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Donkin on Work - Human Capital Management

August 2006 – Campaigning for human capital standards

It is not easy to get some of the UK’s largest employer organisations, investor bodies and companies around a single table, particularly when they represent diverse interests and memberships.

But one common belief seems to be uniting members of the recently formed Human Capital Management Standards Group: there is a crying need for businesses across the UK to improve the way they understand and measure the value of their workforces.

The way that a company creates value in people, either through recruiting excellence, employee development or management, coupled with the way that people deliver value directly in performance, is of paramount interest to all stakeholders in a business – be they investors, customers or employees themselves.

Yet one area of the corporate balance sheet that receives relatively scant attention in many companies is the biggest intangible of all – the knowledge capital invested in and owned by employees, often the biggest cost of an enterprise.

One surprising observation that arose in the group’s latest meeting held last week at the London headquarters of Investors In People is that many big companies are unable to say how many people they have working for them. Those that do might have differing ways of calculating their employee numbers.

The observation arose during a discussion over a proposal to recommend profit per employee as a significant reporting metric of human capital that could be included in annual reports. One possibility might be to adopt a calculation used by Saratoga, the human capital arm of PriceWaterhouseCoopers. The measure divides profit before tax by the number of full-time employees. The head-count used for the calculation is based on full-time equivalent employees, so that two people job-sharing would be counted as a single employee.

The way that Saratoga calculates head count is to total up the contractual working hours, including overtime hours for all employees, and divide by the contractual number of hours for a full-time employee. Contractors, agency staff and consultants are excluded from the calculations.

When it is considered that in its consulting capacity Saratoga recommends the use of this metric alongside others, such as revenue per employee, cost per full time employee, resignation rates and human capital return on investment, it can be seen how complex the work can become in this area.

The HCM standards group, however, is seeking to establish some consensus around a small number of measures - say five or six - or groups of measures. The idea is to establish a base from where companies – including thousands of small and medium sized employers – can develop their human capital management systems. Set some common standards and management will develop in ways that suit particular organisations and industries. Some will need more sophisticated measuring in certain areas that are less relevant to others but the principal of uniformity underpinning diversity will have been established.

The group is concentrating its research and debate therefore on common areas of employment. On the table currently is a list drawn partially from work undertaken for Denise Kingsmill’s Accounting for People Report, partially from research carried out by the Chartered Management Institute and a more recent review by the Institute of Employment Studies, and partially from the recommendation of members.

One measure suggested from debate, for example, was the ratio of acceptances to job offers that gives a clear indication of an organisation’s ability to attract good recruits. This would be a particularly interesting statistic for anyone seeking to compare the success of large-scale graduate recruitment programmes. A high acceptance-to-offer ratio would establish an organisation’s reputation as an employer of choice.

A measure I favour myself is one I featured here some months ago, suggested by Fred Reichheld, the former Bain & Co director. What he calls “The ultimate question [for] driving good profits and true growth” in his book of the same name is this: How likely is it that you would recommend your employing company to a friend or colleague? Rated from one to 10, the scoring from this question, says Reichheld, provides a useful indicator to the overall management competence of an organisation.

While there are many more sophisticated groupings of measures of employee engagement, the scoring from that single question, he believes, can give an at-a-glance indication of the way that people feel about their employer and whether they take pride in their company. What he calls the “net-promoter score,” he argues is the single most important indicator of healthy profits, carrying with them in-built potential for growth and business improvement.

Other possible areas of measurement pulled together from various sources include leadership, training and development, performance improvement and pay.

A leadership measure might look at the percentage of jobs covered by a succession plan but such a measure might say more about a process rather than the quality of leadership. Measures around leadership reputation from attitude surveys or peer reviews may prove more useful indicators for outsiders.

I wonder what bosses such as Sir Alan Sugar, Sir Richard Branson and Arcadia’s Philip Green - all self-made men who never went to university - would think to proposals that companies should list the percentage of their managers who possess degrees?

A few of the other metrics, in a list that IES plans to test among a large sample of companies, includes one that is more of a statement rather an a measure – that HR plays an active role in formulating business strategy. This seems more like HR nest-feathering.

As an investor I would be pleased to discover that HR people were involved in strategy if the HR leadership, like that at the Royal Bank of Scotland, had demonstrated that it can make a difference. But in some companies this might be putting the cart before the horse. There are various areas of human capital management that might be best performed by people with a financial or marketing background.

Measures of staff turnover are useful, particularly when compared within industries. Absence rates are also useful. The higher average absence rates in the public sector compared with those in the private sector say much about the comparable motivation and performance management in respective sectors. But such measures should not be undertaken in isolation.

A bundle of measures around various HR processes such as appraisals, team briefings, suggestion schemes and quality circles may also have some use since research has confirmed that companies employing such processes often perform financially better than those that do not. But the presence of such measures alone would not satisfy my curiosity as an investor. I would want to see evidence of improvements or financial benefits arising from these initiatives to ensure that they were being managed year-on-year, not simply subject to an annual tick-box.

This is why good human capital measures must focus on results that can be compared historically in individual companies, as well as across sectors. The HCM Standards Group has yet to reach a definitive list. Indeed any recommended list cannot be definitive because this kind of measurement and management is evolutionary. Measures must be reviewed over time. But a railway must run on a track and the track can’t change its gauge every day, so there is an imperative to find a tight set of measures that have some validity.

The group is taking soundings from throughout the public and private sectors. Anyone who would seek to make an argument for the adoption of any specific human capital measures should contact the group via Simon Jones, finance director of IIP, [email protected]. For good measure you might copy them to me: [email protected]

©2006 Richard Donkin - all rights reserved