Fiscally responsible CEOs insist that every business decision their companies take must create value. Investing resources in areas of an organization such as infrastructure, research and development, or marketing can be linked to increases in financial performance, and thus shareholder value, in measurable ways. HR has often been considered not to create value, primarily because of the perceived lack of established links between human capital management and positive financial performance. At iLogos, we have worked with many staffing departments of large enterprises that are striving to best present value to C-level management. They ask, “How can we prove that HR excellence builds value for our company?” One resource we direct them to is the book Human Capital Edge, by a team at Watson Wyatt Worldwide. Let’s review the book’s premise. The Human Capital Index For the past several years, researchers at Watson Wyatt have been developing what they call the Human Capital Index. The Human Capital Index (HCI) seeks to measure the impact of human capital management (HCM) practices on shareholder value. This research is based on a survey with over 100 questions relating to HCM practices that’s distributed to more than 750 companies in the U.S., Canada, and Europe. The survey asked companies to describe in detail how HCM practices are carried out, for everything from compensation and training to communications and staffing. Based on the responses received, companies participating in the study were given a score on a scale of 0 to 100, where 0 signifies a company with the weakest HCM practices and 100 represents the ideal. Each company’s HCI score was then matched to objective financial measures for that company, including market value, return to shareholders, and other measures of an organization’s ability to create value. HCI Research Findings The research found that there is a positive correlation between a company’s HCI score and its financial results: the higher a company’s HCI score, which represents how well an organization manages its human capital, the higher its shareholder value. The study identified key areas of HCM practice that are associated with the creation of shareholder value. These are:
- Achieving recruiting and retention excellence
- Creating a total reward and accountability orientation
- Establishing a collegial, flexible workplace
- Opening up communication between management and employees
- Implementing focused HR technologies
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Excellence in all practices is associated with a 47% increase in market value. Analysis was also able to quantify exactly how much an improvement in each area is expected to increase a company’s market value. For instance, excellence in recruiting and retention is associated with a 7.9% increase in market value. Correlation or Causation? When two phenomena are positively correlated, it is tempting to say that one causes the other. But the problem with drawing a conclusion concerning a cause-effect relationship is that one can never be sure which of the two phenomena is the cause and which is the effect. Can we really say that better staffing creates better financial performance, or is it rather that good financial performance makes better resources available to HR, which in turn produces better staffing? The first year of the Watson Wyatt HCI study could only say that the two are clearly linked, and so could not answer the skeptical suggestion that the research only uncovered the more simple truth that strong financial performers excel in HCM practices, instead of the more interesting result that following superior HCM practices actually brings about improvements in the bottom line. Now in its second year, the Watson Wyatt HCI study is in a position to bring more clarity to the issue of whether effective HCM practices actually cause better economic performance. With data from a group of companies at two different points in time, the Watson Wyatt researchers are now able to show that not only are superior HCM practices correlated with financial returns, but they are also, in fact, a leading indicator of increased shareholder value. A “cross-lag panel analysis” shows that the relationship between past HCM practices and future financial performance is stronger than the relationship between past financial outcomes and future HCM practices. These results strongly suggest that better HCM practices actually create better financial results. Putting HCI Results To Use One mandate of HR is to think about retention and make sure that processes are in place that enable employees to remain in the company. For instance, an internal job posting system would make employees more aware of internal opportunities. It would enable every employee to be more aware of his or her opportunity for advancement within the company. As a consequence, an internal job posting system would reduce turnover. As it happens, Watson Wyatt’s HCI research demonstrates that HCM practices that improve retention have a positive impact on market value of 3.2%! Furthermore, improving services to employees and managers by implementing new technology has a positive impact of 2.3%. No better justification could be made to a CEO or CFO. The Watson Wyatt Human Capital Index makes it clear: staffing is a mission-critical component of the success of your firm. If you are challenged, you can articulate the justification for superior HCM practices with strong data and analysis.