Driving Performance Through Enhanced

HR/Finance Collaboration

Effective working relationships across functions — particularly HR and Finance — have traditionally eluded many organizations. A siloed approach won’t work in the future. July 2013

Driving Performance Through Enhanced HR/Finance Collaboration 1

If the U.S. recession focused companies chiefly on fiscal restraint, the recovery is putting growth back into the strategic equation. Amid strong (if still somewhat volatile) stock market performance and increasing consumer confidence, organizations across many industries are weighing various growth strategies and actions to boost performance and ensure they can meet critical revenue and profit projections. Along with the improving climate comes the need to recalibrate the balance between cost management, a perennial focus for fiscal health, and talent management.

We’re already seeing senior leadership teams organize around the increasing convergence of business, financial and human capital objectives. Growth depends, after all, on a competitive cost structure on the one hand and an appropriately sized and skilled workforce on the other. Among the key questions leaders need to consider:

• How will our business goals and strategies change over the next three to five years?

• What cost pressures will we continue to face? What level of performance do we have to deliver, and what’s the best way to achieve that?

• What do we need from our workforce, and how much do we have to invest — and in what areas — to achieve these goals?

• What should our return on that investment look like — in terms of productivity, engagement, retention or other key behaviors — and how can we consistently measure and manage reward return on investment (ROI)?

These are not questions any single part of an organization can or should consider in isolation, especially given the complexities of today’s global market for business, labor and capital. The right answers depend on joint decision making that reflects and prioritizes across a multiplicity of views — from those managing the business day to day to those responsible for its employees and HR programs, to those overseeing its fiscal structure and soundness. While effective working relationships across functions — particularly HR and Finance — have traditionally eluded many organizations, a siloed approach won’t work in the future. The interdependencies and complexities between financial, risk and human capital issues are just too great for virtually any business today.

The good news is that we’re seeing signs of greater collaboration between HR and Finance. But how fast and how broadly does this need to take place? What are the obstacles to overcome and what are the advantages of a genuine collaboration of equals in helping drive an organization’s growth and performance agenda?

Success Through Partnership

“We found surprising commonality in the views of Finance and HR in many areas, indicating a strong foundation on which the two functions can unite around a mutual cost, risk and talent agenda, and build an effective and sustainable partnership for the future.”

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A Solid Foundation, but More Change Necessary

To understand the trend, Towers Watson recently surveyed 340 senior HR and Finance executives about the cost, risks and ROI of their reward programs, and the nature of their own relationship. (See About the Survey, inside back cover.) We found surprising commonality in their views in many areas, indicating a strong foundation on which the two functions can unite around a mutual cost, risk and talent agenda, and build an effective and sustainable partnership for the future. In fact, both respondent groups agree they already work together in several key areas, and both see more collaboration in their future.

Our top findings at a glance:

• ROI is a serious consideration for both functions and an area ripe for improvement.

• Both groups agree people play a critical role in driving performance, although some differences emerge in how to maximize this role through incremental investments in rewards.

• Both groups also have similar views about the top risks of their reward programs, citing inadequacies in leadership development, retention programs and their level of investment in talent. Both also expressed concern that their reward programs were not sufficient to drive the level of innovation needed in the future.

• Top priorities for both groups in the next three years are aligning and differentiating rewards relative to performance, supporting both productivity and cost management goals.

• Pay issues currently draw the most attention from both HR and Finance, but there is an opportunity for enhanced collaboration in benefits, given both the magnitude and volatility of the costs involved, and required plan changes, especially in health care.

Set strategy for reward programs

Set workforce strategy

Determine changes to reward programs

39% 41%

35% 23%

43% 42%

More collaboration in the next three years49% 70%

Develop annual budgets46% 62%

Finance agrees HR agrees

HR and Finance agree they work together, but how much and on what varies considerably.

Snapshot: Collaboration

Driving Performance Through Enhanced HR/Finance Collaboration 3

Building successfully on this existing foundation will require change from both functions, particularly in understanding each other’s challenges, biases and capabilities. Recognizing and respecting the very real impact each function currently makes on the organization is a necessary first step in seeing how collaboration can increase that impact. A joint approach to achieving talent goals at an affordable cost ensures the organization has the capabilities it needs within a competitive overall cost structure. It gives Finance a clearer view into why certain investments are critical and what outcomes they drive. It helps HR understand where the fiscal pressure points are and how to optimize value for cost in shaping effective talent and reward programs.

Aligning Rewards to Drive Enhanced Performance

If there’s a critical rallying point for HR, Finance and business units, it is how — and how well — the organization drives the behaviors and outcomes it needs from its people. Do the functions and business units work collaboratively to ensure their people programs are designed to deliver a direct and measurable impact on financial performance? Is there is an appropriate return on the investment the organization is making in its people, in terms of their productivity, behavior and performance? In other words, how well are programs aligned to business strategies, objectives and the drivers of value for the business?

Based on our survey results, both sets of respondents see fairly good alignment between reward programs and financial goals, although somewhat less alignment (at least in HR’s eyes) around talent goals. Given five-plus years of relative austerity in program investments, this isn’t surprising. But it does underscore the need to recalibrate alignment on the talent side of the equation.

Reward programs aligned with talent goals61% 60%

56% 61%

Reward programs aligned with financial goals64% 74%

Finance agrees HR agrees

Snapshot: In or Out of Alignment?

Investment in rewards produces acceptable ROI

Executive incentive programs structured to discourage excessive risk taking

58% 74%

60% 71%

Reward programs instrumental in driving behaviors/ actions needed for profitable growth

57% 58%

Rate of increase in rewards is manageable

HR and Finance are surprisingly in synch in certain areas, but view cost and risk-related issues differently.

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For many organizations, total rewards expenditures (the combination of pay, incentives, health care and retirement benefits, training, and related workplace programs) dwarf many other corporate investments. In the U.S., health care benefits alone have become such a sizable percentage of the total rewards package that, in some companies, they’ve crowded out even annual salary increases. Both HR and Finance have a shared, vested interest in ensuring that this growing expenditure is allocated efficiently and yields a desired return, whether measured in employee and organizational productivity, talent retention, employee engagement or other metrics.

Executives often believe they’re not getting the return they need on their reward investments. Employees may not see or appreciate the value of what they’re receiving in the aggregate from the organization. Programs come to feel like entitlements that don’t drive the right behaviors. The link between rewards and behavior may be unclear or poorly communicated.

Total rewards optimization (TRO) is a rigorous, analytic tool that addresses and corrects alignment between reward spend and desired corporate outcomes. It combines employee trade-off analysis (pinpointing what really matters to people) with portfolio optimization to present a set of efficient investment allocations. This analysis illustrates how various changes in

programs (improvements or cutbacks) will affect specific employee behaviors being tested and identifies the precise impact on company costs (net increases or decreases) relative to the changes in behavior.

Through this process, TRO answers three critical questions for HR and Finance:

• What’s the right overall level of total investment in rewards?

• What’s the best way to allocate that investment across reward elements to maximize the employee behavior we want to influence?

• How do these results vary across targeted employee segments (whether by business unit, age, job level, tenure, skill group, location, performance or other categories)?

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The Art and Science of Optimizing Rewards

“Total rewards optimization (TRO) is a rigorous, analytic tool that addresses and corrects alignment between reward spend and desired corporate outcomes.”

Driving Performance Through Enhanced HR/Finance Collaboration 5

Of greater concern is the relatively lackluster level of agreement by both functions (61% for HR and 56% for Finance) that their programs produce an acceptable return on investment. We’d expect to see far higher agreement on a key point like this, especially considering the importance of demonstrating ROI on virtually any significant corporate investment. It’s indicative that both functions recognize and have concerns about some degree of current misalignment, particularly in defining specific expectations for employee behaviors and performance.

The fact is, alignment is not a one-time or one-off activity. Rapid shifts in business strategy often outpace related programmatic changes. The drivers of business value may change — without corresponding changes to performance goals or incentive programs. Well-intentioned programs — such as a new performance management system — may produce unintended (and sometimes adverse) consequences, necessitating quick fixes that don’t hold up over time.

Maintaining alignment between workforce programs and business strategies requires repeated assessment and monitoring from HR, working closely with both Finance and business units. It’s the only way to lay the foundation for achieving desired ROI and ensuring a high value-to-cost ratio. In the end, HR and Finance both need to feel comfortable that the monetary investment in workforce programs is appropriate for the outcomes being achieved, and that can only occur when the two functions bring their respective views together. (See the Art and Science of Optimizing Rewards, page 4.) And without formal and regular checkpoints, it’s difficult to achieve desired levels of performance on a sustained basis, whether for individuals, business units or the enterprise overall.

“Maintaining alignment between workforce programs and business strategies is the only way to ensure a high value-to-cost ratio.”

incentive programs rewarding

“HR must initially work to attract the top talent that brings new dollars in the door, and Finance must help manage those dollars to further leverage our advantage”

“Making sure incentive programs are rewarding the right people for the right financial results”

“Forecasting workforce needs, accounting for the contingent workforce, managing workforce costs, workforce planning”

“Ensuring we provide competitive benefits to employees while e�ectively managing the explosive growth in costs”

“Informing strategic planning with workforce data and trends”

“Driving performance accountability”

manage dollars

Forecasting

accountabilityattract top talent

plan

ningdata

trends

right financial results

provide competitive

benefits

HR

Financeco

sts

In Their Own Words: What respondents cited as critical shared priorities:

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This analysis shows management the interrelationships among various operational and financial metrics, and helps identify the levers to pull to impact results. In a specific company situation, management would see exactly how the company’s performance in each area compared across quartiles to that for a defined peer group. Among the questions this can help answer:

• What are the cost/benefit trade-offs between different improvement opportunities? • What are the key metric(s) to measure the effect of improved performance? • What systems exist today to monitor/track these metric(s)? What influence can different employee groups have on each metric?

Realignment starts with a key question: What does the business need to achieve, and how should it structure rewards to achieve those goals and drive the right actions and behaviors from employees? Among the related questions: Are key performance indicators clearly defined and connected to the performance management system? Does the organization have a performance scorecard that considers performance across workforce, operational, customer and financial metrics?

Do employees understand the business model, the key performance indicators and how the organization makes money? Do they have a clear sense of where their role “sits” within the organization and which of their day-to-day activities matter the most to its success? Do employees in risk-heavy roles such as investment understand the scope of their responsibilities? Are they inadvertently being rewarded for risky behavior? Do managers have the training, tools and motivation to recognize and appropriately align rewards with

individual performance, both good and poor? Do performance management programs and incentives create appropriate line of sight to key performance indicators?

Two important tools in addressing these issues are value-driver analysis and value trees. (See illustrations, below and on next page.) The former identifies the financial metrics that drive value for the organization as a whole and compares its performance with that of selected peers to translate business strengths and weaknesses into specific workforce and rewards opportunities. Value trees cascade those enterprise-level drivers down through the organization, basically deconstructing high-level metrics into component job-specific actions and behaviors essential to achieving financial, customer and operational goals. Used together, these tools not only provide a clear strategic direction for the senior team, but offer an equally clear line of sight for employees from their work to the broad strategic agenda.

Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

Value-driver analysis 1: Defining the greatest opportunities for improvement

SG&A as a % of Revenue

Net PP&E as a % of Revenue

Long-term liabilities as a % of

Revenue

Receivables as a % of Revenue

Inventory as a % of Revenue

Capital Turnover

RONA(Pre-Tax)

OperatingMargin

Accounts Payable as a % of Revenue

Cash & ST as a % of Revenue

Revenue Growth

Labor Expense as % of Revenue

Working Capital as % of Revenue

Net Other Assets / Goodwill as % of

Revenue

COGS as a % of Revenue

ILLUSTRATIVE

LEGEND ABC Bold%75th Percentile %50th Percentile %25th Percentile %

StrengthsAreas for Improvement

Driving Performance Through Enhanced HR/Finance Collaboration 7

This analysis continues to deconstruct the broad drivers of business value into more specific operating processes and actions, helping identify very specific interventions in terms of cost reduction, revenue growth or process improvement.

This final example completes the “deconstruction,” showing the wide range of factors (from employee skill, to packaging procedures, to extent of on-time delivery) that are the ultimate targets for greater efficiency and effectiveness in order to improve results at the enterprise level.

This analysis expands the view into people-related costs, again showing how various costs combine to impact broader business metrics, and (in an actual case) including competitive quartile data to better understand the company’s position in its industry. This analysis can help determine:

• Which areas of people cost impact SG&A and Cost of Goods Sold and to what extent?

• Are there better ways to allocate people costs to drive growth?

• What actions could better optimize the reward mix?

Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

Value-driver analysis 2: Determining key people cost drivers

COGS (as a % of revenue)

SG&A (as a % of revenue)

Operatingmargin

Labor expense (as a % of revenue)

Cash compensation expense (as % of

revenue)

Benefits expense (as % of revenue)

Short-term incentives (as % of cash

compensation cost)

Retirement (as % of total benefits expense)

Health care (as % of total benefits expense)

Revenue growth

LEGEND ABC Bold%75th Percentile %50th Percentile %25th Percentile %

StrengthsAreas for Improvement

ILLUSTRATIVE

Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

Tonnage Sold

Average Market Price/Ton

Conversion Costs

Cost of Goods Sold

Total Net Revenue

Cash Tax Rate

RONA

Subordinate Drivers Primary/Secondary Drivers Business Driver

Capital Turnover

Net PP&E

Net Working Capital

Goodwill & Other Assets

Supplies

Cost of Scrap and Other Raw Materials

Warehouse Staff Payroll Costs

SG&A

Warehousing/Delivery Costs

Scrap CostsYield

Plant OverheadDivision Payroll

Market ShareOrder Backlog

Other Revenues

Gross PPE

Accumulated Depreciation

Current AssetsCurrent Liabilities

Primary driver

Subordinate driver

Secondary driver

Corporate Allocation of SG&A

Selling CostsDepreciation

Yield

Freight Costs

Value tree 1: Deconstructing a high-level value driver

Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

Value tree 2: Primary and subordinate drivers

Employee Knowledge of Steel Making Process andCustomer Specifications

Types of Equipment and Technology

Mill Capacity

Customer Demand

Truck Residence Time

Packaging

Product Mix

Quality

Customer Service

Customer Satisfaction

Subordinate Drivers Primary Drivers Business Driver

Employee Skill at Handling Steel-Making Equipment

Process Control Mechanisms

Cost of Product

Conversion Costs

Material Costs

On-Time Delivery

Product Identification

Geographical Location of Plants

Material Yield

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The Linkage Framework In Practice Percentage of total respondents reporting use of metrics for reward ROI

Improving ROI Demands the Right Metrics

The majority of our respondent organizations are measuring reward ROI, most typically with financial metrics (like labor cost as a percentage of revenue) and at least one other type of metric. But very few — just 11% of the total sample — reported using all four of the measurement categories that form the basis for a balanced scorecard (shown below).

Yet in one of the most interesting findings from the survey, those 11% also reported better outcomes than the rest of the sample, particularly in terms of reward alignment and adequate ROI. Specifically:

• 84% of this group reported strong alignment with financial goals, compared with 71% of those using only financial and workforce metrics and financial metrics alone.

• 76% of this group reported their reward programs produced an acceptable ROI, compared with 68% of those using just financial and workforce metrics and 56% of those using only financial metrics.

• 76% of this group also agreed their reward programs were instrumental in driving the behaviors and actions needed from employees, compared with 63% of those using financial and workforce measures, and 58% of those using only financial measures.

While this is a good illustration of the truism that what gets measured gets managed, it also speaks to the importance of a holistic approach to measurement that explicitly recognizes the important linkages that exist from workforce and reward programs, to employee behavior in day-to-day operations, to customer behavior and ultimately to financial performance.

53% 47% 27% 64%

Workforce Operational Customer Financial

56% 48%

6% 21%

69% 57%

Finance agrees HR agrees

Snapshot: Types of Metrics Used

of all respondents use financial metrics

of all respondents use workforce metrics

53%

of all respondents don’t measure rewards ROI at all

12%

64%

Driving Performance Through Enhanced HR/Finance Collaboration 9

Leadership

Reward programs

Talent management

Learning and development

Internal communication

Engagement

Retention

Productivity

Customer service

Customer satisfaction

Customer attraction

Customer retention

Portfolio penetration

Revenue growth

Labor/Operating cost

Operating margin

Net income

ROA/ROE/ROIC

Assets/Liabilities

Total shareholder return

People programsand process Employee behavior Customer behavior Financial

performance

Think of this linkage framework (illustrated below) as the mirror image of value-driver analysis. In the latter, enterprise goals are deconstructed into unit and individual activities, and cascaded down through the organization via a comprehensive goal-setting process to ensure that employees know what’s required of them. The linkage framework, by contrast, supports connections across the organization. It starts with an examination of workforce programs — rewards, communication, performance management, career development — and considers the extent to which those programs help produce the right behaviors and performance. Do they encourage high employee engagement? Do they incent desired contribution levels? Do they present a compelling value proposition to keep people at the organization?

The next link focuses on how employee behaviors affect customers. Are satisfaction levels where they need to be? How loyal are customers? Do they purchase across the product or service line? Is word of mouth positive?

The final link in the chain is financial results — a direct outcome of customer behavior. Are sales and revenues up? Is the business operating profitably? If operating costs are cutting into profits, where do the problems lie and what changes are required in which parts of the chain to achieve desired margins?

By explicitly connecting metrics from the bottom up and the top down, companies can ensure there is appropriate alignment across the organization. Employees understand why and how their role contributes to stated business goals and how their own performance will be assessed and, ideally, see the link between their rewards and successful achievement of goals. Communication of metrics, establishment of specific individual goals and ongoing performance management also depend on managers who both understand their own roles and goals, and can articulate the organization’s goals in a meaningful way so employees see the linkage.

The Linkage Framework Connecting the dots from people and programs to business results

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Narrowing the Gap on Benefits

When it comes to HR and Finance collaboration, the benefit arena is prime turf. HR relies on retirement and health care programs as key elements of the employee value proposition to help attract, retain and manage the flow of talent. Finance pays close attention to the costs and cost volatility of pension programs and the annual cost increases of health care programs. Both can have a large impact on an organization’s bottom line.

Now, external factors, particularly health care reform, are raising the stakes for benefit design, delivery and funding. As public exchanges open for business in 2014, organizations are rethinking their health care strategies for active, part-time and retired workers. Plus, a looming excise tax hitting in 2018 is adding to pressure to manage costs effectively and avoid triggering the tax. While many companies may not rush to the exchanges for their active employees, the new options for retirees — particularly pre-65 retirees — can be immediately appealing and a potential game changer.

It’s an issue tailor-made for HR and Finance collaboration, given the magnitude of the costs and liabilities involved and the personal consequences for both current and future retirees. The move from defined benefit to defined contribution plans shows no signs of abating, leading to a sharp increase in the number of workers without the security of a pension plan, and much uncertainty for those employees as well as their organizations.

These issues highlight important differences between the HR and Finance perspectives. HR more strongly believes the rate of increase in reward programs is manageable, while Finance believes that reward programs will enable predictable retirement patterns and the orderly exit of talent. Moreover, and somewhat surprisingly, a greater percentage of Finance than HR executives also believe that increasing investment in health care and retirement benefits would create more value for their organization.

The need for a greater common understanding exists now and will become only more urgent in the future. A good starting point is agreement on alignment, metrics, ROI and risks of benefit programs. And a dual perspective and partnership on these issues will offer many advantages, not only to ward off any potential adverse impact, but also to use benefits as a positive differentiator in the years to come.

Currently, 40% of Finance executives

say they work most closely with HR on

benefits, compared to 57% of HR

executives who say the same about working

with Finance.

Yet, just 23% of Finance respondents

and 32% of HR respondents said they

currently work most closely on retirement

benefit issues — even though only 49%

of Finance executives and 38% of

HR executives feel their current reward

programs enable their company to manage

retirement patterns and ensure an orderly

flow of talent through the organization.

On the retirement side comes a wave of

boomer retirements, with 10,000 or more Americans becoming eligible for

Social Security and pension benefits in

one form or another every day.

Driving Performance Through Enhanced HR/Finance Collaboration 11

Inadequate retention of people/skills required for growth

40% 49%

34% 50%

Inadequate development of future leaders44% 60%

Finance agrees HR agrees

HR and Finance have very similar views about key risks and top priorities for the next few years.

Snapshot: Risks and Priorities

Top risks of current reward programs

Inadequate investment in talent for critical roles

Top priorities for the next three years

More clearly differentiate rewards across talent segments

37% 56%

38% 43%

Increase linkage of rewards to company performance

40% 48%

Increase linkage of rewards to individual performance

Setting Priorities for the Future

With both functions generally agreeing more collaboration is in their future, what do they see as their likely joint agenda? One focus may well be people risk — an issue that struck a common chord on both sides. Both respondent groups identified the same three top risks related to reward programs, and all related to inadequate development, retention or investment in talent. The other critical focus —also related to managing these risks— is improved differentiation of individual performance and linkage of rewards to both individual and corporate results. Both goals are closely connected and support the twin needs of optimizing reward spend and ensuring investments are allocated in the right ways, for the right people (e.g., top performers and high potentials) to deliver the right value-to-cost ratio.

The time is right for an HR/Finance partnership. Both functions face related challenges in dealing with the realities of a global, highly interconnected economy. Technology, changing consumer behavior and demographics are reshaping traditional business models and affecting organizations’ cost structures and skill needs. Business risks have magnified as organizations move into emerging markets with minimal infrastructure and deal with increased political and social instability in various parts of the world.

Aging populations are putting additional pressure on retirement programs and costs, and posing labor risks as well, as older employees stay in the workforce and gaps emerge in finding sufficient supplies of new skills. Sources of skilled labor are slowly shifting from the developed to the developing parts of the world, raising the ante on what it takes to attract and retain critical talent, and keep diverse and dispersed workforces engaged and productive. Those organizations that stay ahead of these massive shifts will be the ones that break through their traditional silos and bring together their experts in developing human capital, managing and investing financial capital, and keeping the business engine running efficiently.

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A global auto manufacturer’s complex organizational structure, paternalistic culture, generous benefit plans and diverse talent pool had yielded a costly reward structure that was affecting its competitiveness in the market and its ability to maintain its loyal customer base. As a starting point, the company had to identify ways to reduce costs and improve the efficiency of its pension and health care benefits, while enhancing the attraction and retention of key talent. Rather than approach the problem piecemeal, the company undertook a strategic review of its total rewards strategy, drawing on insights gleaned from business results, executive interviews, employee focus groups and benchmarking analyses. It then developed a new philosophy and guiding principles better aligned to its business strategy, particularly its productivity, innovation and growth objectives.

Results

The company developed a multiyear implementation strategy that gradually phased in major changes in programs. It began by establishing a shared services function to provide more consistency in rewards across its many business units. Then, it developed a plan for phasing out the defined benefit pension plan, closing it to new entrants and giving employees

choices among other plans. Compensation programs were redesigned to better align with the marketplace for high-potential employees in pivotal talent pools. In addition, the company developed a new bonus program that places more emphasis on personal and business performance. Next, it will consolidate its health plans to leverage cost savings and administration efficiency. New talent management, and learning and development programs based on the organization’s core values are currently in the development phase.

Impact

Through this work, the company was able to rationalize its total rewards investment, and resize and reallocate monies to ensure it was spending on the right programs in the right ways. That is the essence of reward optimization. Specific outcomes included:

• Improved employee performance and engagement • Reduced benefit costs and volatility • Streamlined, and more efficient and effective administration • Improved associate understanding of total rewards • Improved ability to attract and retain critical talent • Enhanced associate mobility

Case Study: Reward Alignment Yields an Optimized Program

About the SurveyWe undertook this survey of senior HR and Finance executives to evaluate how the functions are collaborating today and the extent to which they recognize the strong connective tissue that ties their respective domains together. We conducted the survey with Forbes Insights in the first quarter of 2013, and drew responses from 340 executives representing global (51%), international (23%) and domestic (26%) organizations. The survey cut across industries but drew large samples from financial services, health care and manufacturing.

Copyright © 2013 Towers Watson. All rights reserved.TW-NA-2012-28883

towerswatson.com

About Towers WatsonTowers Watson is a leading global professional services company that helps organizations improve performance through effective people, risk and financial management. With 14,000 associates around the world, we offer solutions in the areas of benefits, talent management, rewards, and risk and capital management.

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