Posts tagged ‘Shareholder value’
My second take-away from the workforce analytics case-studies and conferences I have heard, attended and experience over the last year is what I call the confusion of cost savings and value creation. While the good news is that we are starting to deliver, my warning would be, that we should be careful not to deliver on the wrong things – or more important; on the least value added things. Let me elaborate.
At most conferences and in most reports by leading consultants, we are being presented with a maturity model, which illustrates activities from the least mature to the most. It goes something like this; first there is some descriptive methods, such as reporting and trend analysis, then maturity increases and the methods goes on to being predictive and prescriptive and finally the maturity goes on to machine learning or something like this. One example of such as maturity model is from IBM shown below (but frankly they all look very similar).
I fully agree with the idea of maturity and that prescriptive analysis is better than descriptive. It is also a good way to illustrate this maturity journey albeit they could be a little more operational in terms of assessing level of maturity and suggested next step depending upon current level. However there is one dimension missing from this picture: the focus of the analysis itself. All good at being mature of the methods but we must also assess maturity on the object of our analysis.
In rough terms: If it the focus is on cost savings elements then the potential shareholder creation will always be limited (it will be the net present value of the cost savings minus the investment). If the focus is directly on creating customer value/business value then the potential shareholder creation will be great.
In fact, I will propose, that there is more value added in doing predictive analysis on a business matters than doing prescriptive analysis on an HR matter.
To be clear, let me come with a few examples. If you are analyzing sickness, employee turnover, recruitment effectiveness or training effectiveness, you are really at the cost savings end of the spectrum. There is no harm (at all) in coming up with evidence based suggestions to reducing employee turnover. Indeed for many companies there are significant money to save in doing that. It is however still cost savings and it won’t get you a seat at the table. So do some of that, but don’t put all your efforts there.
At the other end of the spectrum, you are adding workforce data to customer/profit/sales/other business data. Here the examples are less generic as they are (should be) tailored to each company’s specific strategy and situation. A few I have witnessed/been part of: Finding which service behavior adds the most impact to customer experience/satisfaction, and which training programs are most effective in embedding this behavior. In this example, the workforce data leads straight on to more sales and higher profits. Another example; how does change load (employees’ load of change relative to ability to handle change) impact strategy execution.
These two specific examples had a heavy use of non-workforce data as part of the analysis. In fact, you can test your value maturity on the cost/value axis by testing how much business data you have compared with how much workforce data. If you only work with workforce data, you are probably focusing on cost savings rather than value creation.
Some will sometime argue that “Attracting talent is always business critical and therefore what we do is value creating”. That may be true in some cases but they are missing the point. Indirect value creation is important but less straight forward to prove. In most cases they misunderstand HR processes with business matter.
I therefore suggest that we add a dimension to our maturity models. Perhaps some large consultancy company can show how this may look?
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).
I sometimes get asked; why measure Human Capital ROI? This is simple; to be more efficient and more effective and ultimately to add more value.
Unlike any other asset, people have the potential to add value on an exponential scale. For HR to optimise its value creation, it must master two things: doing the right things (be effective – have a strategic focus) and doing them in the right way (be efficient). Peter Drucker in 1966 explained in his famous book, “The Effective Executive”, that, to add maximum value, a function must master both disciplines.
The figure below illustrates how HR must master both. ROI on Human Capital makes at first the HR activities more efficient by asking the question; how we can get more value out of what we do? The second step – being more effective – comes with the realization that you cannot get a lot of value unless you work strategically.
And it matters. The ROI – or value added if you like – increase exponentially with this effort as can be seen below.
The High cost, No impact HR function is an expensive department which does not add strategic value to the company. This department may be large and may be responsible for many initiatives and activities. This may in turn erroneously be mistaken for a well-run department, whereas it is in fact the opposite.
The Administrative HR function optimises its budget, is very cost-focused and always asks itself, “Can we get more for less?” It is very efficient but lacks strategic focus, and therefore has little impact on the business and on the long-term success of the company.
The Impactful HR function has the ability to support the business by aligning all its activities with the strategy of the company. The problem is that it is very expensive, as it is not focused on optimisation. This may, however, be a deliberate decision, and is often the case where the value and earnings of people are very high. In the service industry, this may be in a consultancy company.
The World Class HR function has the ability to align its activities in such a way that it supports the business and strategy of the company and is very efficient, getting as high a return on its investment as possible. The value creation is significant in this type of department. Human Capital ROI will get you there.
I have written before about the pitfalls of ROI measure (read this blog on how to use ROI on Human Capital). It is not without dangers.
Lets face it – most companies don’t measure ROI on their Talent Management programs. Perhaps this is because they don’t know how to, that they know the result will be scary (very negative) or just because they don’t believe in measuring HR. For whatever reason, they are starting from way behind the starting line.
ROI is a simple tool – and also a tool to be used carefully as it has many pitfalls. However, at is core it has two components; benefits and costs. To improve ROI you need to focus on both. These five suggestions will improve your ROI by looking at how to improve the benefits (4 & 5) and how to lower the costs (1, 2 & 3).
- Improve your development program. You can create value by finding ways to lower the cost of your development program associated with the talent program without affecting the benefit of the program. This can successfully be done using e-learning, coaching and action learning which all have significant lower costs than big classroom-based learning programs. While no program should be based solely on any of the above mentioned, the cost of most programs can be lowered without compromising the benefits using these types of components.
- Shorten your program. Going back in the 60’s it was not unusual to find talent programs which had a duration of three years or even more. This has proved to be wasteful for two reasons; firstly, the uncertainty of forecast of talent needs are too high over such a period. You end up with more talent or competencies you don’t need – and that is a serious waste of money. The second reason is that the added benefits of the final year has proved to be lower than its costs. It is simply not worth it. Best to keep programs at a length of 1½ years instead.
- Create more effective assessment centers (AC’s). AC’s are used to select and develop talent. AC has been under a lot of pressure for two reasons; the validity is often very low and they cost a lot. While both issues are real it is possible to make AC’s valid and cost effective. The difference in ROI between a standard AC and a best practice AC is significant. Make the effort to make a good one.
- Add external candidates to your program. Fact is that you will not have enough talent in-house to meet your need for growth and innovation. Instead of spending good money on people who will not be able to develop at the required speed or achieving the right level of competencies you should acquire them from outside. This is cheaper and earns a better return.
- Have a plan for what happens after the program. The single biggest reason for why talents leave after having been through a talent program is that they are frustrated of not getting moved up in the organization or being offered better projects to work on after the program. This must be addressed up front. Studies suggest that the talent turnover can be halved post the program if proper post-program plans are in place.
The first step is however to measure your return on your Talent Management program. This is not difficult, but requires a solid process based upon best practice. Once this has been done then you can find ways to improve your return. The above five categories will get you a long way.
To produce a value-added Talent Management program you need to understand – and avoid the pitfalls of – five popular myths about talents:
1) Talents are easy to identify. Talent are rarely in the position they ought to be in or in a position which reflects their potential. Identifying an organization’s talents require a rigorous assessment processes. Although this requires a great del of effort studies show that it is better to invest in assessment than development of talents.
2) You cannot measure the value of talent management. Wrong. It is possible to measure the ROI on talent programs and the impact on Shareholder Value. By measuring how much value a program adds (or destroys) it is possible to optimize and continuously deliver effective talent solutions.
3) Talent Management is an issue for the HR department. Talent Management must be owned by the top management. They must see it as their most important job to attract talent to the organization. HR is a natural project team for the talent program and will be instrumental in implementing a successful program. But if the ownership is not firmly with the top management it has no chance of making an impact.
4) If we treat our talents well they will be loyal to our organization. Loyalty towards organizations is scarce these days. Talents must all the time feel that your organization is furthering their career and is developing them in a personal and professional way – otherwise they will leave.
5) We always attract talents. Many companies do not believe that Talent Management is an urgent matter because it has not been a major issues in the past. This is wrong. Attracting talents is a burning platform for all organizations today and all studies show that organizations in the Western World will struggle to find the talents they require.
These myths often stand in the way of a successful talent management program. Studies show that only 7% of American companies believe today that they have a Strategic Talent Management program today despite identifying it as being one of the three most important things for the company right now. Lets’ bust those myths.