Practical tools to measure the output of HR

Intangibles like human capital create a lasting competitive advantage. But how can the HR manager convince his CFO to put them on the balance sheet? How can you measure the real return on investment of your investments in human resources? Try the good old reports about absenteeism your CFO is already familiar with. The CRF Institute provides you with the appropriate ammunition.

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Not even the most hardboiled CFO would deny his HR department can save him al lot of money. That is why figures about absenteeism are the ones he loves most. If the HR manager can show he has been able to reduce the percentage of absenteeism, the CFO immediately knows what that means in terms of cost reduction. Unplanned absences like casual sick days account on average for 9 percent of the total payroll, human resource consultancy Mercer reports. And this figure only includes direct costs like benefits paid to provide income during an absence. Indirect costs like negative influence on co-workers, hiring costs for temporary workers and productivity loss are not included.

However, admitting HR is not only a cost reducing or cost producing department but also a value creator, is for most CFO’s still one bridge too far. Since the 1980s most financial managers are well aware that intangibles like goodwill, intellectual property and brand equity can be translated in terms of an income statement. But how does human capital fit into this picture? What KPIs show HR management can add value to the company? Surprisingly figures about absenteeism he is already familiar with can help opening his mind.

HR and financial results: chicken or egg?
International research, performed by consultancies like Ernst & Young, Gallup, Deloitte and Towers Watson, shows HR has provable added value to business results. Jeffrey Pfeffer, Professor of Organizational Behavior at the Stanford Graduate School of Business, sums this evidence up by saying that good HR practice accounts for gains of 40 percent or more.

HR makes a big difference. It considerably affects the market value of any publicly traded firm and in others they stimulate those who invest in, fund or sponsor the organisation.

The question is: which elements of Human Capital Management (HCM) are the key value drivers? A team at Watson Wyatt Worldwide (now Towers Watson) identifies in their Human Capital Index (HCI) five key areas that are associated with the creation of shareholder value: achieving recruiting and retention excellence, creating a total reward and accountability orientation, establishing a collegial, flexible workplace, opening up communication between management and employees and implementing focused HR technologies.

By matching the scores to objective financial results of the participating companies in the US, Canada and Europe, Watson Wyatt concludes excellence in all practices is associated with 47 percent increase in market value. But the researchers were also able to quantify exactly how much an improvement in each area is expected to increase a company’s market value:

Of course there is always the question which came first, the chicken or the egg. Does good HR practice lead to better financial results, or are companies with good financial results more inclined to invest in HR? During the years however researchers showed there was not only just a correlation between HR and financial results, but also that good HR practices were a leading indicator of increased shareholder value. There was a much stronger relationship between past HR practices and future financial results then the other way around.

Reducing absenteeism as a result of HR arrangements
In times of a financial crisis, even if there are signs of recovery, for a CFO it might still be counterintuitive to invest in human capital. Research shows he will definitely get his return on investment in the future, but he would probably want a more immediate result. What if reducing percentages of absenteeism and thus an instantly profitable output in terms of cost reduction could be linked directly to investments in HR policy?

Research by CRF Institute shows that the HR department actually has a direct impact on the well-being of the organisation and therewith on the bottom-line results. For instance, employers who indicate that ‘development of people & career opportunities’ is one of five top business priorities, have on average 3.7 percent absenteeism. Significantly lower than the 5.2 percent at companies which do not see ‘development of people & career opportunities’ as one the top five business priorities.

Also, flexible working arrangements appear to have a huge impact on absenteeism, the CRF Institute research shows. Offering a sabbatical or career leave could reduce absenteeism by a staggering 33 percent. Companies which offer such an arrangement report 3.6 percent absenteeism; the other companies report an average of 4.8 percent. The same positive effect can be seen at companies offering time in lieu. HR has a direct influence on offering these conditions. Supporting work-life balance is also an element worthwhile investing in.

Telecommuting and the possibility of home-working result in a 40 percent drop in absenteeism. Employers offering this arrangement report an average of 3 percent absenteeism against 5 percent amongst the other employers. Counseling employees on their work-life balance results in a reduction of 37 percent.

Go the extra mile
The most important correlation however is the one between employee engagement and absenteeism. Engaged employees tend to be less vulnerable to work related mental and physical diseases, are more motivated to go the extra mile and thus less inclined to take the occasional sick leave. And employee engagement, consultancy Towers Perrin reports in a study of 50 multinational companies, has a direct impact on financial performance: ‘Over 12 months, companies with high level of engagement outperformed those with less engaged employees in three financial measures, operating income, net income and earnings per share.’

Because there is such a strong correlation between engagement and absenteeism, absenteeism is a strong indicator of engagement. The application of HR practices has a direct impact on both. So although it can seem daunting to monetize the value of the HR strategy and communicate this, by showing the results in terms of absenteeism, the HR department can rightly be shown to be a true profit center.

Literature:
- Bruce Pfau and Ira T. Kay, The Human Capital Edge (McGraw-Hill, 2002)
- Towers Perrin, Employee engagement underpins business transformation (September 2009)
- Robinson D, Perryman S, The Drivers of Employee Engagement, Hayday S. Report 408, Institute for Employment Studies, 2004.
- Pfeffer, Jeffrey, The Human Equation: Building Profits by Putting People First (Harvard Business School Press, 1998)
- David Creelman and Dave Ulrich Workforce Management, “The New ROI of HR: Return on Intangibles”, 2006.
- Taleo Research, Strategic Talent Management, “Staffing’s Impact on Shareholder Value”