Assessment & Evaluation
Published April 2007

The ROI of HR
Patrick Kulesa


"The people component of a business" is a popular phrase in today's organizational lexicon. But to what extent do an organization's people contribute to its success? What is it about people that matters?

For many years, business leaders have recognized that the human capital of an organization is a vital competitive advantage. But just how the people contribution is analyzed, quantified and used to achieve business goals varies substantially from one company to the next.

Studying the specific steps companies take to understand human capital provides guidance for any organization that seeks to maximize its return on the talent in its ranks. Recently, global employee research and consulting firm ISR surveyed 100 senior executives, managers and human resource professionals. Ninety-one percent of respondents said their company uses some measurement related to human capital.

Figure 1 shows the frequency with which specific human capital measures are reported in use. More than half of those surveyed said they track employee head count as human capital metric. Although a very limited measure, increases in head count presumably reflect greater value obtained from human capital, and decreases in head count reflect less value obtained.

After head count, respondents indicated an index derived from employee opinion surveys is the next-most popular technique for assessing human capital. The assumption in this case is that more engaged and satisfied people contribute a greater amount to bottom-line performance. Other traditional human resource metrics round out the list, including training hours, absence, retention and work overtime.

These results suggest there is no strong consensus on the best approach to measuring human capital. The high frequency of metrics from employee opinion surveys suggests this method can provide especially useful feedback and is worth a closer examination.

The indexes developed from employee surveys include measures that reflect the extent of employees' engagement, commitment or satisfaction. Most popular are measures of engagement, which reflect the bond or attachment between the employee and the organization.

Engaged employees possess many potentially profitable characteristics, including support for the goals and values of the company, pride in being associated with the firm and strong intentions to stay with the company and exert extra effort to help it succeed.

Surveys can include a small set of questions, which in aggregate reflect the level of employees' engagement — both across the company overall and within important subgroups. How engaged do employees need to be to provide a return on human capital?

One approach is benchmarking. The most useful benchmarks for comparison include companies in the same industry sector or with operations in the same countries. An additional benchmark includes ISR's annual study, which tracks the engagement levels of U.S. companies that have above-average financial performance. This group of high-performance organizations consistently exceeds averages for U.S. employees on engagement questions.

As shown in Figure 2, results from 2006 indicate employees from high-performance companies are more likely to express favorable opinions on engagement questions than employees in the United States generally. The gaps range from 4 percent to 6 percent, suggesting more engaged people are a characteristic of financially successful organizations.

What benchmarks alone do not provide is the ability to quantify the financial performance gap between companies with high versus low levels of engagement. By comparing engagement levels and financial success across time, this gap can be studied directly.

ISR tracked the performance of 41 global companies across a three-year period. By examining engagement scores across the full set of organizations, companies were split into those with high and low levels of engagement. Three-year change in financial performance between companies with high versus low engagement was compared directly.

As shown in the Figure 3, organizations with high engagement saw improvements in operating margin and net profit margin of 2 percent to 4 percent, and those with low engagement saw declines in those same metrics of about 1.5 percent to 2 percent. Increases of up to 4 percent over three years can equate to millions of dollars in improved profitability for the types of large multinationals included in the study.

Company performance is just one level at which human capital can be studied — within organizations, the financial performance of individual work units typically is tracked quite closely. Engagement levels might be correlated at the unit level with performance to study the impact of more engaged people on unit-level performance within a single organization. Referred to as linkage research, this approach can provide statements of the return on human capital at the unit level.

To illustrate, a branch network within a large, global financial services company studied the link between expressed levels of engagement and performance versus sales targets — a critical measure of financial success. Engagement scores from an employee opinion survey were collected before the period during which the sales targets were studied.

To explore the engagement-performance link, the 477 units across the network were divided into deciles, representing performance versus the network average for employee engagement. Average sales versus target was then calculated for each decile. As shown in Figure 4, branches with above-average employee engagement enjoy higher-than-average sales versus target. By examining the difference in performance across deciles, each 3 percent improvement in engagement can be linked with a 1.4 percent improvement in sales versus target.

Engagement certainly is not the only measure of employee opinion that might be derived from a survey of employees. Such surveys often include a range of measures that reflect both perceptions of immediate work experiences and the overall functioning of the organization. Any of these measures can be correlated significantly with better company-level or unit-level performance.

In the branch network just described, an employee survey measure of talent management correlated with greater earnings per full-time employee, another metric of financial performance.

Branches with above-average opinions of talent management enjoy higher-than-average earnings. By examining the difference in performance across deciles, each 4 percent improvement in engagement can be linked with a 1 percent improvement in earnings.

The specific topics of opinion included in an employee survey can vary widely but are often designed to reflect the major strategic priority or priorities an organization is pursuing. For example, consider a high-tech company that relies on its developers to continually create software solutions to take to market. Such a business model requires a culture designed to maximize the flow of innovative ideas from its people. Its ability to see returns on human capital depends on idea development within its ranks.

This strategic priority has direct implications for the types of topics to be measured in an employee survey, benchmarked externally and included in linkage research. In particular, a company focused on innovation as a strategic priority would want to measure opinions of topics such as: support for diversity of thought, collaboration, tolerance for risk taking, rewarding innovation and bias for action (i.e., taking new ideas forward to execution).

In contrast, consider a manufacturing company that relies on its production capacity to meet deadlines for product delivery to clients. Such a business model requires not a focus on generating ideas but rather a healthy obsession with efficiency of operations. Its ability to see returns on human capital depends on smooth operations that ensure deadlines for just-in-time delivery.

This strategic priority suggests a different set of topics to be measured, benchmarked and analyzed in linkage research. Specifically, a company focused on efficiency of operations as a strategic priority would want to measure opinions of topics such as: physical working conditions, workload/resourcing, clarity of priorities, employee training and performance management.

Just as no two organizations are alike, no two approaches to the most critical human capital metrics should be alike. Strategic survey design ensures the metrics obtained from employee surveys are relevant to corporate strategy, taking human resource data right to the strategic heart of the business.

Many other human capital metrics besides employee opinion survey indexes are in common use. Although not an exhaustive list, these metrics can be grouped into four broad categories:

• Human Resource Metrics: training-to-staff ratio, external training expense, training hours per employee.

• Talent/Capability Metrics: percent of critical roles filled internally, percent minority staff.

• Compensation Metrics: payroll-to-revenue ratio, total compensation expense.

Separation Metrics: involuntary turnover rate, absenteeism.

As with employee survey indexes, these alternative metrics of human capital can be measured regularly, benchmarked against other organizations and examined as drivers of performance in linkage research.

ISR recently completed a benchmarking study of global high-performance organizations. Data in all four categories of metrics were collected from multinationals that consistently exceed their sector averages for net profit margin and return on invested capital.

The study's findings reflect the diversity of approaches to human capital in use today. For example, within the high-performance organizations:

• The mean for average hours of training per year per full-time employee is 29 hours, with a minimum of eight hours and a maximum of 60 hours.

• The mean for the percentage of critical roles filled internally is 68 percent, with a minimum of 50 percent and a maximum of 96 percent.

By benchmarking against these broad measures of human capital, as well as indexes of employee opinion, an organization can determine how well its human resources are positioned to provide return on investment and the extent to which its practices are consistent with top organizations.

The relationships between these human capital metrics and indexes of employee opinion also can be studied directly. For instance, within high-performance companies, opinions of training are significantly linked with actual training hours per employee per year. Specifically, companies with more favorable opinions of the availability and effectiveness of training provide nearly 10 hours more training per year than companies with less favorable opinions.

Understanding how these diverse metrics link with financial performance can reveal how the inter-relationships among seemingly disconnected measures drive business success.

Once research insights related to these linkages are uncovered, what steps can companies take to ensure they appropriately act on the intelligence? Organizations typically employ one or more of three approaches to address human capital findings:

1. Share Best Practices: Managers from units with effective human capital practices meet with managers from units performing relatively poorly to share best practices and transfer knowledge.

2. Set Targets: The results of Figure 4 can be used to determine the level of engagement achieved by units in the top-performing deciles. This level of engagement can be selected as a long-term or medium-term target for other units to meet. Incentives can be provided for incremental improvement to the level of engagement at which the performance advantage appears to emerge.

3. Workplace Interventions: Building on the results of linkage research, organizations can develop interventions to improve specific workplace issues.

What does the future hold for efforts to increase human capital initiatives' ROI? Two growth areas suggest themselves.

First, more companies should be expected to expand beyond head count and employee opinion survey indexes in their efforts to study human capital. Companies are starting to track more regularly the kinds of metrics shown toward the bottom of Figure 1, and these frequencies should increase, along with efforts to benchmark these metrics and incorporate them into linkage research.

Second, evolve models and conceptualizations beyond the engagement of employees to their overall sense of well-being. Recent ISR research shows companies with more employees classified as "energized" — both highly engaged and able to manage job stressors effectively — outperform other companies financially, which suggests that promoting a more general sense of employee well-being is a competitive advantage.

Further work in this line of research and others will continue to reveal the complex connections between human capital and business success.
Patrick Kulesa is the global research director for ISR, where he specializes in organizational research, including the drivers of employee engagement and turnover.


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