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The New ROI: Return on Individuals

Is there a way to measure ROI on the investments you make in people? Sure—and doing so provides you with insights on how to spend your limited resources more effectively.

Can you measure how your company's people investments contribute to the bottom line? Do you have data tying specific personnel initiatives to increased corporate performance the way you have numbers showing the return on an IT investment?

You probably have strong correlative evidence that supports your people programs, but do you have proof that they work? Well, take heart, neither do most firms. But as labor-related costs consume larger portions of shrinking corporate expenditure pies, companies are increasingly motivated to find ways to demonstrate the ROI of their human capital. And some are beginning to do just that.

The ultimate objective is to be able to evaluate a firm's entire portfolio of human capital investment alternatives—training and development initiatives, as well as compensation, benefits, and recognition programs—to determine which ones are most likely to help it reach specific strategic targets. Achieving this goal will not only make it much easier to determine where to spend limited personnel investment dollars, but it will also play a key role in helping Wall Street develop an empirical means of valuing a company's intangible assets (see box on the next page).

This won't happen overnight. Companies are making great progress, but there's still more work to be done. Think of measuring the ROI of human capital as a developing science. The earliest work was conceptual: It showed that a knowledge society's primary source of wealth is its human capital—60 percent to 70 percent of most firms' expenditures are now labor related—and helped establish a link between personnel investment and business performance. That was a good start, but it hasn't yet satisfied the quantitative needs of strategists and analysts.

The ultimate objective is to be able to evaluate a firm's entire portfolio of human capital investment alternatives.

A story Leslie Weatherly tells about the clinical reference lab where she served as vice president of HR and administration is emblematic of the progress companies have been making. Running tests on blood and urine samples, the lab was a high-volume, transaction-based business whose clients expected high quality and 24-hour turnaround. While professional staff with specialized degrees took the lead in running the tests, getting the work done in time required a night shift made up of employees without undergraduate degrees.

The lab's overall performance depended on this latter group's ability to work error-free. After strengthening the recruitment, selection, and training processes, "we set up a variable-pay incentive program to ensure we could manage productivity and throughput and solve long-term problems of absenteeism, high turnover, and error rates" among the night-shift workers, says Weatherly, who is now with the Society for Human Resource Management, in Alexandria, Va. For instance, under this plan, workers who experienced unsatisfactory error rates had their pay reduced. Error rates, absenteeism, and turnover decreased dramatically. What's more, throughput started hitting targets.

The programs that Weatherly and her colleagues set up established a strong correlation between select human capital drivers and key performance indicators. This story shows how close companies are coming to showing true causation between specific people investments and bottom-line results.

The first step to demonstrating this causation is to measure for it. Yet in a recent Accenture study, 70 percent of executives said they never or rarely measure the impact of HR or training initiatives on innovation; nearly 60 percent never or rarely measure their effect on employee turnover or employee satisfaction. "You've got people making bets on hunches but not measuring the impact of those hunches on company results," says Robert J. Thomas, senior research fellow at Accenture's Institute for Strategic Change in Cambridge, Mass.

Accurately measuring the effect of human capital investment on business success requires the right tools. GTE's metrics show that every 1 percent improvement in employee engagement (as measured by a seven-question survey) boosts customer satisfaction by 0.5 percent, notes Thomas. Meanwhile, Merck has tools that assign a dollar value to a measurable increase in performance for an average employee undergoing training, thereby enabling it to determine the ROI of specific training programs.

Other companies are turning to so-called dynamic modeling frameworks. Bath and kitchen fixtures manufacturer American Standard employed such a framework to confirm its hunches that the personnel investments it had made since 2000 had helped company performance during the downturn. The framework also revealed that key processes needed to be strengthened to improve the measures that give American Standard a competitive advantage—time-to-competence, employee satisfaction, and innovation. Based on this data, the company has implemented performance management and leadership development processes that have reduced the time it takes to get new products to market, says Larry Costello, senior vice president of human resources.

Dynamic modeling frameworks, says Jeffrey Schmidt, managing director of innovation at consulting firm Towers Perrin, seek to establish links between human capital drivers (compensation, training), human capital capabilities (leadership, employee engagement), intermediate key performance indicators (productivity, customer satisfaction), and, ultimately, financial performance measures such as stock performance or revenue growth.

Alignment with strategy is what creates value for an intangible asset.
— David P. Norton,
The Balanced Scorecard Collaborative

Cementing such linkages requires proof of causation. For example, to demonstrate that employee satisfaction leads to better company performance, you must show not only that the two factors are related, but also that employee satisfaction precedes the improved company performance. As well, you must determine that the improved performance is not a result of other factors such as economic conditions. Of course, you've got to do more than simply measure your hunches. You need sharp focus on where to spend initially. Unfortunately, because human capital drivers' influence on earnings varies significantly by industry, there is no one formula firms can employ to determine the right mix of expenditures. Moreover, the effects of a specific work force investment will change over time. So how do you choose which drivers to concentrate on now? Let corporate strategy be your guide.

"Alignment with strategy is what creates value for an intangible asset," says David P. Norton, president of the Balanced Scorecard Collaborative in Lincoln, Mass. The higher an intangible asset's strategic readiness, the more aligned it is with the company's strategy and the faster it can be converted into a tangible asset, which can then be turned into something liquid (read: earnings). So by improving an intangible asset's strategic readiness, you're increasing its ability to contribute to the company's goals. For example, Disney's emphasis on customer responsiveness led it to provide extra training for the people who swept the amusement parks so that they could also function as listening posts, gathering firsthand intelligence about guests' experience.

When the big corporate picture is clear, it helps you make decisions about where to spend specific dollars. Not all jobs are equally important—focus your resources where they'll give you the greatest return. Gray Syracuse, an upstate New York company that produces high-performance metals, used the Balanced Scorecard to develop a strategy map, one of whose themes was increasing quality by reducing the amount of rework required. In evaluating the job families that supported this theme, the vice president of HR realized that there was a competency gap in the entry-level job of mold assemblyman. Even though mold assemblymen represented only 5 percent of the work force, the company created additional training for these 30 people so they could work interchangeably on eight different part configurations. In just five quarters, Gray Syracuse was able to drive rework down by 76 percent. Since determining the ROI for human capital is still a developing science, your firm may need to do some experimenting of its own. But no matter how you do it, getting closer to understanding which specific personnel investments make the biggest impact on the bottom line is an essential step in getting the biggest bang for your human capital buck.

Reprinted with permission from "Tying Your People Strategy to the Bottom Line," Harvard Management Update, Vol.8, No. 8, August 2003.

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Loren Gary can be reached at lgary@hbsp.harvard.edu.

Valuing Intangibles

It's now commonplace for a company's intangible assets, of which human capital is a major component, to exceed its book assets by a factor of two or three. But accepted accounting methods—and therefore Wall Street—still treat investments in people as current expenses instead of as assets that have a future value.

The problem, according to Towers Perrin's Jeff Schmidt, is that intangibles don't all behave similarly. It's fairly easy to place a value on so-called hard intangibles such as licenses and distribution rights because they are divisible and salable. But soft assets such as employees' level of engagement, shareholders' confidence in management, and customer loyalty are not easily separable. They are not quantifiable resources that can be added together to determine their total worth. In addition, notes Schmidt, "soft assets can erode very quickly: When two companies merge, for example, the goodwill of the component businesses may have disappeared two years after the merger." Not to mention that the people you invest in can leave the organization whenever they wish to.

At many firms, management's behavior mirrors Wall Street's difficulty in valuing human capital. Executives say people are the company's most important asset, but in a down cycle, they treat positions and training budgets as variable expenses—the first things cut. "We believe that people are the most important lever for improving business performance," Schmidt says. But "we don't know how to pull the lever—and if we do pull the lever, we don't know what's going to happen."

Reprinted with permission from "Tying Your People Strategy to the Bottom Line," Harvard Management Update, Vol. 8, No. 8, August 2003.