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Proving the Value of HR
How and Why to Measure ROI
By Jack J. Phillips, Patricia Pulliam Phillips
Society For Human Resource Management Copyright © 2012 Jack J. Phillips and Patricia Pulliam Phillips
All rights reserved.
The Accountability Crisis
John Hamilton, Senior Vice President of the human resources (HR) department at Apex Business Products, was perplexed and a little confused after attending a meeting with the Chief Executive Officer (CEO), Margarita Lopez. She had asked John to develop a plan to show the senior executive team the contributions of the HR function. Although the CEO fully supported the majority of HR programs and services, she questioned the value of a few of them and was concerned about comments from the senior team. As Lopez said, "Our senior execs wonder how much real value is contributed by the human resource function. Some of them think it could be outsourced, or that parts of it could be eliminated altogether. What they want to see," she said, "is a more direct link between your programs and the bottom-line."
As John reflected on the meeting, he was aware of the excellent HR programs at Apex. Some had even won awards from professional associations. He knew that the senior team placed value on the employees' annual feedback, which provided an assessment of job satisfaction, motivation, and commitment of the employees. This process had provided valuable information to help plan HR programs. John was also concerned that Lopez had mentioned making a link between HR programs' and the company's bottom line. In other words, Lopez wanted to know about the return on investment (ROI) for HR programs. John was aware of the ROI concept but had not seen it applied to the HR function and wondered if doing so was even feasible.
John felt confused as he began the assignment. At the next senior staff meeting he would have to present his recommended plan for showing the value of the HR function to the senior management team. He knew he must have specific approaches to show the team to obtain buy-in. Otherwise he would have a tough challenge ahead as he entered the budgeting cycle.
John's story raises several questions:
What possibilities are available for John to show the HR contribution?
What specific types of measures are appropriate for an overall measurement process?
Is ROI feasible in this context?
How does ROI fit into the measurement mix?
Can ROI become a routine measure?
How can John win the support of the senior team?
How can a measurement system be implemented?
Most executives and HR professionals intuitively agree that investing in people and providing appropriate HR solutions and initiatives can pay off significantly for an organization. The problem is that this intuitive knowledge serves only as evidence, not proof, of payoff. Deciding which programs to invest in, how much to invest, and whether a particular HR program provides value is a haphazard process at many organizations.
This cloud of mystery around HR's impact leaves some executives undecided about how much of a commitment to make in terms of time and resources to HR programs. Instead of making a continuous investment in the HR function, executives faced with a lack of tangible bottom-line results tend to resort to sporadic, inconsistent support of certain HR activities that seem to hold some promise in terms of helping the bottom line.
The ROI Methodology presented in this book can be used to show HR staff and other executives the monetary benefits directly connected to HR programs, particularly major programs that are highly visible, strategic, and expensive. This systematic, comprehensive measurement and evaluation process generates seven types of measures:
reaction and satisfaction with the HR program
acquisition of knowledge and skills needed to implement the HR program
application and implementation of the HR program
business impact related to the HR program
costs of the HR program
return on investment in the HR program
intangible measures not converted to monetary values
This balanced approach to measurement includes a technique to isolate the effect of the HR program. ROI is measured with the same formula that the finance and accounting staff use to measure the return on investing in building equipment, for example.
Developing a book for the HR field always involves the difficult task of managing the vocabulary used in the field. Table 1.1 defines some key terms found in this book.
Major Influences on HR Accountability
Several developments — positive and negative — in recent years have influenced the need for additional HR accountability. All point toward a need to know more about the connection between investing in human resources and the payoff of the investment.
The Triple Bottom Line
Much attention has focused recently on the concept of the triple bottom line. Not only must an organization be successful financially, as demonstrated by traditional bottom-line measures, but it must also be successful with its employees and the external environment.
The employee "bottom line" is not readily defined, but it typically translates into the organization having favorable work conditions, treating employees fairly and equitably, and compensating them adequately, while fully recognizing the potential and capabilities of employees in a diverse environment. This measure has stimulated many organizations to search for ways in which to monitor, measure, and even value the employee contribution. Consequently, HR practitioners sometimes feel pressured to address this bottom line, yet they have no clear understanding of what it means. The "external environment" refers to the impact on and interaction with the community, the country, and the environment. Being a good corporate citizen and protecting the environment are two key issues.
Several publications and organizations recognize employers of choice every year or so. One of the most popular recognitions is Fortune magazine's annual list of the "100 Best Companies to Work For." The Great Place to Work Institute has its list of the "Best Small and Medium Companies to Work for in America." Many organizations strive to be included in the rankings. This status enables them to attract new applicants and to retain valuable employees. Pursuing employer-of-choice status often drives HR programs to improve the work environment and to use this standing to promote the organization to potential candidates. This phenomenon is driven by the employee retention issue that became such a critical topic during the 1990s.
The phenomenon has sometimes caused organizations to create too many programs that offer some fabulous new benefit, perk, or unparalleled opportunity. In some cases, the competition for the awards has placed strains on the HR function. Although improved retention and lower recruiting costs can offer significant value, the programs may not add enough value to overcome their costs. A measurement process is needed to show the payoff of these investments when they are substantial.
HR Investment and Macro-Level Studies
Recent studies attempt to link the investment in human resources to the ultimate payoff for the organization, which is often reflected in productivity or profitability. These macro-level studies, which cut across functions within organizations, attempt to correlate the organization's success with investments in human resources.
Criticism of these studies suggests that they do not show a significant relationship or that they fail to show a cause-and-effect relationship. For example, a profitable and productive firm may have ample funds to invest in a variety of programs to make the organization an attractive place to work. This finding does not, however, mean that the investment in the HR programs has led to the profitability.
Take, for example, QUALCOMM, an innovative, successful research and technology firm that holds the patents for much of the wireless communication technology. QUALCOMM has thousands of highly competent employees, and the company is consistently very profitable. The company invests heavily in building an employer-of-choice workplace. QUALCOMM is a regular on Fortune's "100 Best Companies to Work For." But which came first? Did the employer-of -choice workplace generate the profits, or did the profits enable QUALCOMM to afford creating a workplace that merits distinction as an employer of choice? When reviewing macro-level data, such questions abound. Still, putting all criticism aside, these studies represent compelling insights into the power of investing in human capital.
Human Capital Management Focus
The concept of human capital is perhaps overused these days because so much has been written about how to monitor, measure, and value the human aspects of organizations. Nevertheless, much work still needs to be done with this topic. In its early movement, much attention regarding human capital focused in the area of HR accounting — an attempt to account for the value of employees through traditional financial reporting methods. The difficulty lies in the methods for assigning a monetary value on the contribution or capability of human "assets." Although some progress was made, to date very few results and examples have been offered.
The human capital management trend also grew out of early benchmarking work of the 1980s as HR firms began to measure data and compare key indicators. A variety of measures on compliance, compensation, benefits, safety, retention, and absenteeism were developed. Today's human capital measurement mix contains those metrics plus others, such as leadership, innovation, employee engagement, and learning. These new measures are critical to organizational growth and success. The challenge is to identify the appropriate blend of measures that reflects the status of human capital and enables decisions to be made about what to do with them.
Top Executive Demands
Senior executives are asking the HR function to show value. In some cases, human resources is asked to show value or have its budget cut. Sometimes value must be shown before budgets are approved. In a few situations, this concern has led to outsourcing major parts or even all the HR function. For years, human resources escaped this level of scrutiny as employers invested in human capital on faith. They inherently believed that the more they invested in people, the more people would respond to the nature of their work. Today, executives are asking for data.
Few organizations have the courage to admit to an HR disaster. The consequences of a flawed, ill-advised, or ineffective HR practice, program, or strategy can make excellent reading, particularly in the popular press. Unfortunately, a growing number of these stories are making their way into the HR professional publications. An intriguing example is an exposé of the cost of an unwise HR strategy developed by Rent-A-Center. A decision to eliminate HR contributed to a $47 million payment required to settle litigation. The story is a classic one in which imprudent practices and strategies went astray, not only costing an exorbitant amount in direct payment but ultimately destroying the morale of the organization. Although these types of disasters are reported more frequently in the press now, hundreds of others go unreported but probably represent massive mismanagement of human resources.
From an accountability perspective, HR staff has opportunities to add value. If, however, HR programs are mismanaged, the consequences can be negative. Appropriate data are needed to show how well programs are working and to demonstrate their contribution to the organization. A comprehensive HR measurement system can help prevent some HR disasters, thus minimizing losses and changing the image of the HR function from one of a nice-to-have auxiliary department to one of a critical business function that contributes in a positive way to the organization's bottom line.
Perhaps no development has influenced the HR function as much as the advent of technology. Most HR transactions are now automated, including compensation administration, benefits administration, payroll, employee record keeping, recruiting, training, and orientation. Technology has eliminated the need for some HR staff. In certain cases, human resources has been shifted to other areas (for example, finance or information technology), leaving some HR staff disconnected from where the work is often done. On a positive note, technology has enabled collection of vast amounts of data that were previously unavailable. Employee and performance data can be organized, integrated, and reported in meaningful formats, thereby providing HR staff with the tools to measure the impact of the HR function and major HR initiatives.
Outsourcing of HR services has been a visible trend among organizations during the last decade. Outsourcing means good and bad news. The good news is that many routine HR functions — not central to human resource's primary mission or values — can be outsourced. This trend was initiated primarily in the payroll and employee-processing areas but has now expanded to include almost every part of the HR function. In some cases the entire HR staff and processes have been outsourced to external providers who offer the same services.
The bad news is that outsourcing is sometimes pursued for the wrong reasons. HR practitioners fail to provide appropriate data and results to demonstrate the function's contribution to the organization. Sometimes outsourcing brings a short-term fix of immediate cost savings because fewer people earning lower salaries are doing the work. On a long-term basis, however, the result can be detrimental because satisfaction with the outsourced services can deteriorate.
The Accountability Trend of All Functions
The fact that human resources is not the only function being asked to show accountability is somehow comforting to know. Many other functions are undergoing the same level of scrutiny, paradigm shifts, and changes. To be sure, they are all more accountable for expenditures.
Consider, for example, the information technology (IT) function. A few years ago, technology and IT groups had a blank check. They could implement almost any type of new technology, and it would be accepted because of the prevailing notion that technology was a competitive weapon that no firm could afford to be without. Unfortunately, many technology implementations were dismal failures that added enormous costs but did not improve — or sometimes made worse — the very situations they were supposed to improve. In recent years, IT has been asked to show value even before investments are made and then to carefully track the value to make sure that the projections are realized. This scrutiny has caused those responsible for implementing technology to measure not only the ROI but also a variety of other qualitative and quantitative measures, thereby producing a balanced profile of success — the same process presented in this book.
A Paradigm Shift for HR Accountability
The factors described in the foregoing sections have had a sizable effect on HR functions and their attempt to improve the effectiveness, impact, and the overall accountability of the HR function. Because of these influences, three important shifts have taken place in HR functions, as outlined in the sections that follow.
HR Measurement Trends
Table 1.2 shows some of the major measurement trends developing as a response to major influences on the HR function. These trends are shaping the way that HR functions react to major accountability issues. Not only are they prominent in the United States, but they are also reflective of the trends in major industrialized nations, as reported in surveys of HR practitioners and managers in more than 30 countries. These trends underscore the progress being made to bring accountability to human resources.
Shift from Qualitative to Quantitative Measures
Figure 1.1 shows how measurement approaches have evolved in recent years. In the 1960s and 1970s, most measurement was attitude and compliance oriented. This was the time when attitude surveys, case studies, and HR auditing measured the HR pulse. The concept of management by objectives was introduced. Next, during the 1970s and 1980s, the focus was on benchmarking and tracking key items and costs. Parallel with the advent of major benchmarking efforts, HR executives began to compare processes to others and monitor key indicators over which they had the most control.
During this time, organizations also focused on understanding the cost of human resources and on trying to control it in any way possible. Now, in the 1990s and continuing into the first two decades of the twenty-first century, the focus is on value-add and impact. Measurement approaches attempt to show value and to include financial measures. The concept of profit centers, scorecards, and ROI dominate the measurement landscape.
Excerpted from Proving the Value of HR by Jack J. Phillips, Patricia Pulliam Phillips. Copyright © 2012 Jack J. Phillips and Patricia Pulliam Phillips. Excerpted by permission of Society For Human Resource Management.
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