Posts tagged ‘Financial community’
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:
- 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).
- 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.
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?
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.
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.
I was recently asked an interesting question by a friend about how the world looked like if my overall vision for HR was fulfilled. How, did he ask, would he be able to see the difference between now and the desired future.
My overall vision for HR is that I want HR to be totally business orientated, be the engine behind growth and innovation and get the credit it deserves for adding significant value to the business.
While I was thinking, I was reminded of a thought I had while I was working as an investment analyst in London. Whenever a company presents itself to the financial community – and thereby their owners – it is always represented by its CEO and CFO. They would talk about strategy and numbers and argue why their company was best positioned for the future. I always felt that it was wrong that HR was not represented. HR is – our should be – much better placed to know and tell their owners how the future looks like. Also financially. Achieving the strategy and meeting the budget comes down to the behaviour of the people in the organization and the combined skills of the people. HR know about that – not the CFO.
So a tangible difference between now and my desired future would be, that companies in the future are represented by the CEO and CHCO (Chief Human Capital Officer) when communicating with their investors.