I sometimes get asked; why measure Human Capital ROI? This is simple; to be more efficient and more effective and ultimately to add more value.
Unlike any other asset, people have the potential to add value on an exponential scale. For HR to optimise its value creation, it must master two things: doing the right things (be effective – have a strategic focus) and doing them in the right way (be efficient). Peter Drucker in 1966 explained in his famous book, “The Effective Executive”, that, to add maximum value, a function must master both disciplines.
The figure below illustrates how HR must master both. ROI on Human Capital makes at first the HR activities more efficient by asking the question; how we can get more value out of what we do? The second step – being more effective – comes with the realization that you cannot get a lot of value unless you work strategically.
And it matters. The ROI – or value added if you like – increase exponentially with this effort as can be seen below.
The High cost, No impact HR function is an expensive department which does not add strategic value to the company. This department may be large and may be responsible for many initiatives and activities. This may in turn erroneously be mistaken for a well-run department, whereas it is in fact the opposite.
The Administrative HR function optimises its budget, is very cost-focused and always asks itself, “Can we get more for less?” It is very efficient but lacks strategic focus, and therefore has little impact on the business and on the long-term success of the company.
The Impactful HR function has the ability to support the business by aligning all its activities with the strategy of the company. The problem is that it is very expensive, as it is not focused on optimisation. This may, however, be a deliberate decision, and is often the case where the value and earnings of people are very high. In the service industry, this may be in a consultancy company.
The World Class HR function has the ability to align its activities in such a way that it supports the business and strategy of the company and is very efficient, getting as high a return on its investment as possible. The value creation is significant in this type of department. Human Capital ROI will get you there.
I have written before about the pitfalls of ROI measure (read this blog on how to use ROI on Human Capital). It is not without dangers.