Posts tagged ‘ROI’
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.
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.
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:
- you want to compare investment alternatives/projects
- you want to know which elements of a program is adding value and which are not
- 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).
It is impossible these days to open a HR magazine, go to a HR conference or read a HR book without being overwhelmed by terms such as ROI on HR, HR analytics, KPI’s, measurement and Human Capital Management. These buzzwords which are trying to make HR ‘harder’ have really gained acceptance in the HR world today. In many ways, this is a good thing.
The problem with metrics and KPI’s is however, that they actually do work. That is, if you start to measure people in certain ways and you link their pay to meeting those measures they will in most cases try to meet these goals (KPIs) at the cost of other things.
“What you measure is what get’s done” as the old saying goes. It is therefore imperative that you measure the right things.
I was recently inspired by a Ted-talk about measuring performance. The talk was given by Dr. Chris Shambrook who supports organizations with leadership development. He makes the argument that when organizations talk about performance they are usually talking about results. So when you ask a person about how his performance is, what most people think of is results – how well are you doing against the goals set for you. What performance really means is “doing the things you need to do in order to get the things that you want”. He argues that organizations should focus on performance more than results. I totally agree.
I recently wrote about something similar when I advocated that HR also should track effort in the performance management system. Inspired by John Wooden, arguably the best coach in sport’s history, who famously never talked about winning games and wasn’t focused on the points on the board but instead for him it was about sticking to the fundamentals and making an effort to reach your potential. If you do that, he argued, the points will come.
Jon Ingham is a big more cynical when he state that “the easier something in HR is to measure, the more likely it is to be pretty low value”, but I agree with him. It is easier to measure results but HR should be more focused on measuring performance. However just because it is more difficult does not mean impossible. It just means that you should look somewhere else for your best KPI’s.
I freely admit, that I believe HR can add significant value through good analytics, metrics, ‘true’ evaluation and cleaver KPI’s. However I also believe that they are difficult to get right, and if not done properly you can actually do more damage by using ‘ugly’ KPI’s. If you want to do it, make sure you do it right. In that sense I am not a true ‘Demming’ who believed that “In God we trust, all others must bring data”.
By focusing on performance instead of results you focus on how much potential you have and how you need to develop that. That in return will give you more control over delivering your results. Isn’t that what we are supposed to do?
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:
- 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.
- 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.
- 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.
- 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.
- 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.