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The ultimate definition of Human Capital

If you Google “definition of Human Capital” you will be surprised and overwhelmed. It is a vast and contradictory  amount of definitions you will get. And frankly not very helpful as they don’t explain exactly what it is. For example, if you look at Wikipedia under ‘Human Capital Management’ you will find that it redirects to ‘Human Resource Management’. To them it is the same thing.

To me, the definition of human capital is: “all strategic issues of people, performance and culture in an organization”. This is still vague and broad so let me elaborate. This is probably best illustrated in the figure below. HR can be viewed from three levels; strategic, tactical and operational. While it is important to get all three right, it is the strategic element which encompass Human Capital.

The definition of human capital includes two things; the strategic framework and the core strategic activities. This is illustrated in the figure further below.

The strategic framework is the set of principles and guidelines to which all strategic HR activities should adhere. They should be documented and implemented in such a manner that they are aligned with the company’s own mission, and operational so they can be used in the HR processes. The framework covers;

  1. HR strategy which must be totally aligned with the company’s strategy.
  2. Performance culture. All companies have a culture, but not all promote high performance and superior customer service. While HR is not the bearer or primary shaper of a company’s culture, it is up to HR to design and implement activities so they promote such a culture.
  3. Measure & evaluate. HR must measure and evaluate its initiatives constantly in an objective and tangible way. By using tools such as HR Analytics, HR can make better strategic and people-investment decisions, thus making HR more efficient

While all HR activities have an strategic and an operational side to them, there are some activities which are more strategic by nature. Activities which HR must get right to master Human Capital Management and they are core to the definition of Human Capital.

  1. Leadership Development. Leadership Development is a must-win battle any organization. Leaders shape the culture of the organisation and make the processes stick. Leadership Development must involve top management participation to underline its significance. Leaders, at all levels, must be able to guide and motivate based upon human understanding, respect and responsibility – competencies which must be constantly developed.
  2. Performance Management is one of the most effective strategic HR activities. Research show that it is directly linked with: 1) higher profits; 2) quicker execution of company strategy; and 3) reduced employee turnover through higher engagement in their work. Goal alignment also makes it possible to establish a true pay-for-performance culture by linking reward systems with both individual and team performance. Also, performance management serves both as a clear measure of individual performance and development, and also provides a clear pipeline to talent identification and succession planning.
  3. Talent Management. ‘The War for Talent’ is continuing with increased speed despite the current global slowdown. According to The Economist, Board members in global multinational companies single out the ability to attract and retain talent as the single most critical catalyst for growth today. Talent Management is a range of continuous processes and development programs that aim to identify, attract, retain, engage and intelligently deploy the best employees in order to become the future leaders on all levels – a leadership and specialist pipeline.
  4. Employee Engagement is widely recognized to be major driving force behind many business outcomes. Research clearly shows that engaged employees are more productive, more profitable, more customer-focused and more loyal. Improving engagement requires a constant focus on changing behaviors, processes and systems to anticipate and respond to the organisation’s needs. Improving engagement means measuring and analysing the level of engagement. It is not possible to improve what you cannot measure.
  5. Succession Planning has two main purposes: one is to mitigate risk by having emergency successors identified, to step in when needed; the other is to have a longer-term development view of how positions are filled. The advantages of doing this well are anchored in business continuity. An effective, proactive succession plan leaves the organisation prepared for the loss of key employees, and prepared for growth, filling new jobs and employee promotions.

This was a long post on the definition of Human Capital but I think it is important to get right. I would be happy to be challenged on the above.

16/12/2011 at 10:53 7 comments

Human Capital move stock prices

I went to a very interesting event in London a few weeks ago. It was arranged by Human Potential Accounting and the event was titled “The Future of Investment: Human Capital”. A panel composed of people from different parts of the investment community – private equity, regulators, pension funds, investment banks etc. – discussed how much they use Human Capital when assessing the value of companies. The topic is ever relevant and interesting.

When I think back upon my time as financial analyst in London, I remember that a lot of our valuations was based upon gut feeling. This gut feeling (should PE be 15x or 17x) had a great impact on valuations and much of it came down to Human Capital. It was soft, people stuff such as ‘ability to execute’, ‘trust in management’, ‘aligned organization’, ‘ability to change’ and ‘ability to innovate’. I never tried to put an exact value on these things, but I would write things such as “I do not believe the management will be able to deliver on this strategy” or something like that.

About 80% of the market value of a stock is not accounted for by the tangible assets on the balance sheet. In the early 80’s this figure was closer to 40%. So clearly the intangible value matters more today that they did 30 years ago. Human Capital is without doubt one of the most important intangible assets.

So when people ask “is Human Capital actively used in valuing stocks today” the answer is both ‘yes’ and ‘no’. No, I never see an explicit value put on any parts of Human Capital and it is never capitalised on the balance sheet. But ‘yes’, people issues matters a lot when investors, analysts and companies assess the market value of a company.

13/10/2011 at 13:33 1 comment

HR due diligence just got a lot harder

 M&A due diligence is important. Very important. Dependent on which study you read, 60%-85% of all mergers and take-overs do not deliver the financial and/or strategic benefit it was expected. The due diligence process is supposed to assess if the deal makes strategic and financial sense AND if the two companies together can execute the process so the benefits can be reaped. And if it doesn’t – then to cancel the deal. Well, as the numbers show – it does seem to work.

The financial due diligence is often rigours and plays a major part of the overall due diligence process. In many cases it is the only due diligence which is really performed.  But judging by the failure rate of M&A’s – it does not appear to be enough.

How can the success of M&A be improved? Answer: HR due diligence must play a bigger role than they do today.

Four things will improve the M&A success rate:

  1. HR must be involved earlier. HR is usually only involved in the second half of the pre-deal stage. Usually after the financial and legal due diligence.  That’s too late. HR should be involved at the first stage of a deal.
  2. HR due diligence must go deeper into the organization. Many HR assessments only deal with the top management level. Many talents and key people are however based further down the organisation. Also, many practical  integration problems occur at the middle-manager level. This level should also be included.
  3. HR due diligence must be more comprehensive. Many assessments are limited to a few superficial HR metrics (number of employees, union membership, staff turnover, pension liabilities, compensation plans etc.). This is partly because HR is involved too late. Becoming more comprehensive also means adding more types of data, which could include behavioural data, cultural information and engagement levels.
  4. HR must use more professional methods and processes. A proper, professional and value-added HR  due diligence must be based upon a strict and rigorous process where relevant parts of the company is x-rayed, objectively measured and assess in specific relation to being able to execute on the successful integration of the two companies. Nothing more. Nothing less.

04/08/2011 at 19:06 Leave a comment

3 reasons why not to measure retrospectively

It is tempting to measure retrospectively – but try to stay away from it.

You may have just held a course or completed a successful leadership training program. Or you are finding that your talent management program is being well received. Now you want to show that it added value to the business by measuring retrospectively. Don’t.

I can think of 3 reasons why you should always start your measurement before the program:

1. True evaluation requires a before measurement.  Paul Kearns (http://www.paulkearns.co.uk) highlights that pre-training evaluation work – establishing how the activity is going to add value to the organisation and obtain performance measures for each trainee before the training starts – is the most important in any evalution process. I couldn’t agree more.

2. It is too easy to ‘adjust reality’ when doing it retrospectively. To reconstruct an original intend is always difficult – when you are trying to evaluate it is even harder. You must be able accurately to reconstruct the true context, behaviour and results from the time before the activity in order to assess the progress. You may have data going back in time but it is more difficult to reconstruct the original intend. (see this White Paper from Kirkpatric Partners: here)

3. Measuring is also about assessing if the activity should be done or not. Measuring is not an end in itself – it is a mean to create better HR activities. An important benefit of doing all the hard work before the program is to make adjustments so the outcome is strategically focused and create the most shareholder value. If you only do post-activity-measures then you don’t get all those benefits.

In short, measuring and evaluating is great but do it right – true evaluation starts before the activity is launched.

10/06/2011 at 08:45 3 comments

Do you really know how to measure Engagement?

You want to increase productivity, lower employee turnover and absenteeism and make your company attractive so you can attract the best talent. Fine. This you can measure with ease.

Then you decide that you want to improve on the results and you need to find out what should be improved. How do you decide what to measure?

When I studied psychology, I was told that ‘Motivation’ was a concept mostly used in the 80’s, that ‘Job Satisfaction’ was the most robust measure in Industrial Psychology and that ‘Commitment’ was about to become the most important. Since then has ‘Engagement’ become the new measure  of choice and now it appears that ‘Motivation’ is back again – completing the circle.

Most of these concepts are measured through surveys. But do you know what questions to ask if you want to know about one concept rather than the other? In other words, do you know what you measure?

You might say; “Well does it matter? All I want to know is, if the people are happy and enjoying work”. Actually it does. Research shows that these different concepts correlate (very) differently with different outcomes. In a bit (too) general terms, if you really want to know about employee turnover, it is best to measure ‘Commitment’ or ‘Job Satisfaction’. If you are more interested in productivity then measure ‘Engagement’ or ‘Motivation’.

Bottom line: Measuring is not difficult. It is harder to find out what to measure and how to interpret what you have just measured. Be careful.

01/06/2011 at 13:56 2 comments

Human Capital in Financial Statements

Looking through financial statements today it is clear that there is a huge gap between what companies say are their most important asset – people – and what they report in their financial statement – tangible assets, products etc. Financial regulators – such as SEC and FSA – as well as stock exchanges are not much better. They demand certain items to be in the financial statements but not one demand information about people. This is amazing when you consider that more than 80% of the market value of the average S&P500 company is intangible assets i.e. above the book value of a company.

I think a major reason has to do with the fact that no credible standard has been put forward. If a company wanted to show the value of their software developers, sales people and marketing departments as well as receptionists and top managers how should they account for this? By number of people? By total cost of the people? And how do you show investments into this asset base and what about depreciation of it? Does CROIC (Cash Return On Invested Capital) make sense for people or do we need completely new metrics? I just don’t think they know.

Luckily a bunch of really good initiatives are underway to try to come up with standards for accounting for people. An interesting White Paper about this topic can be downloaded here:  http://hcminst.com/articles/

I believe it is very important to come up with global standards for financial accountability of human capital. Today it is impossible for investors to have any feel for the quality of software developers at company X compared to company Y. The financial accounts today simply does not begin to describe this important asset base. How should investors and owners understand what they have invested in?

26/05/2011 at 20:44 1 comment

Measuring HR is a mean – not an end!

I was speaking with an executive HR person the other day. He told me that one of the things he measured – and which was a KPI for him – was the response rate for the semi-annual employee satisfaction survey. His target was 90%. At the time when I spoke with him the response rate was only 80% and he was telling me all the things he needed done to get the response rate up to 90%. He had to find out which departments had low rates and speak with the head of each department. He had to send individual reminders out the employees. He would write about it in the next edition of the internal personnel magazine. He was even considering getting the CEO engaged in the project.

There is nothing wrong in aiming for a high response rate in a employee satisfaction survey. However,  it is worth questioning the motive behind such as wish. Surely the goal is to create a high(er) level of job satisfaction. The mean is therefore to perform a survey to understand what the level is and why it is low (or high) and what should be done about it. A good survey can do that. But the survey is not an end in itself – it is a mean to understand what to change to increase job satisfaction.

For the purpose of finding out what the satisfaction level is in the organisation and why it really doesn’t matter  if the response rate is 80% or 90%. I seriously doubt that the remaining 10% will say something completely different. Statically it has little influence. So the KPI should not focus on the response rate but on the outcome i.e. job satisfaction.

The wrong focus can lead to the wrong actions. This HR executive is about to spend a lot of energy on improving the response rate instead of increasing the job satisfaction. A waste.

18/05/2011 at 14:22 1 comment

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