1 ® west virginia ipma hr fall conference september 29, 2004 human capital – cost vs. investment

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West Virginia IPMAHR Fall Conference

September 29, 2004

Human Capital – Cost vs. Investment

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Presented by:

Neville KenningNational Director, State Government ConsultingHay GroupLos Angeles(213) 892 [email protected]

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First, Let’s Deal with the “Buzz”

This Too Shall Pass

First we were Personnel and then we became Human Resources

1930’s – Scientific Management (Time and Motion Studies)

1960’s – 1970’s – Office Productivity

1970’s – MBO

1980’s – 1990’s – Quality Circles and TQM

1990’s – Broadbanding, Reengineering and Teams

2000’s – Human Capital

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First, Let’s Deal with the “Buzz” (cont’d)

Its not a new idea

“We’ve moved to a period where the major criterion for judging things is cost effectiveness. In the 40’s and 50’s it was growth. In the 60’s and 70’s it was morality. Now there is no set of objective ideals except cost benefit. Business is moving to reexamine basic assumptions; the services they use, their portfolios, bank, lawyers, consultants, agencies, philosophy, employee benefits. Companies will be a lot more candid about certain operations that are not working, a lot more willing to say that the Emperor has no clothes. This affects service businesses. The issue of cost effectiveness will be critical. . . . You’ll have to explain everything (in cost-benefit terms).”

Florence Skelley, PresidentYankelovich, Skelley and

White,ADWEEK, August 1983

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“Determining the costs and benefits of HR programs. . . .will be one of the five top issues facing HRD professionals in the 1980s.

Jan Margolis, PresidentAmerican Society of Trainingand Development, 1980

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Human Capital Indices are “popping up” everywhere in consulting practices, publications, etc.

Studies show that superior human capital practices in the private sector not only correlated to financial returns but are also leading indicators of increased shareholder value.

Yes, it can be measured and proven of value in the privatesector.

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HCI ScoreLow

(0-25)Medium(26-75)

High(76-100)

21%

64%

39%

Practice Impact on Market Value

Total rewards and accountability

16.5%

Collegial, flexible workplace 9.0%

Recruiting and retention excellence

7.9%

Communications integrity 7.1%

Focused HR service technologies

6.5%

Prudent use of resources -33.9%

Expected change in market value associated with a significant one standard deviation (1SD) improvement in HCI dimension.


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Why is Understanding the Value of Human Capital Important?

Human resources expenditures are the “big ticket item” in the service sector in general and the public sector in particular.

Human Resources staff are under pressure to become “business partners” (people who add value) rather than overhead (people who cost money).

Becoming a business partner requires our ability to prove our worth and speak the language of our “customers” – dollars.

We have “stakeholders” who view employees as a cost, rather than an asset in which we need to make an investment. “What do you mean, we need to pay that much – I can get my ranch hands for 3 and ¼ per hour and they work hard.”

It can be measured and proven of value in the private sector, but what’s the value in the public sector?

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Why is Understanding the Value of Human Capital Important? (cont’d)

We get a much different reception when we present to a case that shows dollar benefits of our initiatives and services. “If I can show you how we can more appropriately spend $200,000 and improve productivity and service, would you be interested” vs. “we need $200,000 for this training program.”

As Human Resources professionals, we have been reluctant/ unwilling or “just don’t know how” to evaluate and measure the effectiveness of what we do.

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Why this reluctance?

People do not know how to calculate human capital value.

Fear that evaluation will show that programs do not work, are not worth their cost.

Belief that cost-benefit figures are phony, “fuzzy math.”

It’s a finance thing.

Evaluation is not worth it.

There is no real incentive to do it.


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Major trends affecting the talent pool:

A demographic shift

An aging workforce

Teachers

Nurses

Public Servants

The decline in mentoring

A more mobile workforce

Work/Lifestyle Pressures

Changing Aspirations/Commitments

The need for more “positives” and fun in life

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The Value of Understanding the Concept of Human Capital

Understanding the model for human resources effectiveness and the “centrality” of the role of leadership.

Knowing how to value our human capital programs and initiatives.

Valuing and engaging our human capital.

The keys to understanding the value of the concept of humancapital are:

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The Model of Human Capital Effectiveness

ValuesValues& Culture& Culture


Core WorkCore WorkProcessesProcesses


IndividualIndividual& Team& Team

CompetenceCompetence



ResultsResultsResultsResultsStrategyStrategyStrategyStrategy

Organization,Organization,Team & JobTeam & Job

DesignDesign


DesignDesign

Reward &Reward &RecognitionRecognition


ManagementManagementProcesses &Processes &HR SystemsHR Systems


LeadershipLeadershipLeadershipLeadership

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The Model of Human CapitalEffectiveness (cont’d)









ResultsResultsResultsResultsStrategyStrategyStrategyStrategy


DesignDesign


DesignDesign





LeadershipLeadershipLeadershipLeadership

• The capability of people — individually and as teams — to carry out the strategy

• The ability of leaders to mobilize the organization around the strategy

• The way in which accountabilities are organized

• The manner in which behavior, capability and/or results are reinforced

• The key processes through which management influences people

• The way in which the organizational norms support the strategy

• The sequence of activities through which resources are transformed to meet customer needs

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“To think proactively rather than reactively”

In order for an organization to achieve success in the

future, it must rely on the capabilities of its people.

In today’s labor market, the key is to have people with the right

skills and competencies, in the right jobs, in the right

culture. This requires intelligent planning and

effective use of our key asset, that being our people.

Why the Importance of Understanding the Model for Human Capital Effectiveness?

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Why the Importance of Understanding the Model for Human Capital Effectiveness? (cont’d)

Attracting, keeping and engaging our workforce is about:

Achieving our organization’s vision and image in a changing economy.

Attracting, retaining and motivating a talented workforce committed to our organization’s purpose.

Aligning what matters most to employees with achievement of our organization’s strategy and success.

Marketing the story of a compelling place to work in the local community, your organization and with employees.

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Training director: How do you know they need management training? What aren’t they doing now that management training would get them to do?

Line manager: They don’t communicate too good.

Training director: (Thinking “so what?”) Really! Who doesn’t communicate too well with whom? What communication problems have you seen?

Line Manager Well, the number one complaint we’re getting from their subordinates is that they never get any feedback or any advice about how they can advance in this place.

“Joe, you gotta get us some first-level supervisory training. Myfirst-level folks don’t know anything about management.” Typically,the training director will take this request at face value and developor buy off-the-shelf a first level supervisory training program.

Following the advice to “value the problem” before intervening, theConversation might go a few steps farther.

Knowing How to Value our Human Capital Programs – A Training Example

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Training director: (still thinking, “So what?”) Well, is that causing any problem that you can see?

Line manager: Damn straight! I’ve lost four critical skills engineers out of 20 in the last three months!

Training director: (Thinks, ‘Aha, turnover!) How much does an engineer make when he or she leaves?

Line Manager: Sixty thousand bucks.

Training director: You know, studies show that replacing professionals costs at minimum the salary they are making when they leave. If you’ve lost four of them, that has cost the organization $240,000, and if you keep losing them at the same rate, that will cost us $960,000 this year.

Line Manager: (Expletive Deleted!)

Knowing How to Value our Human Capital Programs – A Training Example (cont’d)

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Knowing How to Value our Human Capital Programs – A Training Example (cont’d)

The Training Director has established a baseline cost for a problem that might be helped by management training: turnover due to a lack of performance management feedback and career planning discussions with employees.

More importantly, the Training Director knows how to focus the training to impact on the specific problem.

The potential impact:

If a training program for 20 first line managers costs $60,000, a saving of just two engineers, worth $120,000 – a reduction in turnover of 12.5% - would not only pay for the training but would produce a return of more than 100%.

These make it an easy sell to the line manager.

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Step Labor Outlay

1. Counseling, warning meetings Manager(s) Employee

2. Documenting performance problems

Manager(s) Employee HR Staff

3. Termination meeting Manager Employee HR Staff

4. Exit Interview Employee HR

Out-placement fee

5. Administrative: payroll, security, credit union, unemployment hearings

HR (legal, etc.) Severance pay Unemployment benefits Litigation (legal fees and settlement)

6. Lost productivity during separation period, e.g., absenteeism

Individual Team

Lost productivity, quality problems Overtime, temporary worker costs

7. Cost of position being vacant Team Lost productivity, quality problems Overtime, temporary worker costs

Knowing How to Value our Human Capital Programs – Turnover and Staffing

I. Exit Costs

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Step Labor Outlay

1. Recruiting/Communication of job opening: job description, job posting, advertising, college (and other source) relations

Manager HR staff

Advertisements Travel and expenses

2. Pre-employment Administration HR staff Tests

3. Interviews HR staff Travel and expenses (recruiters and applicants)

4. Hiring-decision meeting Managers HR staff

5. Post-employment administration HR Employee

Relocation: moving, temporary living, etc. Medical exams

6. Orientation HR Manager Employee

7. Training Trainers Employee

Training materials

8. Learning curve Employee Team

Lost productivity, delays, quality problems

Knowing How to Value our Human Capital Programs – Turnover and Staffing (cont’d)

II. Entry Costs

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Knowing How to Value our Human Capital Programs – Getting Selection Right

The value of a selection system is getting good hires while rejecting those who would be bad hires.

What is a good hire?

More productive

Stays longer

How to Calculate this?

Number of Good Hires x Average Salary x Value of Productivity x Years on Job as compared to the same formula for Bad Hires.

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Knowing How to Value our Human Capital Programs – Internal Hirings and Promotions vs. External Hirings

Filling positions from internal hirings and promotions is likely to be more cost-effective than external hiring because:

Acquisition costs are significantly less; and

An internal person’s learning curve is much shorter.

Other benefits include:

Morale and motivation of employees, hence productivity gains.

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Knowing How to Value our Human Capital Programs – Career Planning

The value of career planning is most readily shown by reduced turnover, increased productivity and the number of internal promotions vs. external hires.

Employees who are in an organization and job they like will most likely perform better, are less likely to leave.

“Career counseling and planning programs that get employees to set performance goals in today’s job and developmental goals for tomorrow’s job can increase productivity by 19%” (Latham and Locke”).

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Knowing How to Value our Human Capital Programs –Handling Employee Relations Effectively

Step 1: Manager-Employee meeting

Who Full cost/hour Time Total Labor

Manager $38/hour .50/hour $19.00Employee $12/hour .50/hour 6.00

$25.00End!

Total if manager does handle effectively$25/incident

Manager does not handle effectively-issue goes to HR

Step 2: Employee goes to HR

Employee $12/hour .75/hour $ 9.00HR $30/hour .75/hour 22.00Counselor $31.50

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Knowing How to Value our Human Capital Programs –Handling Employee Relations Effectively (cont’d)

Who Full cost/hour Time Total Labor

Step 3: HR-Manager-Employee Meeting

Employee $12/hour .75/hour $ 9.00Manager $38/hour .75/hour 28.50HR $30/hour .75/hour 22.50Counselor $60.00

Step 4: HR checks with manager and employee

Employee $12/hour .20/hour $ 2.40Manager $38/hour .20/hour 7.60HR $30/hour .40/hour 12.00Counselor $22.00

Total if manager doesn’t handle effectively $138.50/incident 5.5 x more expensive!

Total if manager handles effectively $25.00/incidentSavings Benefit if manager handles effectively $113.50/incident

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Knowing How to Value our Human Capital Programs – Managing Absenteeism

“There is no cost – he or she is getting paid anyhow;” or

“We are paying for that time and not getting any work for this pay, so the cost is a day’s salary;” or

“We are paying salary + health insurance + pension + unemployment insurance etc., so the real cost is salary plus benefits;” or

“I see an empty desk for which we are paying the rent, utilities etc., so the real cost is the full cost of employment;” or

“I still have to get this work done and I have to pay for a temp or pay other employees overtime.”

Scenario – one employee absent for a day. What is the cost ofthis event or the benefits of preventing it?

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Knowing How to Value our Human Capital Programs – Managing Absenteeism (cont’d)

The major costs of absenteeism are:

The cost of time of the absentee employee;

The cost of managerial time spent coping with the absence – rescheduling work, reassigning work, hiring temps, arranging overtime, etc.; and

Out-of-pocket outlay or “opportunity” costs such as lost productivity, delays, missed deadlines, etc.

Absenteeism runs at about 3% of total time paid in USA industry at an estimated $205billion/year. If a 100 employee department with the average clerical employee salary of $15,000 and average supervisory salary of $30,000 can reduce its current absenteeism rate of 3 per year by 10%, there would be a savings of $16,185 per year. Not much you say – add that up across the size of your organization.

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Knowing How to Value our Human Capital Programs – Managing our Classification and Compensation Plans

1. Number of employees: approximately 24,000

2. Average salary and benefits cost/employee: $35,000*

3. Total payroll: $840MM (24,000 Employees x $35,000)

4. Assumed misalignment of classification and compensation that is likely to exist if 5-7 years since plan was last reviewed: 15% of employees*

5. Estimated misallocation of compensation: $126MM ($840MM x 15%)

In addition:

6. Average Rate of turnover for the organization: 12% per year

7. Estimated percentage of turnover caused by compensation issues: 33%*

8. Approximate cost to replace an employee: 75% of the annual salary of the position*

9. Total cost of employee turnover caused by compensation issues in the organization: $24.948MM ($840MM x 12% turnover x 33% compensation factor x 75% of the salaries of the position)

* Assumption (conservative)

The Value Equation

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Knowing How to Value our Human Capital Programs – Managing our Classification and Compensation Plans

1. Number of employees:

2. Average salary and benefits cost/employee:

3. Total payroll:

4. Assumed misalignment of classification and compensation that is likely to exist if 5-7 years since plan was last reviewed:

5. Estimated misallocation of compensation:

In addition:

6. Average Rate of turnover for the organization:

7. Estimated percentage of turnover caused by compensation issues:

8. Approximate cost to replace an employee:

9. Total cost of employee turnover caused by compensation issues in the organization:

The Value Equation (cont’d)

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Creating an Environment Where Employees Feel Valued and Engaged

Tangible Rewards

Inspiration/Values

Quality of Work

Future Growth/

Opportunity

Work/Life Balance

Enabling Environment

Engaged Performance Model

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Perception of the Value of Work

Challenge/Interest Achievement

Freedom & Autonomy Workload Quality of Work Relationship

Competitive Pay Good Benefits Incentives for Higher

Performance Ownership Potential Recognition Awards Fairness of Reward

Learning and Development Beyond Current Job

Career Advancement Opportunities

Performance Improvement & Feedback

Quality of Leadership

Organizational Values and Behaviors

Reputation of Organization

Risk Sharing Recognition Communication

Physical Environment Tools and Equipment Job Training (Current Position) Information and Processes Safety/Personal Security

Future Growth/

Opportunity

Work/Life

Enabling

Tangible Rewards

Tangible Rewards

Future Growth/

Opportunity

Future Growth/

Opportunity

Supportive Environment

Recognition of Life Cycle Needs/Flexibility

Security of Income Social Environment

Enabling Environment

Inspiration/Values

Inspiration/Values

BalanceWork/Life Balance

Quality of Work

Creating an Environment Where Employees Feel Valued and Engaged (cont’d)

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Creating an Environment Where Employees Feel Valued and Engaged (cont’d)

Organizational Personality Clarity of Purpose Understanding of Responsibility Standards for Performance Linkages to Rewards

Employer of Choice Attract Retain Recruit

Engaged People Positive Climate Motivation Enthusiasm and Energy

Engaged Performance Competitive Advantage Employer of Choice Sustain Results

Work Requirements

Individual Motives

and Capability

Good Leadership

Supporting

Management Styles

Superior

Perform

ance

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Lessons We Can Learn from the Worlds Most Admired Companies

The 8 key attributes that are features of the Worlds Most Admired Companies:

1. Innovativeness

2. Quality of Leadership

3. Long Term Investment Value

4. Social Responsibility to the Community and the Environment

5. Ability to attract and retain talented people

6. Quality of Products and Services

7. Financial Soundness

8. Wise use of Corporate Assets

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Lessons We Can Learn from the Worlds Most Admired Companies (cont’d)

What distinguishes the “best” from the rest?

Ability to attract and retain talented people

Culture

Leadership

Performance Management and Measurement

Strategy Implementation

Managing through economic uncertainty

These attributes are not just for success in the private sector – they are key components for success and effective management and utilization of human capital in the public sector.

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In Summary The Old:

Strategy Structure People Process The New

Strategy achieved through People Its not about spending more on our human capital – its about”:

Attracting and Retaining Top Talent Understanding what engages employees

Clear direction from leadersCompetitive RewardsOpportunities to Learn and DevelopTo be ValuedGood Work EnvironmentChallenging WorkFeedback

Investing wisely Being able to calculate the “ROHCI” and sell our value propositions

1 ® west virginia ipma hr fall conference september 29, 2004 human capital – cost vs. investment

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