Harvard Business School Working Knowledg e Archive

The HR Scorecard: Linking People, Strategy, and Performance

4/2/2001
Competitive advantage in the new economy relies on intangible assets like brand recognition, knowledge, innovation and, in particular, human capital. As a result, business leaders must rise to this occasion by incorporating the HR function into the firm's overall corporate strategy. In this excerpt from their new book, Brian E. Becker, Mark A. Huselid, and Dave Ulrich explain how "managers throughout the firm can understand exactly how people create value and how to measure the value-creation process."

The HR Scorecard

The Evolving Picture of HR: From Professional to Strategic Partner
Recent decades have witnessed dramatic shifts in the role of HR. Traditionally, managers saw the human resources function as primarily administrative and professional. HR staff focused on administering benefits and other payroll and operational functions and didn't think of themselves as playing a part in the firm's overall strategy.

Efforts to measure HR's influence on the firm's performance reflected this mindset. Specifically, theorists examined methodologies and practices that are focused at the level of the individual employee, the individual job, and the individual practice (such as employee selection, incentive compensation, and so forth). The idea was that improvements in individual employee performance would automatically enhance the organization's performance.

Although such research attempted to extend the range of HR's influence, it did little to advance HR as a new source of competitive advantage. It provided scant insight into the complexities of a strategic HR architecture. And simply put, it didn't encourage HR managers to think differently about their role.

In the 1990s, a new emphasis on strategy and the importance of HR systems emerged. Researchers and practitioners alike began to recognize the impact of aligning those systems with the company's larger strategy implementation effort and assessing the quality of that fit. Indeed, although many kinds of HR models are in use today, we can think of them as representing the following evolution of human resources as a strategic asset:

The personnel perspective: The firm hires and pays people but doesn't focus on hiring the very best or developing exceptional employees.

The compensation perspective: The firm uses bonuses, incentive pay, and meaningful distinctions in pay to reward high and low performers. This is a first step toward relying on people as a source of competitive advantage, but it doesn't fully exploit the benefits of HR as a strategic asset.

The alignment perspective: Senior managers see employees as strategic assets, but they don't invest in overhauling HR's capabilities. Therefore, the HR system can't leverage management's perspective.

The high-performance perspective: HR and other executives view HR as a system embedded within the larger system of the firm's strategy implementation. The firm manages and measures the relationship between these two systems and firm performance.

We're living in a time when a new economic paradigm characterized by speed, innovation, short cycle times, quality, and customer satisfaction is highlighting the importance of intangible assets, such as brand recognition, knowledge, innovation, and particularly human capital. This new paradigm can mark the beginning of a golden age for HR. Yet even when human resource professionals and senior line managers grasp this potential, many of them don't know how to take the first steps toward realizing it.

Quotation
the most potent action HR managers can take to ensure their strategic contribution is to develop a measurement system that convincingly showcases HR's impact on business performance.
Quotation

In our view, the most potent action HR managers can take to ensure their strategic contribution is to develop a measurement system that convincingly showcases HR's impact on business performance. To design such a measurement system, HR managers must adopt a dramatically different perspective, one that focuses on how human resources can play a central role in implementing the firm's strategy. With a properly developed strategic HR architecture, managers throughout the firm can understand exactly how people can create value and how to measure the value-creation process.

Learning to serve as strategic partners isn't just a way for HR practitioners to justify their existence or defend their turf. It has implications for the very survival of the firm as a whole. If the HR function can't show that it adds value, it risks being outsourced. In itself, this isn't necessarily a bad thing; outsourcing inefficient functions can actually enhance a firm's overall bottom line. However, it can waste much-needed potential. With the right mindset and measurement tools, the HR architecture can mean the difference between a company that's just keeping pace with the competition and one that is surging ahead.

A recent experience of ours graphically illustrates this principle. In a company we visited, we asked the president what most worried him. He quickly responded that the financial market was valuing his firm's earnings at half that of his competitors'. In simple terms, his firm's $100 of cash flow had a market value of $2,000, while his largest competitor's $100 of cash flow had a market value of $4,000. He worried that unless he could change the market's perception of the long-term value of his organization's earnings, his firm would remain undervalued and possibly become a takeover target. He also had a large portion of his personal net worth in the firm, and he worried that it was not valued as highly as it could be.

When we asked him how he was involving his HR executive in grappling with this problem, he dismissed the question with a wave of his hand and said, "My head of HR is very talented. But this is business, not HR." He acknowledged that his HR department had launched innovative recruiting techniques, performance-based pay systems, and extensive employee communications. Nevertheless, he didn't see those functions' relevance to his problem of how to change investors' perceptions of his firm's market value.

Six months after our meeting, a competitor acquired the firm.

The sad truth is that the HR executive in this story missed a valuable opportunity. If he had understood and known how to measure the connection between investments in HR architecture and shareholder value, things might have turned out differently. Armed with an awareness of how investors value intangibles, he might have helped his president build the economic case for increased shareholder value.

The story of Sears, Roebuck and Co.'s recent transformation stands in stark contrast to this anecdote and shows what companies can achieve when they do align HR with the larger organization's strategy. 1 After struggling with lack of focus and losses in the billions in the early 1990s, Sears completely overhauled its strategy implementation process. Led by Arthur Martinez, a senior management team incorporated the full range of performance drivers into the process, from the employee through financial performance. Then, they articulated a new, inspiring vision: For Sears to be a compelling place for investors, they said, the company must first become a compelling place to shop. For it to be a compelling place to shop, it must become a compelling place to work.

But Sears didn't just leave this strategic vision in the executive suite or type it up on little cards for employees to put in their wallets. It actually validated the vision with hard data. Sears then designed a way to manage this strategy with a measurement system that reflected this vision in all its richness. Specifically, the team developed objective measures for each of the three "compellings." For example, "support for ideas and innovation" helped establish Sears as a "compelling place to work." Similarly, by focusing on being a "fun place to shop," Sears became a more "compelling place to shop." 2 The team extended this approach further by developing an associated series of required employee competencies and identifying behavioral objectives for each of the "3-Cs" at several levels through the organization. These competencies then became the foundation on which the firm built its job design, recruiting, selection, performance management, compensation, and promotion activities. Sears even created Sears University in order to train employees to achieve the newly defined competencies. The result was a significant financial turnaround that reflected not only a "strategic" influence for HR but one that could be measured directly.

Few firms have taken such a comprehensive approach to the measurement of strategy implementation as Sears has. Granted, retail service industries are characterized by a clear "line of sight" between employees and customers. Thus their value-creation story is easier to articulate. But that doesn't mean that other industries can't accomplish this feat. The challenges may be greater but so are the rewards.

Why HR? Why Now?
Consider the following:

In most industries, it is now possible to buy on the international marketplace machinery and equipment that is comparable to that in place at the leading global firms. Access to machinery and equipment is not the differentiating factor. Ability to use it effectively is. A company that lost all of its equipment but kept the skills and know-how of its workforce could be back in business relatively quickly. A company that lost its workforce, while keeping its equipment, would never recover. 3

This excerpt captures the difference between physical and intellectual capital and reveals the unique advantages of the latter. The Coca-Cola Company's experience testifies to this reality. According to then-CFO James Chestnut, after transferring the bulk of its tangible assets to its bottlers, Coke's $150 billion market value derived largely from its brand and management systems. 4

The evidence is unmistakable: HR's emerging strategic potential hinges on the increasingly central role of intangible assets and intellectual capital in today's economy. Sustained, superior business performance requires a firm to continually hone its competitive edge. Traditionally, this effort took the form of industry-level barriers to entry, patent protections, and governmental regulations. But technological change, rapid innovation, and deregulation have largely eliminated those barriers. Because enduring, superior performance now requires flexibility, innovation, and speed to market, competitive advantage today stems primarily from the internal resources and capabilities of individual organizations including a firm's ability to develop and retain a capable and committed workforce. As the key enabler of human capital, HR is in a prime position to leverage many other intangibles as well, such as goodwill, research and development, and advertising.

Excerpted from The HR Scorecard: Linking People, Strategy, and Performance HBS Press, 2001.

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Footnotes

1) Steven P. Kirn, Anthony J. Rucci, Mark A. Huselid, and Brian E. Becker, "Strategic Human Resource Management at Sears," Human Resource Management 38, no. 4: 329-336; and Anthony J. Rucci, Steven P. Kirn, and Richard T. Quinn, "The Employee-Customer-Profit Chain at Sears," Harvard Business Review 76, No. 1 (January-February 1998): pp. 82-97.

2) Rucci, Kirn, and Quinn, "The Employee-Customer-Profit Chain at Sears," 89.

3) Robert McLean, Performance Measures in the New Economy (The Premier's Council of Ontario, Ontario, Canada, 1995), 3.

4) Thomas Stewart, "Real Assets, Unreal Reporting," Fortune, 6 July 1998, 207.