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Excellent sources to learn more:

A report on The War for Talent. McKinsey & Co.

ASTD Benchmarking Services and ASTD Research

First, Break All the Rules: What the World's Greatest Managers Do Differently. M. Buckingham, C. Coffman. (Simon & Schuster, 1999)

The War for Talent. E.Michaels, B. Axelrod, H. Handfield-Jones. (Harvard Business School Press, September 2001)

 

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 Using these out-of-date measurement systems to manage today is roughly analogous to steering a car with the rear view mirror.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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