2004 - The links between human capital and profit
The Chartered Institute of Personnel
and Development, an organisation that represents
more than 100,000 personnel and human resources
managers in the UK, is not known for the strength
of its opinions.
So when it delivers a robustly-worded
response to government proposals covering company
law, we ought to sit up and take notice. The CIPD
is dismayed at the way the Department of Trade
and Industry has interpreted recommendations of
the Accounting for People taskforce on human capital
reporting in Operating and Financial Reviews (OFRs).
These reviews will need to be
included as a legal requirement in the annual
reports of publicly listed companies for financial
years from January 1 2005. In its response to
the DTI's draft regulations on OFRs, the institute
says that the Accounting for People recommendations
have been "severely weakened and undervalued".
The comment is disturbing because
the Accounting for People report anticipated OFRs
that would contain important information on employment
polices and practices useful for investors to
assess the future direction of the companies they
were considering as an investment prospect.
Industry bodies have lobbied
hard to ensure that future legislation will not
create new bureaucratic burdens that could harm
the competitiveness of business. But has the lobbying
been too successful? If we take the view that
OFRs are designed solely to improve the transparency
of business policies, there may be an argument
against greater disclosure. Why should a well-run
company spend time and effort developing policies
in areas where it sees little of relevance to
the business and to which the directors will be
This would explain why the DTI
has avoided using the strict accounting concept
of materiality. Instead it has chosen to give
directors much greater discretion over the way
they review and identify relevant factors. Does
this mean that some OFRs could get away with including
little more than figures on the total number of
employees in a company? The question needs to
be asked since the DTI has declared nothing stronger
in its consultation document than "the Government
hopes that companies will use the (Accounting
for People) guidance when preparing their OFR".
"While we agree that the
ultimate right to not include human capital information
should be available as a last resort, and so long
as it can be adequately explained and justified,
the requirement to provide it should be more strongly
expressed and supported by the DTI," says
the CIPD. This goes to the nub of these requirements.
If the OFRs are to mean anything, they must contain
solid information, not bland statements and platitudes
about the importance of the workforce. They should
also deal directly with the concept of "human
capital", a term which is used repeatedly
in Accounting for People, but which has been replaced
in the DTI document with "information about
There is a big difference between
employee information and human capital. Human
capital is a well-defined economic idea based
on studies that have linked investment in the
skills and education of people with their prospective
economic worth. It is not a piece of management
jargon or a faddish term for human resources.
It is a measurement-based discipline that is going
to be as important for business in the 21st century
as cost-accounting was in the 20th century.
This is why the reporting of
human capital should not be seen as a burden for
Mastery and understanding of
human capital measurement and the way this relates
to other measures of business performance is transforming
the way many companies do business.
You need only look at businesses
such as Sears and Enterprise Rent-a-Car, both
of which link their reward and management systems
closely to customer satisfaction feedback.
Research at Sears in the US has
shown how increases in employee satisfaction feed
through to improved customer satisfaction and
revenues. The key to these systems has been the
introduction of effective measuring systems. Some
companies shy away from measuring employee attitudes
in the belief they are dealing with "soft"
issues. But well-designed attitude surveys can
identify the areas in which employees and managers
need to concentrate their efforts. Detailed research
at Enterprise Rent-A-Car, the largest car rental
business in North America, has enabled the company
to create its own customer satisfaction index
which rates the service performance of individual
Managers are unable to achieve
promotion unless they achieve better than average
customer satisfaction scores, even if their branches
may be achieving higher than average growth in
sales and profits. Neither of these companies
would have difficulty reporting on these human
capital measures although Enterprise Rent-A-Car,
as a privately-owned company, does not need to
worry about shareholders. Instead, it ensures
that its employment policies are in line with
its attitudes to service. It promotes from within,
allows a high degree of autonomy in the way that
local branches are run and links a significant
proportion of managers' pay to branch profits.
These companies do not need a piece of legislation
to convince them of the need for effective human
They have refined their measuring
systems to avoid creating stodgy processes that
get in the way of day-to-day operations.
Companies and investors in the
UK need to realise that effective human capital
management can make a strong impact on profits.
Unfortunately too many companies
fail to investigate the link between policies
on, for example, training, pay and recruitment
and the bottom line. But measuring areas of employment
alone is not enough.
HR managers must begin to use
specific measures to demonstrate cause and effect.
The best way to do this is to canvass the opinions
of employees. What kind of training do they value?
How would they like to be paid? Would they care
to risk some of their salary as a variable profit
and loss-related figure? If so, how much? The
answers to some of these questions might be just
as enlightening as tables of figures in a set
of accounts. This is why the disciplines behind
human capital reporting are so important to businesses.
Even if the government allows plenty of room for
directors' discretion on employment reporting
in the OFRs, companies should not take the view
that they have won some kind of reprieve.
The market is a far sterner judge
of performance than any reporting requirement
and it is the companies that best understand the
relationship between work and profit that will
win in the long run.
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