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Human Capital: Sharpening the tool to prove HR’s worth

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Audit
Picture the scene. The HR director of a major corporation goes into the CEO’s office. “So,” says the CEO, “I know you have spent US$250m on a global SAP implementation, US$50m on consultants and turned HR upside down. You call it transformation. But what do I get out of it?”


All too often, it’s a fair question − and a tough one to answer. In its drive for transformation in recent years, the HR function has sometimes focused more on its own needs than those of the business as a whole. Greater speed, efficiency and effectiveness are clearly good things to aim for. But unless they are delivering real and quantifiable business benefits, the necessary investments will become increasingly hard to justify.

To put it another way, HR has been preoccupied during the past decade with what it will do, and how. The rest of the business is now looking for the why. If satisfactory answers are not forthcoming, questions may be asked about whether HR actually delivers sufficient value to justify its existence and the previously unthinkable may become a reality with the demise of the HR function.

Defining terms
So, despite the transformational gains of recent years, HR is facing a battle to prove its worth. Many HR professionals feel the answer may lie in the concept of ‘Human Capital.’ But what does this loose, catch-all term really mean − and how can it be harnessed to demonstrate HR’s delivery of value?

Human capital can essentially be summed up as: ‘The practical knowledge, acquired skills and learned abilities of an individual that make him or her potentially productive, and thus equip that individual to earn income in exchange for labour.’ However, as this definition suggests, human capital is not really capital at all in the strictest sense of the word. The term was actually coined to enable a useful analogy to be drawn between investing in resources (people) and in physical capital (tools, machines, buildings).

This analogy works fine, to the extent that investment in both human and physical capital makes sense if the value of the additional future benefits exceed the costs incurred now to obtain them. But the analogy breaks down in one important respect: physical capital can usually be traded on the market, whereas human capital investments are embedded in the ‘mind’ of an individual. This makes human capital much harder to value accurately.

Harnessing human capital
Given this background, two questions arise for HR, and ultimately for the entire business. How should an organisation invest in its human capital to achieve the greatest possible business benefit? And how does it know which human capital initiatives drive specific improvements in corporate value?

To find the answer, companies need to establish a way of measuring the impact of human capital investments. This search should be led by HR, to ensure that the right definition and perspectives are applied to human capital. Once the appropriate method of measurement has been established for the particular business, it becomes a powerful tool for HR to demonstrate the correlation between investment and value created.

Picture the position of HR in a business whose competitive edge depended on its employees’ ability to absorb and apply new skills very quickly. This places the onus on HR to build and maintain a steep learning capability. With the right measurement basis in place, HR would be able to show that investment of x in resourcing and training generated an income of y – making the value delivered explicit to the CEO and the business.

Some principles to apply
This sounds ideal, but it is easier said than done. One problem is that there is no one-size-fits all solution, since the optimal way of measuring investment and returns on human capital tends to vary from organisation to organisation. The correlation between the consistent application of HR practices and the businesses financial performance is as unique as the business itself, and needs to be analysed as such.

However, there are some clear principles that HR can usually apply in its efforts to lay down the right basis for demonstrating value delivery. They include:

  • Taking an holistic, organisation-wide perspective of HR’s role, objectives and influence. The effort of transformation has often resulted in too much navel-gazing in HR, and too little focus on enterprise value creation. Where this is happening, it needs to change.
  • Adoption of a pragmatic, not a strategic approach to initiatives, backed up with empirical data. Hard facts carry more weight than airy assertions when trying to convince line managers that certain practices (and behaviours) improve business outcomes.
  • Use of HR data and analytics where possible to identify cause-and-effect correlations between human capital initiatives and financial performance. (Becker, Huselid and Ulrichs’s research (2001) showed such linkages do exist, with the underlying message being that the HR activities need to be aligned with the business.)
  • Seek to blend HR’s traditional left-brain, people-orientated mindset with right-brain data analytics. This means taking a balanced view of human capital management, and thinking as a skilled craftsman − rather than an engineer at one extreme or a psychological counsellor at the other. Invest in developing these analytical skills within your HR team.

Conclusion: human capital in action
When applied in combination, these principles can clarify HR’s contribution dramatically. Imagine a business in which a high proportion of revenue derives from repeat business from existing clients. Intimacy between sales staff and customers is key to stable relationships, and thereby to financial performance.

So HR will apply recruitment criteria and launch development and incentivisation initiatives specifically designed to reinforce and prolong the sales-customer relationship. In parallel, it will embed and track metrics to show the impact of this human capital investment on financial performance.

To date, human capital may have been an imprecise and soft term. But a clear focus on it will mean that HR’s ‘soft’ days are over, enabling it to prove its worth to the CEO and the business more explicitly than ever before.

Article by Melanie Bibby and Neil McEwen, PA Consulting Group.

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Annie Hayes

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