Human capital management can add value to an organisation

Good human capital management can add real value to an organisation, explains Nicola Sullivan

This recession has brought an almost unprecedented interest in the link between an organisation’s financial performance and the way its employees are rewarded and managed. As failed financial institutions have found enough money in the pot for generous bonuses and benefits, public outcry has grown. The contentious subject of reward in comparison with company performance received widespread attention earlier this year when it emerged that Sir Fred Goodwin, former chief executive of the Royal Bank of Scotland (RBS) Group, was to receive an annual pension of almost £750,000 and had been paid an advance of almost £3 million, despite RBS posting a pre-tax loss of £40.7 billion for the year ended 31 December 2008.

Meanwhile, in its review of the global banking crisis, published in March, the Financial Services Authority (FSA) said pay policies and remuneration such as bonuses would be scrutinised more closely in future to ensure they reflected performance and discouraged high-risk behaviour. Organisations that do not comply could be forced to put more capital aside to cover their risk-taking.

The review, conducted by FSA chairman Lord Turner, also noted that high levels of remuneration in banks, particularly big bonuses paid to executives and traders involved in activities that generated significant losses, had been the subject of intense public interest during the financial crisis.

So, with the spotlight firmly on the link between employee reward and financial performance, the time is ripe for employers to consider their approach to human capital management (HCM). This concept views employees as an asset, albeit an intangible one, that adds monetary value to a company. In turn, this drives greater returns for investors, who reap the rewards from a higher share price.

Jim Crawley, a principal at Towers Perrin, explains: “”It began to be realised that the value of many organisations is significantly greater than the combined value of their assets. For example, a firm like Microsoft is remarkably small. A year or two ago, it had 50,000 people, which in the great scheme of things is hardly anything compared to the market valuation of Microsoft. Market analysts became concerned that the market was valuing something it could not account for.

“It was the value of intangible assets that was driving the stock price of organisations like Microsoft. Clearly, the market was valuing intangible assets in a way that was somehow different from the assets you can put a financial value on. This led to a variety of attempts to put a financial figure on the knowledge and skills of organisations’ employees. That is one definition of what human capital is.” HCM began to take shape in the UK back in 2003 when a task force was set up by the Department of Trade and Industry, now the Department of Business, Enterprise and Regulatory Reform. The task force, chaired by Denise Kingsmill, then deputy chairman of the Competition Commission, looked at the performance measures used to assess investment in human capital; best practice in human capital reporting; and the performance measures most valuable to stakeholders, such as external investors.

The task force’s report, Accounting for People, was presented to the Secretary of State for Trade and Industry in October 2003. Among its recommendations was that all reports of HCM should have a strategic focus and be communicated clearly and fairly to illustrate a board’s understanding of the links between its HCM policies and practices to its business strategy and performance. It also said such reports should include information on the size and composition of a workforce, as well as on employee retention and motivation. The task force called for reports to provide details on the skills and competencies necessary for success, the training offered to achieve these, remuneration and employment practices, and leadership and succession planning.

However, six years on from the task force’s recommendations, HCM reporting has yet to become common practice.

The government retreated from plans, due to have been enforced in 2005, that would have placed a statutory requirement on employers to conduct an Operating and Financial Review. This would have required firms to include, in their annual report, people issues that impacted on their financial performance. Instead, the government introduced an Alternative Business Review requirement, which leaves it to directors’ discretion what they report around performance and people management.

Health and wellbeing initiatives, for example, can have a great impact on the performance of employees and, subsequently, the organisation. Boardroom reporting is, therefore, one of the issues taken up by Business in the Community (BITC) in its Business Action on Health campaign. This aims to get 75% of FTSE 100 companies, as well as 20% of BITC’s 850 members, committed to reporting on health and wellbeing of staff at boardroom level by 2011.

BITC has set up a steering group to develop consistent health and wellbeing reporting criteria for employers to follow. It will also design a tool to help firms report on health and wellbeing, and plans to launch a pilot scheme by the end of this year. This will enable interested employers and steering group members to find out how the tool works in practice. Their feedback will be incorporated into the final version of the tool.

Productivity link

Louise Aston, health director for BITC’s campaign Business Action on Health, says: “”It is likely that the sorts of measures we are looking at are connected somehow with the correlation between health and wellbeing, engagement, and how that links with productivity. A lot of the criteria for health and wellbeing are around the promotion of good work. This is not a campaign around lettuce and gym membership – it is a lot more profound than that.

“A lot of it is around how we define boardroom reporting. It might be that it is not necessarily in organisations’ accounts. It might be in their CSR [corporate social responsibility] strategy report or it might be just on their website.”

Alliance Boots, for example, includes details on absence reporting and retention in its CSR report. Alex Gourlay, chief executive of its health and beauty division, also serves as chairman of Business Action on Health and is actively involved in the campaign’s push to achieve greater levels of boardroom reporting on health and wellbeing.

Aston says one member of BITC’s steering group, Henderson Global Investors, is keen to see quarterly reporting online to demonstrate the changes and progressions within a company more frequently, rather than waiting for its annual report.

Hugh Shanks, principal at Towers Perrin, says human capital reporting can also give investors an idea of a company’s future performance, rather than basing this on financial figures, which are largely historical. “The share price is partly influenced by the financial fundamentals of the business, such as the return on capital employed and the profit generated, but also an analyst’s view of the firm’s future earnings,” he says.

So HCM can have a significant impact on relations with investors. To help those looking to invest in firms with good human capital practices, Axa Investment Managers offers an investment equity fund, the Axa World Fund Human Capital Fund, based on the principle that financial performance starts with staff productivity and good HCM.

But some observers remain sceptical about HCM’s ability to influence analysts and investors. Dr Zella King, senior lecturer at Henley Business School, says: “I think analysts and investors in general recognise HCM is important, but they do not necessarily put that much credit in data that could be produced in the public domain because, for one thing, they think there is a certain suspicion that they will only be getting a positive picture. Will there be lots of spin around the nature it has produced? Is it actually a fair recollection? The only way to get around that is to have a standardised approach.”

Absence levels

“What does a figure of 10% absence levels mean in pharmaceuticals or retail? Does it mean the same? Do you need to know it relative to last year? A figure on its own is not that useful unless you can see it in context and that requires it to be industry-specific.”

An aspect far more likely to grab the attention of investors and analysts is the skills and strengths of executive management teams, and how these are managed from a human capital perspective, says King.

“Analysts are very interested in the human capital embodied in the senior management team, which is understandable given the recent crisis and the failings that have come to light in senior management,” she says. “So it is not surprising they recognise the importance of having a strong management team. They are much more interested in human capital metrics that reflect the quality of the senior management team than they are about people below that.”

But measuring the direct link between an organisation’s human capital and its financial performance can sometimes be tricky. Employers can often establish the state of their human capital by measuring levels of sickness absence and checking how long it takes to fill job vacancies, as well as looking at employee engagement levels. Employers can determine the extent to which their HR function and reward package are engaging and motivating employees.

Towers Perrin’s Crawley says: “If organisations are serious about managing the human capital investments they are making in their employees clearly, they need to establish some measures and see the extent to which they can improve those measures through the investments they are making in things like pay and benefits, through training, and through anything that is a cost or investment to the organisation.”

This is where the effective use of management information (MI) comes in. MI plays a major role in helping employers determine the financial contribution of individual employees to the business. For example, using HR systems, such as those provided by SAP and Oracle, employers can link employee data, such as salary details, their role within the company, any bonus they receive, the projects they are working on, and training they have received, with information on performance and productivity, for example sales figures. Matching and analysing this data enables organisations to drill down to identify an employee’s individual contribution to the business.

Oracle’s E-Business Suite HRMS system allows employers to manage HR in an integrated way, also complying with HCM. The software can also be used to define performance objectives, which can then be tracked for the rest of the year, as well as help employers align an individual’s objectives with those with the business.

Brian Cormacan, business development manager of HCM systems at Oracle, says: “Employers can move on to the next level and look at trends throughout the business. Does it give them a sense that their competition is doing something or their brand as an organisation is not as attractive as it might be?” The concept of HCM is also influencing HR system designs. For example, Doug Sawers, managing director of Ceridian UK, says: “It is influencing us enormously. We are designing our product set and solution set around those things that bring the biggest benefits to our clients. These are the same things that increase the value of the human capital asset that businesses have got.”

Alternatively, employers could design their own tools to support their HCM strategy. RBS, for example, operates an online human capital toolkit, which it launched back in 2005 and is designed to measure the effectiveness of the bank’s people strategy and its impact on business performance. The tool, available to its HR staff, includes surveys, measurements, benchmarking, research, and reporting on all people-management issues.

Disposable resource

An organisation’s approach to HCM and the extent to which it influences benefits provision will depend on whether its employees are viewed as an asset worth investing in or simply as a disposable resource.

Dilys Robinson, principal research fellow at the Institute for Employment Studies, says human capital strategies will be coloured by an employer’s attitude to its workforce. “There are some organisations where people are valued a lot because they are the experts or the specialists. Other types of people are not seen in such a positive way; they are seen very much as resources. The underlying philosophy of the way people are seen in different places might impact on the sort of pay and benefits systems that are set up.”

External factors, such as the economic climate or budget constraints, can also influence the benefits provision underpinning an organisation’s HCM.

Karen Horne, chief operating officer of human capital for the UK and Ireland at Ernst and Young, says that although in previous years there may have been an emphasis on short-term reward and annual bonuses, this may no longer be suited to an economic environment that has seen many businesses collapse at such a rate that their reward strategies can not keep up.

“Cash every year is quite compelling,”” says Horne. “It is also very useful and very effective for driving short-term financial performance. Employers might say ‘we want to drive profit through the business and if you do it this year, you will get x amount of cash’. You could have a really good year, but then you find in the following year the company has declined. This does not alter the fact the employers have paid everything out.”

There is currently pressure on employers that are implementing pay cuts or freezes to ensure that their senior management is also seen to feel the pain, because a responsible and equitable approach to remuneration in the current economic climate is likely to reassure investors and maintain morale across the workforce.

Above all, employers should ensure they reward employees for the right things in order to maximise the value of their organisation’s human capital, says Horne. It can be dangerous to award bonuses purely based on an employee’s effort, and such benefits should be paid only if they will generate financial returns for the company.

Horne concludes: “It is about linking the money you pay to the money that you have got, to the money that you create.”

Case study: Government streamlines HR

The Scottish government uses HR software to improve efficiency and give employees more control over their long-term career development, as well to consolidate information on its human capital.

The software and self-service system, provided by Oracle, allows the government to streamline administrative processes from the point an employee is hired right up until they retire. It has also been used to obtain up-to-date information on each employee, which is held on an individual record. The new system, which was designed to reduce administration and cut costs, replaced a legacy database for government and agency staff, and other disparate in-house processes. The software has also been used to manage sickness absence and track staff training.

Melanie Lawrie, E-HR application support manager at the Scottish government, says the system has helped to create a culture that empowers employees to reach their career goals, while helping the organisation to deliver on its corporate objectives.

Case study: Healthy reduction in absence

The Health Store, the UK’s largest co-operatively owned buying group supplying health and wholefood retailers, has reduced staff absence levels after addressing human capital management with an integrated HR system. The organisation has reduced staff absence from 7% to 2% after introducing a system that allowed it to record employee absence and attendance, while also streamlining the rest of its payroll processes.

Denise Bradley, HR manager, says: “Paper processes used to dominate HR and payroll, creating various issues and inefficiencies. It was impossible to extract information to monitor staff absence and was costing the business thousands of pounds a year.”” Despite incurring extra costs by outsourcing its payroll, The Health Store found further advantages in the system, provided by COA Solutions. “”Morale has also been boosted as employees know the clocking-in system enables staff to be treated fairly and equally,”” says Bradley. “”For instance, poor attendance and lateness no longer go unnoticed, meaning hard-working staff are justifiably recognised, making for a happy and productive workforce.”