3. Few Business Executives Understand Return on Human Capital

Measuring Human Capital: Business Executives Perspective on Influence, Standardization and Governance is a dissertation study sponsored by Mercer. It was conducted by Ephraim Spehrer Patrick, a Principal in Mercer’s Human Capital business in Frankfurt, in January and February 2010 with 132 participants from Germany as well as the US, Australia and other European and Middle Eastern countries. This article is a summary of the research findings.

Business leaders frequently state that people are their greatest asset – but in reality, very few of them have the evidence to back up their claim. A recent Mercer study found that while most executives believe that “human capital” (the value of people and what they produce) is very important, far fewer of them measure it or have any idea of the return on their investment.

There are a number of reasons for the discrepancy – not least the difficulty of quantifying the value of intangible assets and of coming up with a standard approach. But growing pressure in three main areas – cost control, corporate governance and sustainability – will force companies to address the issue.

The need to control costs will continue to preoccupy businesses as they strive to do more with less in uncertain post-recessionary economies. As such, they will increasingly be forced to justify spending between 21% and 60% of their total revenue on compensation and benefits, training and development, and other people-related investments, by quantifying the return.

What’s more, analysts and investors view human capital measures as important predictors of a company’s future health – not least because of the significant impact we intuitively know individuals have on customer satisfaction, productivity and revenues. Likewise, more and more questions are being asked about whether the high pay many companies award to their most senior executive correlates with superior performance, or whether it could be contributing to those organizations’ decline.

According to Mercer’s research, most business executives believe that human capital plays a key role in helping their firms achieve results and competitive advantage. More than four in five (83%) respondents think that it has a strong impact on customer satisfaction, 77% feel that it has a strong impact on productivity and 65% believe that it helps increase revenues. Yet this belief amounts to little more than an act of faith. 84% of business executives surveyed admitted to having no more than a moderate understanding of the return on human capital in their organizations.

Respondents also saw human capital as the second most important intangible asset, after customer relationships, in terms of its role in creating and sustaining competitive advantage. But while 95% agreed that intangibles should be monitored closely, nearly 60% admitted that intangible assets in their business are not measured properly.

One of the reasons human capital is not measured properly is that it is difficult to do. Inadequate data support is a factor: Human capital information is often managed on a country, division or business-unit level, when what is required is a companywide system to collate and analyze the information consistently. The technology is available to do this, but it has not been fully exploited.

Another factor is the variable ability and enthusiasm of HR professionals to measure human capital. More than half of the business executives responding to the survey believe that human capital measurement is the preserve of HR, but some of them doubt whether HR is up to the job.

And while human capital measurement could borrow from the methods applied to determine other intangibles – not least brands - a consistent approach is stymied by the significant ideological differences about how human beings and their contributions should be valued. For example, many academics and practitioners believe that qualitative measures – engagement, knowledge and skills, leadership capabilities and so on – are the most pertinent predictors of business health and sustainability, whereas the business executives who responded to the survey believe that quantitative measures, such as compensation, absence and recruitment costs, are equally relevant.

As a side note, a recent government-funded initiative in Germany - the Human Potential Index – sought to create a standard set of measurements that would allow both internal and external audiences to see which organizations were best at managing their people in order to deliver business results. But the initiative foundered because HR opinion leaders and academics believed that it was too prescriptive.

Another key finding of Mercer’s research is that most business executives are unwilling to disclose human capital information to external stakeholders, with fewer than 20% on average prepared to do so. Ironically, while they feel disclosure could undermine their competitive advantage, it might actually enhance it, because at present many research analysts don’t factor a company’s wider human capital assets into their valuations. Mercer’s analysis of the way organizations measure their human capital has led to a number of recommendations.

1. Establish human capital measures on a company level. These should be relevant for your organization and linked to the overall business and HR strategy, but are likely to comprise a mix of qualitative and quantitative measures.

2. Once you have a set of workable measures in your organization, you could start to benchmark them against peers in your industry. Human capital measures are much more industry-specific than geography-specific.

3. Prepare yourself to report selected human capital metrics to external stakeholders, such as analysts, banks and investors, as doing so can have a positive effect on your company’s market value in the long term.

4. While business executives – the chief executive and finance director, in particular – should be involved in determining which human capital measures to use, HR should be the driver and owner of the overall process.

Establishing a human capital measurement and management discipline represents a significant opportunity for HR to be recognized as a strategic contributor to the organization. After all, as the adage goes, what gets measured gets managed, so measuring the return on investment in human capital is likely to improve the way it is managed. At that point, business leaders may say not just that their people are their greatest asset, but also that they are an appreciating asset. And they will be able to prove it, too.³