Human capital - not just another term for HR?

The term "human capital" is gaining ground among government and HR professionals. Here, we outline recent human capital reporting proposals and discuss their implications.

Key points


  • The UK government wants companies to report regularly on people as well as financial issues.

  • It is argued that reporting on human capital is necessary because it represents a systematic way of assessing the contribution of people's skills and competencies to business performance.

  • Others fear that human capital reporting may restrict the discretionary behaviour that is so vital to good management.
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    Despite the efforts of personnel (latterly HR) professionals, for most of the 20th century, labour has been treated as the poor relation of the other "factors of production". Most companies have not been that interested in fully exploring the extent to which the individual and collective attributes of employees made a difference to the success, or otherwise, of their business.

    The popular slogan, "our people are our most important asset", although never publicly contradicted, has not been truly believed because nobody could come up with a convincing way of measuring the full contribution of employees to an organisation's value. According to Richard Donkin, author and senior Financial Times columnist, the simple reason for this is that, in the workplace, people act in very different ways - some are good organisers, some are inspirational, some have tidy desks and tidy minds, others may produce the occasional creative gem and little else, while others spend much of their time gossiping.

    Another difficulty with measurement, which Donkin acknowledges, has been that many successful firms do not have a particularly sophisticated approach to the management of human resources, while many that do lurch from crisis to crisis. Additionally, any move to assess the full contribution of employees can be perceived as a potentially dangerous intrusion into organisational hierarchies and may erode the autonomy many employees and managers have in controlling their work.

    Measuring financial performance

    While theorists have struggled with the task of how to measure the true financial value of companies, the once self-confident art of creative accounting as a means of artificially inflating a company's value has not only fallen into disrepute, but has contributed to instability within markets and resulted in calls for tighter regulation of company accounts and consulting firms.

    Traditionally, methodologies for measuring a company's value have focused on a number of financial factors, such as dividend yield, price:earnings ratio and the value of physical assets. More recently, softer approaches have become fashionable, such as the balanced scorecard1 developed in 1992 by Robert Kaplan and David Norton, which established a business measurement philosophy relying on a mix of financial and operational indicators.

    A strategic management concept, rooted in the principle that "what you measure is what you get", the balanced scorecard presents managers with a number of different perspectives from which to identify performance measures. In its original form, as developed by the initiators of the concept, the balanced scorecard complements traditional financial indicators with measures of performance relating to customers, internal processes, and innovation and improvement activities.

    According to the theory, such measures differ from the narrow financial performance indicators traditionally prioritised by companies, because they are grounded in an organisation's strategic objectives and the competitive demands it faces.

    Developing a balanced scorecard has been compared to flying an aeroplane. Pilots need information about many aspects of the flight, and relying on one instrument while ignoring others may result in disaster. Similarly, in successful businesses, the complexity of managing an organisation means that managers should be able to view performance indicators in several areas simultaneously.

    For some time, academics and consulting firms in the UK and North America, the main breeding grounds of HR management theory, have been busy establishing a new "science" that attempts to establish a direct correlation between an organisation's human capital (its people), its profitability and its competitiveness.

    A theory of human capital

    The term "human capital" is steadily creeping into the vocabulary of almost everyone with an interest in employment. But what does it mean? And is it just another term for human resources?

    The Organisation for Economic Co-operation and Development (OECD)2 defines human capital as "the knowledge that individuals acquire during their life and use to produce goods, services or ideas in market or non-market circumstances".

    Economists have been concerned with human capital for a long time, suggesting that investment in human capital, such as education and training, provides a return for individuals as well as economies, increasing both employment rates and earnings.

    It is common knowledge that demand for workers with only basic skills is falling. And, according to the OECD, there is evidence that demand for human capital is changing as a result of changes in the organisation of work, often combined with more intensive use of information and communications technology, increasing the requirement for "soft" skills such as teamwork, flexibility and communication skills.

    The corporate version of human capital relates to the market performance of firms. Until recently, serious attempts to measure the intellectual, emotional and creative factors that define the competitive strength of companies have failed to grab the imagination of many organisations. The HR community has been ambivalent about human capital, regarding it as a buzz word, or HR by another name. But things may be changing. Many HR professionals believe that a growing interest in "human capital reporting" may signal the best chance yet for HR to gain recognition of its strategic importance within organisations.

    Human capital reporting

    The government, keen on target-setting and benchmarking, is enthusiastic about developing approaches to measuring the value of human capital. In July 2002, trade and industry secretary Patricia Hewitt announced an initiative to encourage companies to extend the range of human capital issues that are included in company reports. Hewitt says that investors need to know that the value of a company's human capital is secure and is maximised in the same way as other assets, including plant and machinery3.

    Recent research for the Chartered Institute of Personnel and Development (CIPD)4 highlights how 10 UK-based companies, including Marks & Spencer, Shell and Tesco, are improving the way they manage staff through measuring how effectively they use them.

    The authors define human capital as "the competencies which employees apply to the production of goods and services for an employer". Although none of the 10 companies in the study uses the term "human capital", many believing it reduces employees to the status of economic units, all are enthusiastic about "competencies".

    Marks & Spencer is attempting to measure two different things: the capability of employees, through a skills survey; and employee engagement with the organisation, through the establishment of an Employee Insight Unit. Tesco, which has devised its own version of a balanced scorecard "steering wheel", has set up a People Insight Unit to demonstrate more precisely which "people policies" contribute to business success.

    BT, another case-study company, views the delivery of an effective learning strategy as being more important to them than measuring human capital per se.

    Harry Scarbrough, principal author of the report, and professor at Warwick Business School, says that reporting on human capital presents real challenges. He objects to the term "human capital accounting", believing that putting a financial value on people is offensive. Some accounting firms, keen to get on the human capital bandwagon, may disagree.

    Scarbrough argues that reporting on human capital is necessary because it represents a systematic way of assessing the contribution of people skills and competencies to business performance.

    He sees four reasons to move forward on human capital reporting:

  • it puts the contribution of employees into the organisation's reporting framework;

  • it helps companies identify employee contribution to the firm as an asset and not just a cost;

  • it gives fresh impetus to equal opportunities, because better firms will understand the contribution and importance of a diverse workforce; and

  • it provides a stronger sense of how robust a firm will be in the future.

    Scarbrough points to some potential dangers of such reporting, particularly if it is introduced as part of the company law reform agenda. He says the biggest danger is that firms will respond in a minimalist way: "We will get boiler plate responses which are simply formulaic repetition that people are important assets, which fail to address how the firm is addressing issues of human capital."

    He is also concerned that the wrong indicators and measures of human capital could have a negative effect. For example, if companies included indices on training without adding context (investment made and value created from skills), then there is a danger that they will simply want to reduce training costs.

    Scarbrough's view is that there is also a danger of companies establishing a plethora of indicators of activity which may be taken out of context, adding that many human attributes and qualities essential to business success are not quantifiable. "If you really want to understand how human capital is being developed, a lot of the questions are how questions not what questions, such as 'how is the company motivating its people?'" he says.

    Most of the existing human capital reporting currently undertaken by firms is historical and says little about what will happen in the future.

    Scarbrough wants to see companies employing more than 500 people to provide a narrative in their annual report to shareholders covering:

  • acquisition and retention of human capital;

  • development of human capital (reward, motivation and communication); and

  • performance - indicators that express the value of people and people skills to the organisation.

    Scarbrough says that human capital reporting should be seen as an opportunity to enhance people skills, and therefore productivity. "External reporting will stimulate managers to look more intensively at the talent base they have within the organisation, bringing down barriers to equal opportunities and creating a more informed market for talent and skills, and is likely to lead to better management in the long term," he says.

    Richard Donkin, author of Blood, sweat and tears: the evolution of work5, which describes a history of work from prehistoric times to the present day, stresses that work is driven not just by economic trends, but also by a combination of personal factors - people's desires, always staying one step ahead of their ability to afford them; the psychological need to define ourselves by our work; and a work ethic that continues to drive us long after the drive that spawned it ceases to be relevant. He challenges the work ethic that he sees pushing more and more people to live lives subsumed by the demands of their employers, and he invites them to ask why they do it.

    Donkin says that approaches to evaluating human capital speak the language of the big accountancy firms, a number of which have come under the spotlight for over-valuation of companies. Human capital reporting creates an extended role for these firms, many of which are heavily committed to human capital consulting.

    Donkin fears that human capital reporting may restrict individual and group creativity. He says that the discretionary behaviour that is vital to good management could be in jeopardy. He adds that human capital approaches, if not managed properly, will take individualism and the individual out of work. For him, human capital views people as a mass movement, which he equates to "Taylorism"6.

    Donkin's concern is that human capital initiatives, if unchecked, will take work study to new levels of precision. "The danger is that it will take the 'human' out of human resources," he says, "and you start losing the most valuable thing you have and that is your humanity. The idea that you can create all types of recordable data based on human achievement is nothing more than a nirvana."

    1. "The balanced scorecard: measures that drive performance", Robert S Kaplan and David P Norton,Harvard Business Review, January 1992, more information at http://harvardbusinessonline.hbsp.harvard.edu/ .

    2. The well-being of nations: the role of human and social capital, OECD, 2001, available at www.oecd.org .

    3. Speech to the Cambridge Faculty of Law, 5 July 2002, available at www.dti.gov.uk/ministers/speeches/hewitt .

    4. Evaluating human capital, Harry Scarbrough and Juanita Elias, Chartered Institute of Personnel and Development, available from CIPD Publishing, tel: 0870 800 3366, price £50.

    5. Blood, sweat and tears: the evolution of work, Richard Donkin, 2001, published by Texere, available from Amalgamated Book Services Ltd, ISBN 1587 991 44 6, tel: 01622 764 555, price £9.99.

    6. Named after Frederick Winslow Taylor (1856-1915), the American inventor and engineer who was the first to make a scientific study of industrial management. Taylor's system of management corresponds to the early development of mass production and assembly line manufacture and is characterised by extreme elaboration of the division of labour, the reduction of work to machine-like operations, and extreme labour discipline and supervision of work.

    Box 2: Human capital reports in 2002: key findings


    1. Chartered Institute of Personnel and Development:     Evaluating human capital

    Within a number of the CIPD's case-study organisations, human capital evaluation is focused most rigorously on small concentrations of individuals who were seen as highly talented and critical to the firm's future.

    There is no Holy Grail in the evaluation of human capital - no single measure that is independent of context and that could accurately represent the impact of employee competencies and commitment on business performance.

    The human capital perspective provides a new rationale for the role of the HR function, where HR is no longer viewed as a cost centre, but rather an asset provider.

    HR practitioners are conscious that methods that are too closely associated with their function may not be able to secure commitment from other groups in the organisation. This means that initiatives centred on human capital are often given an internal "brand".

    Within case-study organisations, developments in human capital have highlighted new forms of expertise within and between HR and other functions. Such groups are seen as being linked more explicitly to change and innovation and the data that they generate are being developed for wider business reasons, which are strategic rather than bureaucratic in nature.

    A CIPD taskforce is currently developing an external reporting framework for human capital.

    More information available at www.cipd.co.uk .


    2. Deloitte & Touche and Personnel Today: Measuring human capital value

    Business performance is powered by the effective use of capital: financial; technological; and human. In a world of knowledge-based economies in which companies must compete in an ever-wider arena while doing more with less, human capital is emerging as the most challenging to secure, the most difficult to quantify and yet the most critical to success.

    The concept of measuring human capital is seen as useful by many organisations, but the results show that only around half of organisations manage to do this successfully, with HR benchmarking and HR metrics being the most-used approaches.

    There are two key business imperatives for HR in this area:

  • Education is needed to provide clarity as to what an organisation may seek to gain from the existing set of approaches and the way in which the analysis should be used to drive effective management of human capital. This will ensure that organisations have the information to enable them to choose the most appropriate methodology, depending upon their requirements.

  • There is a real requirement for the creation of a simpler, user-friendly set of credible measures that can help organisations to make more educated decisions about their deployment of and investment in human capital.

    • More information available at www.deloitte.com .


    3. PricewaterhouseCoopers: Global human capital survey 2003

  • Profit margins are higher where the HR function is satisfied with its influence on business strategy.

  • Revenue per employee is higher when spending on the HR function is higher.

  • The greater the number of employees who have access to HR self-service, the lower the number of HR staff.

  • Companies that outsource deliver relatively more strategic HR input.

  • Larger organisations that use shared services to deliver HR have a small reduction in the number of HR staff.

    • More information available at www.pwcglobal.com .


    4. Watson Wyatt:     Human capital index - European survey report 2002

  • Companies with the best people management deliver nearly twice as much value to shareholders as their average competitors.

  • Key HR practices associated with higher value continue to show up in bear as well as bull markets.

    • Watson Wyatt looked at return on equity over the past two years for those companies that participated in both the 2000 and 2002 European human capital index (HCI) studies. During these turbulent economic times, the high-scoring (top quartile) HCI companies in the 2000 study generated returns of over 20%, while the low-scoring HCI companies showed a negative return on equity.

    More information available at www.watsonwyatt.com/europe .