I argued in a blog last week that ROI is not always the answer for HR. I argued that if it was just about getting approval for a project then ROI was too complicated and time consuming. If on the other hand it is used to make better HR investment decisions and/or to evaluate HR projects then ROI is an excellent tool. In many respects, I am a big fan of ROI but I think you should be aware of the pitfalls of ROI.
One person commented and asked me if I could suggest alternatives to ROI. What a great challenge. Let me therefore suggest three alternatives in this and two coming blogs.
The first alternative to ROI is CROCI – an acronym for “Cash Return On Capital Invested”. I used this ratio intensively when I worked as an financial analyst. In my view, it is a much better ratio to gauge the creation of shareholder value and certainly much better than ROI. Without getting into too much nerdy details, then this ratio takes pre-tax pre-interest operating free cash-flow and divide it with gross capital invested. In some ways it is comparable to ROE (Return on Equity) but the strength of this one is that it is calculated on a cash basis and this is important.
Why would this be relevant to HR? If HR used CROCI it would be forced to think about cash when working out investment returns on HR projects. HR often produce non-cash benefits and this is not always as interesting to a CFO as cash benefits are.
Let me offer a (very!) simple example. You want to improve your annual review processes. This includes investing in an upgrade to the existing software and a 3-hour mandatory training module for all employees. One of the benefits is that each appraisal meeting will take one hour instead of the current two hours. Your company has 25,000 employees. The total one-time cost is $3m (software upgrade = $1.3m, internal development time = $0.2m, time for employees to attend training = $1.5m). You calculate that the annual savings on one hour twice a year (annual review + mid-year review) is $1m, so the ROI over a five year period is 147% or 20% p.a. (based on a 5% inflation). Not bad.
The problem with this is that some of the costs and benefits are cash and some are not. The CFO will ask you where he can draw the $2m you will give him in return. And you can’t. There is no $2m. Most of this is paper money and some is even fictitious. If you are the head of a department and your employees get two hours more each year I doubt that you will see an increase in productivity of two hours a year per employee. On the other hand, if your employees will have to go to a three hour training module in annual review processes you will probably not lose three hours – you will ask them to ‘run a bit faster’ or stay a bit longer at no extra cost.
If you use CROCI instead you will only be allowed to use the cash benefits and costs. This is more real to the CFO and in many ways closer to reality.
The major drawback from CROCI is that it makes it even more complex and difficult to calculate the return on a HR investment. For many, this tool will be too time consuming and non-relevant. In most cases CROCI will be too complex and add little value for HR. But in some cases it will be a better tool than ROI.