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Human Capital Return on Investment

INDICATORS OF SUCCESS

 

When I was writing my book Remuneration Management, I decided not to complicate the matter too much, in the hope that whenever I had the opportunity in the future I could come back and develop further the part on the indicators (metrics) of success. Obviously, here I will attempt to merely lift the curtain, moreover I have to admit that I myself am still in the process of studying and improving my understanding of the subject, and the more I explore HC metrics, the more the scope broadens and my questions become more profound.

Businesses pursue financial goals which get monitored by investors or the leaders of the companies themselves whenever decisions are taken for investment or change of business goals. HC investments (staff costs) appear as only a several  numbers in a company’s financial statement, but the productivity resulting from them and how they can affect the return on investment are all questions whose answers may actually improve the company’s financial performance.

True, we don’t yet have the standardized metrics needed to measure how far HR management has achieved a certain level of success. It is also true that the accurate interpretation of data requires the use of at least several indicators, which, however, should not prevent us from seeking and applying the best practices available. The financial downturn has lead to a minor increase, and often even to decline in revenue and profit, which makes analysts in developed economies opt for cost optimization instead. In Bulgaria, the term ‘cost optimization’ is used to conceal actions taken to actually cut costs. A material of the Human Capital Management Institute quotes an article by Tom Davenport (Davenport, Harris & Shapiro, 2010) published in Harvard Business Review, where the authors believe that leading companies such as Starbucks, Limited Brands, Best Buy and others are well aware of the profits which may result from improved employee engagement or talent retention.

With full confidence in the capacity for optimization, measurement, analysis and the taking of specific action, as well as in business development opportunities, the Human Capital Management Institute proposes that a separate sheet called Human Capital Financial Statement (HCF$ TM) is added to the companies’ financial statements to provide data measuring the impact of human capital on financial performance. The proposed HCF$ TM may have the following three parts:

  • Human Capital Impact Statement
  • Human Capital Asset Statement
  • Human Capital Flow Statement

The final formula according to which the impact of human capital’s productivity is calculated looks logical, although somewhat complicated for the Bulgarian situation.

 

Total workforce productivity – http://www.hcminst.com/

Total workforce productivity – http://www.hcminst.com/

 

I do not intend, though, to present here the ideas behind a Human Capital Financial Statement, which anyone interested can see discussed in detail at http://www.hcminst.com/.

Let me just add that throughout my career as a consultant I have often observed my clients’ growing interest when, in the course of a presentation, we come to the topic of Return on Investment in Human Capital. This interest is usually triggered by the discussion of both company data over a certain period, most often several years, and comparisons between the company in question and rivals from Bulgaria and abroad.

In other words, the use of HR management (HRM) performance indicators in developed economies has come to be seen as a key tool in trend analysis and forecasting, providing information needed in strategic decision making and process optimization. HRM experts use the results from the analysis to take action aimed at improving effectiveness, HC return on investment, talent loss risk avoidance, and optimization of the processes used in HC management.

It is hardly a secret that HCM performance indicators are not particularly popular in Bulgaria, the main reasons, in my opinion, being the following: the difficulty in selecting indicators, the laborious process of data collection and analysis, the challenging task of finding rival data for comparison, and in many cases the fact that HC managers simply dislike numbers. To prove that all of the above (except for the last one) are not so hard to deal with, I decided to use an HC ROI indicator for four companies based on publicly available information mostly taken from their annual financial statements. (By way of digression, let me recommend here a web based provider of „hard-to-get information on more than 80 emerging markets “ – ISI Emerging Markets).

Having chosen the brewing industry, I gathered information for the period 2007/2011 for the following companies: Bolyarka VT, Zagorka, Kamenitza and Carlsberg Bulgaria. Out of the broad spectrum of HC productivity indicators, I have chosen

 

Human Capital Return on InvestmentHC ROI.

 

Why HC ROI?

HC ROI is an indicator in which a single figure combines the company’s financial performance (profit and loss) with the amount of personnel costs (investment).

It reveals how revenues, cost control and the efficiency of HCM policies affect each other.

I have come across several HC ROI formulae where higher values stand for higher return, i.e. the company has gained more than the investment it has made in remuneration and social security contributions.

Using the example of Deloitte Bulgaria, I left the companies’ financial revenues and expenditures out, based on the assumption that HC have no direct impact on these.

I use the following formula to calculate HC ROI:

 

(Profit before tax+ Personnel costs) / Personnel costs

The result shows the profit before tax gained by the company per 1 BGN invested in remuneration.

Personnel costs include all costs paid by the employer as cash or in-kind income: salaries, bonuses, overtime, rewards, benefits, social security contributions.

Alternative formulae:

(Operating income – Operating costs)/Personnel costs

((Revenues – (Total costs – Personnel costs))/Personnel costs

In the four publications below I will present annual data used to calculate HC ROI for the four companies in question for the period 2007/2011.

 

Chart one shows the information about Kamenitza. The analysis is available here.

 

HC ROI, Kamenitza, 2007-2011

HC ROI, Kamenitza, 2007-2011

 

Next comes the Zagorka chart.

 

HC ROI, Zagorka, 2007 – 2011

HC ROI, Zagorka, 2007 – 2011

 

To this, we add the Carlsberg Bulgaria chart.

HC ROI, Carlsberg Bulgaria, 2007 – 2011

HC ROI, Carlsberg Bulgaria, 2007 – 2011

 

And finally, the Bolyarka VT chart.

 

HC ROI, Bolyarka VT, 2007-2011

HC ROI, Bolyarka VT, 2007-2011

 

And this is what the combined chart of all of the above looks like:

 

HC ROI in Bulgaria’s brewing industry, 2007-2011

HC ROI in Bulgaria’s brewing industry, 2007-2011

 

Every company has its strengths and areas for improvement; and it is HC professionals’ detailed analysis and skills on which the goals to be pursued and the actions to be taken in HCM depend, so as to maximize the business benefits from it. A focus on advantages as well as a good knowledge and clear vision of how to tackle problem areas are fundamental to gaining a competitive advantage.

Texts in brackets such as ‘not shown on chart’ or ‘data about other HC indicators required’ are an example that in most cases when data are analyzed we need additional  metrics like total profit, profit per employee, comparisons with companies from similar industries operating abroad, personnel costs breakdown by department or activity, sales force efficiency, level of employee engagement, etc.

The indicators I have discussed are in one way or another related to remuneration management which certainly adds to the subject of my book, but one should be aware that there are also very good metrics measuring the various activities which fall under Human Capital management: recruitment efficiency, training efficiency, absenteeism, internal communication levels, personnel costs to revenue ratio, average values per employee for the following indicators: profit, revenue, remuneration, fixed to variable pay ratio, fluctuation of manpower and fluctuation costs, talent retention, level of internal promotions, engagement, payslip costs, etc.

Let us not  forget that such indicators should be used at the macroeconomic level. Claims are often heard that labor productivity in Bulgaria is much lower than that in developed economies, but no procedures are ever proposed to calculate this productivity, nor do we know anything about the specific steps taken to improve it.

 

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HC ROI for Kamenitza, 2007-2011

As a follow-up on the article on Human Capital Return on Investment, below I have presented the Kamenitza chart.  ...

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