if they are to effectively manage
human capital. These metrics predict the future performance of the
company—the metrics that enable organizations to be driven with
the steering wheel rather than the rear view mirror—the metrics
that provide sound, analytically responsible guidance for improving,
rather than merely justifying, human capital investments.
The tough question,
of course, is “Just what the heck are these metrics?” Alternatively
stated, “How do you figure out how to measure (make tangible) what
matters, when what matters is so highly intangible?”
Fortunately, an emerging
body of research evidence provides guidance in answering these questions.
Moreover, it makes good sense. The findings essentially laying out
the “human capital value chain” are these:
1.
In addition to being fairly compensated, people place
high value on:
- Being in an environment
where they can grow and learn and advance
- The managerial
skills/abilities of their immediate supervisor
- Being treated
fairly, appreciated and acknowledged
- Doing work that
makes a contribution
2.
These determinants of employee satisfaction drive employee retention
3.
The retention rate among key employees drives customer
satisfaction
4. Customer
satisfaction drives customer retention
5.
Customer retention drives profitability and other
measures of financial performance including total stockholder return.
Embedded in this
value chain are the metrics that provide the foundation for measuring
and managing an organization’s human capital advantage. For the
most part, these metrics are inherently soft. Moreover, they focus
almost exclusively on employees’ assessments of how well an organization
is doing in meeting the employees’ requirements. This focus is likely
to be met with resistance inside some organizations that rely on
a more hard-nosed management approach. But like it or not, in a
world where human capital advantage hinges on the principal of mutual
gift giving, measurement of it is necessary for good management.
So in addition to the traditional efficiency metrics, the existing
research base suggests that key metrics to track include:
A. Employee’s
satisfaction with the quality of their learning/development opportunities
B.
Employee’s satisfaction with the management skills/abilities of
their immediate supervisor
C.
Employee’s satisfaction with the extent to which they are treated
fairly, feel appreciated and acknowledged for their work
D.
Employee’s sense that the work they do makes a difference
E. Retention
rate of key employees
These factors can
and should be linked to the harder measures of performance such
as customer satisfaction, customer retention, sales per employee,
and unit labor costs. In essence, metrics A-E above provide a research-based
foundation for the human capital measures that matter—those that
have consistently been demonstrated to be determinants of organizational
performance. They provide a strong analytic foundation for the human
capital inputs into a balanced scorecard type of measurement system.
These types of measurements
provide an overview of how well people (human capital) is being
managed. Another level of measurement below this one is also necessary
to provide guidance on how to generate improvement in the measures
outlined above. This next level of measurement captures the effectiveness
of the ”interventions” that an organization uses to improve its
human capital advantage. A disproportionate emphasis should be given
to measuring the effectiveness of an organization’s learning interventions
because these affect, either directly or indirectly through the
quality of management, most of the items listed above in A-E.
Three categories
of learning intervention measures should be captured:
1.
Inputs—measures of the intensity of learning resources
available to employees, including formal and informal learning opportunities.
2.
Outcomes—intermediate measures of the effectiveness
of learning (such as Kirkpatrick levels 2 or 3 for formal learning
interventions or other comparable forms of employee assessment of
effectiveness for informal learning opportunities).
3.
Organizational Learning Capacity—an overall assessment
of an organization’s commitment to and capacity for learning
By studying the inter-relationship
among these three categories of learning intervention measures,
and between them and items A-E (the human capital advantage measures),
an organization would develop a good understanding of how to better
manage its learning interventions to drive performance through improvements
in human capital advantage.
This is, of course,
a tall order. Few organizations have the learning and data management
infrastructures in place to do this type of analysis in a highly
rigorous manner. But that should not be used as an excuse for doing
nothing. As an insightful colleague is fond of saying, “The perfect
should not be the enemy of the good.” Those organizations that do
launch sophisticated learning management infrastructures can begin
to use the data capture capabilities they contain. These organizations
then can analyze the determinants of human capital advantage and
their link to performance in a much more rigorous manner than has
been possible before now.
Practical Tips and
Tools
The measurement agenda
outlined above represents a huge stretch for most organizations.
But if human capital is to be managed as the strategic asset that
it so clearly has become, then this is a challenge that forward-looking
organizations must tackle in earnest. Fortunately, there are excellent,
free or inexpensive research-based resources available to help:
ASTD
has developed a free benchmarking
service for measuring:
- Investments in
education and training
- Learning outcomes,
along with diagnostic measures of barriers and enablers of learning
transfer
- Core measures
of human/intellectual capital
- Employee satisfaction
The
Gallup organization
has done extraordinary research on the fundamental determinants
of employee retention, and the distilled and practical implications
of this research are available in First
Break All The Rules.
Saba
has distilled and quantified the learning organization literature
into its “Learning Capacity Index” which will soon be available
online and free of charge. In the interim, you can obtain a copy
by sending me a request.
Taken together, these
resources can go a long way toward providing organizations with
practical “how-to” tools for measuring and managing human capital
advantage.
Laurie
Bassi, President of Human Capital Dynamics and Saba Fellow, is by
training an economist but as her comments suggest, it might be unwise
to introduce her that way to civilized people. Send email with your
reactions or questions to lbassi@hcdynamics.com.
LB060602GR
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