Posts filed under ‘Human Capital ROI’

The number one problem with ROI in HR (and other such metrics)

ROI in HR problems

I am convinced that ROI can offer significant value to HR. ROI can make HR better by making better investment decisions and improve evaluation of activities. Also ROI can show how HR adds shareholder value. In theory at least. Because ROI has a lot of problems.

The number one problem is that ROI calculations are not used as they should. Never. Ever.

In many HR departments a business case is made before any new initiatives are approved. The expected return on investment is also included. This is good. The expected benefits are identified and estimated together with the expected costs (usually easier to identify). If the ROI is positive – as it usually is in these cases – the program may be approved. Here ROI is used ahead of the program to get a budget.

The value of doing ROI estimation is however not in the business case, but in the evaluation of the program afterwards.  You evaluate the program versus your expectations – and then you get valuable insights into how to make the program more efficient and effective. Also you get a good feeling for how to make realistic ROI estimations in your future business cases (something very few are capable of) which will make them more trustworthy.

But, I have only met a handful of HR executives and companies where they have actually calculated the ROI post of the program. The fact is that most companies do not evaluate the value of their activities and initiatives. Once the budget has been approved the interest in the ROI estimation completely disappears.

The reasons are many, but usually they have something to do with lack of resources (“do you know how much it costs to evaluate a talent management program?”) or lack of incentive (“we’ve got the funds, who cares about evaluation”) or even ability (“we don’t know how to do it”).

This way of doing things typically favors those, how are good at making models with impressive benefits and those, who can convince others about their assumptions rather than those, who can make realistic assumptions and execute well. Implementing well is not rewarded.

While this may be true for all kinds of ROI-like measures – and there are many good alternatives – I believe that ROI is especially prone to this misuse.

So my advice is; either follow-up on your pre-program estimated ROI or don’t do it at all. Frankly, it is a waste of time.

11/04/2013 at 13:32 5 comments

3 alternatives to ROI in HR – Part 3

ROI is used more and more in HR when justifying or evaluating HR projects. But it has at the same time come under a lot of criticism for being too difficult to use in HR. The first alternative I suggested was another financial ratio – CROCI – which may be better due to its focus on cash and the balance sheet. But while it is a much better ratio than ROI, it is more complicated to use. The second alternative was friction & flow, which is highlighting that HR should create flow and remove friction allowing employees to get on with their day-to-day things. This alternative is very common sense (its strength) but very vague (its disadvantage).

My third alternative is trying to measure HR’s strategic relevance. To understand why, let’s take a step back and ask “what is the purpose of HR?”. What is the ultimate outcome of the services HR provides? I am not thinking about HR’s activities (recruitment, annual appraisals, talent management etc.). So answers like “To hire the best talent” or “To retain our best people” are not good answers. They are ‘means’ not ‘ends’ purposes/goals. I am thinking about HR’s true and ultimate purpose.

For me, there is only one purpose for HR, which is to: “support the vision and strategy of the company”. This can be followed up by “…by hiring, developing, deploying and retraining the best talent and creating an environment for high performance “. In other words, an HR activity has value if brings the company closer to its strategic targets.

So my third alternative to ROI is what I will call the “Strategic Value Index” (made up for the occasion). It goes something like this. Any HR initiative will get a number of points – from 0 to 100 – based on how strategic and impactful it is.

Two examples may illustrate the index:

  1. Imagine a succession management program. It is designed to identify emergency and long term successors for top 100 managers, identify skills gaps for the long term successors and create individual development programs to fill these gaps. The design is excellent but in reality it does not work. The long term successors are not used with a position becomes available and the development programs are seldom effective. This program will get a Strategic Value Score of, say, 40. It will get a lot of points for a great design, being strategic in its set-up, but very little for execution. In addition, the program has an annual total cost of $1m, which gives a Strategic Value Index score of 40 (40/1.0).
  2. The second example is an upgrade to the annual assessment days for graduates. Each year, 100 graduates are invited to the annual assessment days with a prospect of a job. 25 young hopefuls are offered a job. The current selection process is not good (close to random). An upgrade will align the company’s strategic competency needs with the exercises and selection criteria of the assessment centre. The Strategic Value Score is,  say, 20. The program gets a lot of points for being strategic, its ability to align competency needs with recruitment criteria but does not get many point for impact. The upgrade will cost $100k, which gives a Strategic Value Index score of 200 (20/0.1).

A program should only be approved if it is above the dotted line on the graph to the right. If there are more programs to choose between, the program which is furthest above the line should be approved (best value for money). In the above example, of the two programs HR should choose the upgrade to the assessment centre.

Strategic Value Index

The advantage of this tool is, that it rewards strategic impact, which is really important. Better to do a smaller program which gets the company in the right direction according to its strategy than creating a monster of a program which has no strategic value.  A second advantage is that it is relatively easy to measure AND you can use it in case you want to evaluate to investment decisions. ALSO it is an excellent communication tool with you C-suite.

This index does not really exist. I just made it up. But perhaps it should be used?

18/10/2012 at 15:38 2 comments

3 alternatives to ROI in HR – Part 2

Alternatives to ROI in HR

In this series , I look at alternatives to ROI in HR. I was asked to come up with alternatives since ROI is sometimes met with some resistance. In my last post, I argued that CROCI is an excellent alternative to ROI if you are looking for an even better financial ratio. It is better because it also focuses on cash and balance sheet items.

But perhaps it is worth asking the question: Is ROI in HR worth the ROI? You often need a tremendous amount of time and resources when measuring intangible activities like human behavior. And frankly is this measuring process worth it? If you calculate how much time goes into the whole process, it is likely you will have lost any savings the project generated.

In my view, the answer is that ‘yes’, sometimes it is worth doing a ROI on a project but for many (most) project it is not. For a talent management project you should always do a ROI, but for 10 leaders doing a leadership workshop it is probably not worth it.

So you need an evaluation system, which on one hand is simple and easy to use but also give you valuable information on which you can base decisions.  An alternative to ROI is then perhaps not a financial ratio but perhaps something else. Something very basic.

So my second alternative to HR is flow & friction.

I was inspired by the Harvard Business Review article written by J. Craig Mundy called, “Why HR Still Isn’t a Strategic Partner“. It is a great article in many ways, but in this article he writes about flow and friction: ” Of every action you take as an HR leader, ask this simple question: does it cause friction in the business or does it create flow? Friction is anything that makes it more difficult for people in critical roles to win with the customer. Flow, on the other hand, is doing everything possible to remove barriers and promote better performance”. Excellent stuff.

When you are faced with an investment decision you should use friction as the primary evaluation criteria. For example; should you upgrade your appraisal processes, should the IT department go on a course to upgrade their SAP competencies or should you send your middle mangers on a coaching program? Your choice of program should be the one which creates most flow or removes most friction.

11/10/2012 at 15:52 2 comments

3 alternatives to ROI in HR – Part 1

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.

Alternative to ROI in HR

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.

04/10/2012 at 09:48 3 comments

ROI is not the answer in HR

ROI in HR

ROI has become such a buzz-word for HR practitioners and not least for HR consultants.  You cannot read an article, a book or a blog about HR without it being there somewhere. It has become the holy grail; If the consultants can show that their service has a high ROI they can sell more. For practitioners it is more about selling their ideas up in the organization (read: to the CFO).

In other words: my claim is that ROI is really just something HR use to get approval and budget for projects and for consultants to sell their projects. The assumptions don’t have to be right, they just have to be good enough to get it though the people who approve budgets. And if that is how it is used then ROI is not the answer.

Don’t get me wrong I believe ROI is a great tool for HR to use (if used right). When I was working as a financial analyst I always tried to measure the shareholder value. For a financial analyst ROI doesn’t work – it is too simple (others such as Enterprise Value, Return On Invested Capital, Return on Operating Free Cash Flow and Cash Return On Net Capital Invested are all more appropriate). But for HR I actually do believe that ROI is the best tool for HR to use.

You should only use ROI when:

  1. you want to compare investment alternatives/projects
  2. you want to know which elements of a program is adding value and which are not
  3. you want to evaluate if a program has added financial value.

For these three things, ROI is great. But don’t use it just to get projects past your CFO. There are much better ways to do that.

The problem with ROI is that it is very sensitive to a few assumptions and if you tweak them a bit in the project planning stage you can easily end up justifying anything. And we don’t want to go there again. So please understand that ROI is a serious evaluation tool – and a good one at that – and not a forecasting tool (others are better).

24/09/2012 at 20:25 6 comments

Cognitive dissonance and HR Analytics is a bad cocktail

HR Analytics (or workforce analytics) promise to give HR executives better data to make better decisions. The potential of analytics is however easy to evangelize and difficult to achieve. I find two psychically challenges with workforce analytics especially interesting; the problem with too much information and the problem with making wrong decisions even with the right data.

The first problem is eloquently described by Jeremy Shapiro, who in his recent post writes about “cognitive load“. Here he points out that too much information will make us make decisions which are either emotional driven or irrational. He use research from neuroscience to back this up. I agree with his point completely when he writes that “know what decision you are asking someone to make. What information is needed to make that decision? Keep that data, and strip out the rest”. In other words; although analytics can provide you will ton of data don’t use it all, but keep it down to the essentials. (Check out this TED-video to see how this can be done with medical data).

The second problem is however a bit more problematic. I would propose that data in itself – even in the right measure and presented the right way – will not necessarily lead to better decisions. Why? This is explained by the social psychological concept called “cognitive dissonance”.

Cognitive dissonance is essentially the discomfort we feel when we have two conflicting cognitions (beliefs, emotional reaction, values and ideas). Take for example the doctor who is smoking. He knows that smoking is bad for his health.  He may even know the exact science behind all the health problems smoking can cause but he continues to smoke anyway. If the doctor does nothing, he will continuously feel bad about his smoking habit – he will be plagued by guilt. However, because we humans don’t like this feeling  we will add a cognition to relieve us of this pain. In this example, the doctor can do several things: He may ‘accidently’ find research which questions how unhealthy smoking really is. He may conclude that smoking relieves him of his stress at work and therefore is worth the potential problems he may suffer later. He may conclude that because his father smoked all his life and didn’t suffer of any medical problems that he is genetically immune to smoking-related health problems. Whatever he choose to do, the doctor will create a belief that can make him live with his smoking habit.

In short, cognitive dissonance will create a bias for a certain decision despite other factors such as facts and evidence may favor the alternative. So even if HR executives are faced with facts supplied by analytics, it does not mean that he/she will use that data to make better decisions. Not if that data will create cognitive dissonance.

Let’s look at a simple example: The head of Talent Management has been presented with evidence which suggests that the current talent program has no tangible impact on productivity and talent turnover. Analytics is also able to show that the ROI on the program has been negative the last three years. However, the head of TM has not only designed and approved the project but she has also told the board of its successes and won praise for them. This presents her with a problem as the data suggests that she has not done her job well. The analytics data should now be used to change the program or to scrap it altogether, but it may not happen. The head of TM will have to find a way to live with this cognitive dissonance and not make that best decision.

So what to do? Social psychology theories suggests ways to overcome this bias. You can find a good overview on Wikipedia. Essentially, I believe a solution is to have a CAO (Chief Analytics Officer) who is powerful enough to challenge HR on the results. If analytics is a sub-department of HR or a non-powerful support function, the decision maker can get away with some of the typical cognitive dissonance strategies (avoidance, distortion, reassurance, confirmation, re-valuation).

Analytics is not a end it itself – it is a mean to create better HR decisions. Cognitive load and cognitive dissonance may stand in the way unless it is proactively dealt with.

23/05/2012 at 14:22 24 comments

5 myths about the hardest thing when measuring ROI on HR

Measuring ROI on HR is not difficult. In fact, with some training anyone can master this. If you know how to do it right, it is really all about planning, persistence and probabilities. However, at (at least) one point during the process, you will be left with a question which goes something like this: “How much of theses benefits was the result of this project and how much was due to other factors?”. This is the problem of isolating the impact of the activity.

The problem of isolating the impact when measuring ROI on HR is real but it should not – as many do – lead to the conclusion that you therefore cannot measure ROI on HR. You just need to overcome the issue.

In every HR project there will be a multiple of factors which influence the outcome. You create a talent management program and subsequently the turnover of talent fall. How much is explained by the talent management program and how much is due to general higher unemployment rates (and therefore fewer jobs for talents to leave for)? You send your middle managers on a training program in effective communication and subsequently the job satisfaction goes up. How much is due to other factors such as spring arriving, generous pay increases, general increase in job satisfaction across the country, the fact that your product has improved and your customers are more happy? Isolating the benefit is tricky.

Jack and Patricia Phillips write in their book “Show me the money”, which I will recommend to anyone wanting to embark on the journey of becoming better at doing ROI on HR, about common myths when isolating the impact of the activity. I believe there are five myths:

  1. The project is complementary to other activities and projects and therefore we should not calculate ROI on this project. All projects complement each other. So do all investments across the business. This is not a reason not to look at the individual components. Indeed if done well, this will actually show the value of how they complement each other.
  2. Estimations adds no value. During the process of isolation you will need to make certain estimation based upon experience or ‘best guesses’. Although this should only be done when there are no other alternative, it can provide value and credibility.
  3. There is no control group so therefore we cannot isolate the impact of this project. The best way to isolate the impact is though a control group. No doubt about that. Control groups can prove cause and effects. But this is often not possible to use such a design. Correlation studies can be used instead although they do not prove cause and effect. They may make the link probable and this is good enough in many cases. The challenge is make the conclusion as credible as possible.
  4. It is obvious how this links to shareholder value, so we do not need to isolate the impact for this project. I hear this so often. “It is so obvious that the leadership development program adds value – just look at the strategy map” . Unfortunately this is not the case. Stakeholders may conceptually understand it but they are more willing to accept it when they see the proof.
  5. Others don’t do it – let’s ignore it. 10 years ago, you could have ignored it. You could have pointed out that the isolation issue made it impossible to do a ROI calculation on your HR activity. No longer.

ROI on HR is not difficult. But there are a few steps in the process, which requires more attention and care than others. Isolating the impact is one of them.

22/02/2012 at 10:25 2 comments

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