Measure for measure

Investors are waking up to the importance of human capital management. We talk to Denise Kingsmill and others about the challenges it poses for HR professionals.

Linking the impact of people management policies to business performance has long been the Holy Grail for HR professionals. So the current campaign to formalise the management and reporting of human capital, under the guise of the government-backed Accounting for People taskforce (see HR - your number is up ), could be the catalyst needed to establish the workforce as a business asset rather than a cost.

At first sight the idea seems straightforward- to devise a common set of metrics that companies can use to measure the effectiveness of their employees. These metrics could then form the basis of an external report to stakeholders, including investors, employees and the community, on just how well an organisation manages its people. Companies readily report on investments in fixed assets and provide plenty of financial information to external stakeholders, so reports on human capital seem a logical extension.

The reality is more complicated. Within the world of HR and management research, the case to establish the link between effective human capital management and business performance has been made. But there is still much to do to persuade the wider world, and particularly the investment community and City analysts, of the merits of managing, measuring and reporting on people issues at all.

Denise Kingsmill, chair of the Accounting for People taskforce, argues that human capital management (HCM) is a key source of competitive advantage and, ultimately, profitability. Her message is that any organisation that wants to compete successfully needs to ensure that its workforce has the right mix of people, with all the skills and experience to fit the needs of its business.

Kingsmill accepts that interest among the taskforce's target groups has been mixed. But she argues that the major quoted companies are persuaded of the link between productivity and HCM and would like to be able to report on it in a way that would allow comparison across their industry sector. Kingsmill is working hard to emphasise HCM as a performance issue.

"There is a big productivity gap in this country. We are not producing as much as our competitors. Our HCM is poor," she says.

The inquiry team is not only fighting to spread the message to a wider audience, it also has to find a way through the complete lack of agreement on how human capital can be managed, measured and reported on. The Chartered Institute of Personnel and Development (CIPD), along with other expert commentators, recognises that human capital poses a distinct set of problems for company reporting (see Holding employers to account ). Unlike other assets of the firm, human capital is not owned by the organisation but is secured through the employment relationship.

The taskforce faces its biggest challenge in identifying practical measures and benchmarks that will gain wide acceptance and currency. It is due to report in late October, following a wide-ranging discussion document published in May.

Speaking after all the submissions to the consultation paper had been made, Kingsmill conceded that the nature of what should be reported, and how, is still generating major differences of opinion. More in-depth discussion will go on over the summer as the inquiry team tries to come up with a framework that will be both effective and practical. But Kingsmill is keen to stress that the consultation is not an exercise in democracy. The team is looking for the ideas that are the most interesting and influential.

One likely outcome, according to Kingsmill, is that the inquiry will extract areas of best practice from all the submissions. One organisation might report and measure well on diversity, another on training. The team is likely to pick and choose areas of best practice that can be used as examples for others to follow.

One likely reporting mechanism is through Operating and Financial Reviews (OFRs), due to be introduced for large companies as a result of the government's overhaul of company law. The OFRs are designed to cover information that will allow an informed assessment of the company's operational and financial position, as well as its future business strategy and prospects. Some groups, such as the CIPD, see the OFR as an ideal means of reporting on human capital. But others, such as major institutional investors represented by the Association of British Insurers (ABI), are wary and claim that human capital measures will provide too much non-core information.

Kingsmill's team, however, is likely to favour the use of OFRs with recommendations about how organisations can usefully capitalise on the opportunity to establish human capital reporting.

Kingsmill admits that the response from investors and the City has been mixed. "Some analysts don't know what we are talking about. We need to educate the investment community on what constitutes the drivers of productivity. Chief executives are a lot further along the road than investors, who are a little old-fashioned,"she says.

One sign that investors are showing an interest in HCM comes from Pensions &_Investment Research Consultants (PIRC). The consultancy has recently launched a GovernancePlus Service to meet the information needs of institutional investors on corporate governance and corporate social responsibility. The reports, initially on the FTSE-350 companies, include in-depth analysis of the major corporate governance issues, including human capital.

Peter Southwood, policy executive at PIRC, believes that the consultancy detects a new interest from investors. "Investors are starting to recognise the link between human capital and the profits and performance of companies,"he says.

PIRC's reports on human capital look for an adequate group-wide employment policy, a commitment to reporting on a regular basis and board-level responsibility for employment, and below that a senior manager responsible for HR. They also look at engagement issues such as established works councils, regular employee satisfaction surveys and evidence of standards such as Investors in People.

Perhaps a more typical view from the investment community is illustrated in ABI's submission to the Kingsmill inquiry. The ABI, whose members manage £1,000 billion of investments, gives the initiative a guarded welcome, but questions the relative importance of HCM and argues that it should be reported in company annual reports only when HCM issues are identified as a significant risk factor affecting the business.

Watson Wyatt, a consultancy with wide experience of proving the link between HR performance and business performance, says that investors are starting to take a harder look at human capital issues. It is currently talking to three different asset management groups about how they might start to assess the people management policies of the companies theydeal with.

Watson Wyatt HR consultant Stephen Dicker says: "One of the major problems is having an analyst who is skilled enough to read the people management information." He admits that most investment clients are not ready to go into an organisation to look at human capital data. "Most analysts do not know how to have the conversation. It is very rare that an HR director is part of an analyst's visit to a company," says Dicker.

Nevertheless, once the idea of human capital reports makes it onto the analysts' radar, avoiding a negative perception will be critical. "If reporting is too opaque, investors may mark a business down. Evidence of an HR strategy and sensible measures to achieve that will be useful. Areas that are obscured or skated over will give cause for concern," says David Baty, partner for HR strategy with PricewaterhouseCoopers (PwC).

Whatever framework is eventually drawn up for reporting human capital, the ability of firms to report will be limited by the data they hold. An accurate picture of the activities that companies are able to measure comes in research from PwC. In a study of 1,000 organisations across Europe earlier this year, PwC identified the HR categories most often measured and reported on internally.

Headcount is top of the list, with 97% of companies internally reporting on this area, followed by employee turnover (85%), training (79%) and absenteeism (61%). Other measures regularly reported on are employee satisfaction (43%), retention (38%), fair pay (33%), diversity (26%) and productivity (24%).

This has clear implications for external reporting, which will be limited at first by the information that companies collect.

"The relatively low levels of reporting on fairly straightforward issues by leading organisations suggests that human capital reporting has some way to go," says Baty.

He notes a slight disconnection between what HR directors say is important and what they measure. Employee satisfaction, for instance, is often cited as a key issue, yet less than a half of organisations regularly monitor it.

"It seems to us that measurement and reporting lags behind the aspirations of the HR community," says Baty.

A major stumbling block to encouraging companies to report is confidentiality. David Baty points out that most major companies already compare their key metrics against sector norms, such as pay rates, through industry associations. They know where they are operating compared with their contemporaries, but they are likely to be reluctant to publish details on what they are doing themselves.

Research carried out last year by Deloitte & Touche illustrates the uncertainty over HCM. The results show that while organisations recognise the potential benefits of HCM approaches, they do not find it easy to realise these benefits.

Deloitte & Touche found an array of approaches used to measure human capital; but, worryingly, only half of respondents viewed their own approach as effective, and many companies struggled to achieve their goals from the measurement process.

Brett Walsh, head of human capital at Deloitte & Touche UK, points to several possible reasons for this, including: business leaders are not sure what they should be trying to measure or exactly what they should do with the information or are unaware of the methodologies available to them; or HR managers are not under pressure from the board to account for human capital or are sceptical about the validity of the results.

The most popular approach to measuring human capital is the use of HR benchmarking and HR metrics, with half of all organisations in the Deloitte & Touche research using this tool- but only just over half of these found the method any better than fairly effective (see table). A similar result was reported for the next most popular method, the balanced scorecard. Deloitte & Touche points out that a significant amount of resource is being used, with limited benefit in return.

The research found that less popular tools - such as the HR practice effectiveness model, which assesses the contribution of the HR function and HR practices to business performance, and the economic value added (EVA) approach, which measures overall corporate performance based either on the total cost of capital employed or investment in the business - are considered effective by a higher percentage of users (76% and 73%, respectively).

The HR practice effectiveness model was seen to provide three main benefits: demonstrating a link between HR activities and business performance; directing HR investment strategy; and measuring the efficiency of HR internally. The EVA approach is viewed as providing effective input into the decision-making process for budgets and investments and into informing the strategic planning process.

Watson Wyatt's HR consultants have a firm view that there is no one-size-fits-all set of measurements to assess human capital usefully. They argue that each organisation has to find the few critical measures that relate to its business strategy. For example, Watson Wyatt's research findings illustrate the direct impact of employee engagement on customer satisfaction and the subsequent effect on business outcomes such as shareholder value.

"Incorporating these meaningful, people-related measures into an integrated measurement system is essential," says Watson Wyatt's Dicker.

He points out that a decline in employee commitment, for example, can be expected to lead to lower standards of customer service, and eventually a decline in customer satisfaction and reduced profitability. He argues that a number of high-profile companies have had their employee commitment and customer satisfaction weaken almost two years before their share prices entered a long period of decline.

"Effective organisational measurement is not just about collecting the right data, it is also about using data effectively to drive performance," Dicker says.

Watson Wyatt HR consultant Doug Ross argues that a company needs to be able to set out its strategy, and its promise to employees, stakeholders and customers, and needs to illustrate how well it is delivering on that promise in its annual report. Numbers can then be added, but to illustrate the reporting issues rather than to drive them.

"The critical metric is about whether the promise to shareholders and customers and employees is aligned. And then whether these are aligned to business strategy," he says.

Ross argues that useful metrics can be extracted from questions such as "To what degree are employees committed to the strategy and can we measure employee attitude?" and "To what degree do employees believe they are aligned to the work that they are asked to do?" He says that answers to these types of questions will generate the most useful human capital reports.

When Kingsmill's team reports in the autumn, its proposals are likely to include flexibility for organisations to report in ways that reflect their circumstances, and the introduction of a common core of minimum reporting. The recommendations are likely to include plenty of examples of best practice, and it will be up to leading organisations to take up the challenge to report on human capital in as meaningful a way as other key assets.

Kingsmill has been critical of the failure of HR professionals to raise the profile of HCM. "HR professionals have a role as implementers not influencers. They will have to raise their game and start getting engaged. They are going to have to get involved in business thinking," she says. She acknowledges that there are some very strong examples of where HR is engaged, but all too often the HR organisation is down underground in an organisation. "This initiative should offer them a kick-start. It will give the HR profession a huge opportunity to develop a major role."

Approaches to measuring human capital

Source: Deloitte & Touche.