Posts tagged ‘Value-added HR’
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?
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).
HR analytics promise to give HR better data so they can make better decisions. And who would disagree? If you don’t know your levels of, say, talent turnover, how do you know if you have a problem, which of your current programs work and which don’t etc. In other words, with no or poor data you cannot make good decisions. I totally agree.
The incorrect assumption, which is sometimes made by some in the HR analytics community is, however, that people automatically will (or is even likely to) base their decisions upon good objective data. I would argue this is wrong.
I have previously argued that the concept of cognitive dissonance will actually make people make irrational and poor decisions even faced with good and objective facts. Elsewhere it has been argued that information overload (too much good data) will make people to make emotional or irrational decisions. Studies with placebo effects have also proved that people will act and make decisions based upon (irrational) beliefs rather than facts and data.
To understand why, I think it is important to remind ourselves of the difference between data, information and knowledge (see Davenport and Prusak for more).
1. Data is the fact of the world which can be subject to graphs, tables, statistics etc. They often reside in company’s archives, computers or records. Data do not carry any inherent meaning and more data is not always better as it can be difficult to make sense of raw data.
Examples: We have 5,000 employees, our annual talent turnover is 8.2%, profit per FTE (Full Time Equivalents) is $100,000.
Implication: Human beings cannot base their actions or change behavior on data alone!
2. Information is inferred from data and essentially means that the data has been processed by a human being (or increasing by an intelligent computer) and conclusions are drawn on the basis of the data. Peter Drucker said that information is “data endowed with meaning and relevance”. Some call them “value-added data” – it is sent from sender to receiver indented to change the receiver’s perception of something.
Examples: The talent turnover rate is too high and should be at 4%, our talent turnover is higher than our competitors’ and have been trending upwards
Implication: Evidence from diverse areas such as behavioral finance, social psychology and neuroscience show that people rarely act on the basis of information. Concepts such as cognitive dissonance (and many other) simply override information. More habit-breaking actions are impossible to make on the basis of information whereas more routine and simple actions can be done.
3. Knowledge is inferred from information and is produced by taking information and adding experience, evidence (research, case-studies, theory), contextual information, consequence etc. To produce knowledge requires human beings – it cannot be produced by intelligent software only. It represents our ‘map of the world’.
Examples: Increasing pay levels will not reduce talent turnover in our company but a 2-year talent management program will.
Implication: Knowledge is the only level which will produce ‘real decisions’ and therefore impact behavior in individuals and organizations. HR must take the best possible information and turn it into knowledge before it has the impact it was meant to have. An approach which looks at a mix of experience, values, context and not least (a high degree of) evidence-based research will produce knowledge.
So when we say that HR analytics will enable HR to make better HR decisions we need to understand that it has the potential but it will not necessarily do so. If the data is presented as, well, data then it will have little or no effect. If it is produced as information it may have some but not much impact. If HR analytics can produce real knowledge it will have a profound impact.
The solution is therefore not to remove HR analytics away from HR as has been suggested by some. No doubt that the actual skills of setting up and running an effective analytics department requires skills not present in any HR department today. But removing it too far from HR makes it difficult to use this data and information to produce knowledge. Knowledge is produced by human beings with experience in the subject matter. At least a (very) strong connection between the analytics department and HR must be established.
I freely admit that I believe HR analytics can add a lot of value in any organization. I also strongly suggest that it is only by converting information to knowledge that it can fulfill its promise of being an enabler of better HR decisions.
Measuring HR is important because it is the only way to make HR more effective and efficient. The only way! It does a lot of other things too – such as creating an objective tool to making better investment decisions and it makes HR more credible as a strategic partner for the rest of the business.
The evaluation method must be objective and tangible and preferable use tools such as HR analytics.
KPI’s are important but ultimately I believe that all strategic HR initiatives should be measured using an ROI tool. If you want to work strategic, you need a tool which can tell you if you are creating value. ROI does that. It is not without complications (read about ROI dangers) but I think it is the most appropriate one to use.
There are five common pitfalls when measuring HR using ROI:
- Too complicated. Be careful about making this too complex. Avoid lots of paperwork and too many meetings. ROI is a simple tool. It requires careful thinking about its assumption and what goes into the equation, but it is not complicated.
- No before measurement. Evaluation requires before and after measurements. If you only measure after the activity has taken place you don’t get the full picture and you cannot assess the value creation (here are 3 reasons why not to measure retrospectively).
- Using a standard system. Every organisation is unique – don’t use one-fit-all template. While it is tempting to copy one from another department or company it simply will not work.
- Making measuring HR an end in itself. To measure is not the end – it is a mean. Measuring HR is a mean to create better HR. Sometimes ROI measurements can develop a life on its own and itself become the purpose of the project (read here for why measuring HR is not an end).
- Measure too much. I believe you should only measure a few initiatives. Those which mattes and which have an impact on strategy and overall efficiency. ROI measurements are laborious but potentially very value added. Only measure the few parameters which matters. Apply the 80/20-rule
Measuring HR is an important element of working with HR. Measuring HR is not complicated but also not easy. It requires strategic thinking, good data and a willingness to use the results.
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.
At its very core, the problem is that most succession plans are never used. And if not used, it is hardly a controversial to say, that they don’t add value. Many large international companies spend much time and resources on developing a complete success planning program, which intends to identify a person who will take over if the executive is hit by a bus or suddenly leaves the company. I have never actually heard of the famous bus incident so I guess it is for when executives get fired or leave.
There is today very little evidence to support the view that it adds value to have succession plans for top management level, however some case studies and data suggest that this is more valuable for some middle-managers and many specialists. Maybe that’s where the focus should be.
So what to do for the succession plans to add value?
- Succession planning works best in organisations where there is little change and a high degree of predictability. No wonder then that the term originates from the military. This is true for some organisations but for most the reality is that they experience so much change, re-organization and lay-offs that succession makes no sense.
- The quality of the successors must be very good, which means that a constant gab-analysis and gab-closing exercise must take place. This development project is valid when a successor is needed but wasteful when it is not.
- Management must be committed to use the identified successor (which frankly is not the case today, as highlighted in a recent McKinsey study of talent management).
One possible solution to lower cost and improve returns would be to make a Just In Time Succession Plan. When a job is open, find out who is the most suitable and let that person take the role. If any development is needed post hire then spend the money there.
Finally there is the option of asking a executive search company to always have a list of five candidates ready for all of the top management positions and review the list with the search company on a regular basis.
P.S. I would encourage you to read chapter 5 in “Talent on Demand” by Peter Cappelli for more on this subject.