The Capital Idea

Building human capital is a good thing. But how much data do you need to prove it?

Tuesday, February 1, 2005
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There seem to be two basic schools of thought on human capital.

Both share the conviction that such capital and its nourishment are essential to competitive advantage and, ultimately, survival. Or, in a pithy summation offered by balanced-scorecard guru David Norton, human capital "is the foundation of value creation."

What self-respecting human resource executive would disagree?

Where the schools part ways is in how much one should obsess over the concept. It's the difference between operating from an unshakable, gut-level faith in the vital importance of human capital-as well as the importance of simply getting on with the basic nuts-and-bolts HR business at hand-and an alternate approach involving deep organizational introspection and sophisticated, painstaking analyses of systems, levers, drivers, pivot points, linking elements and-in a perfect world-tangible results.

It's also the difference between believing in the value of crowing about one's investment in human capital and striking a more low-key, circumspect posture.

A premise of the high-profile approach is that an outward declaration of one's commitment to building human capital can pay dividends beyond the actual investment in human capital itself. For example, disclosing corporate spending on employee learning and development efforts in an annual shareholders' report, while not required by accounting rules, may cause investors to view a company more favorably and drive up the stock price to reflect its "true" value based on anticipated future financial rewards.

The low-key school, in contrast, is confident that carefully considered but unheralded investments in human capital ultimately will bring whatever financial rewards are due through higher profitability.

What determines which school a company belongs to? Can HR make the call? And should HR bother to try?

Alas, it's often not up to the human resource leader. It may instead be the product of something beyond his or her control, such as the philosophy or personality of a charismatic CEO. In that circumstance, it pays if the top dog is an ardent human capitalist.

Backing the Vision

Such is the case with Robert L. Bagby, chairman and CEO of A.G. Edwards, the 117-year-old, $2.5 billion St. Louis-based securities and financial advisory services firm. "Our only product is knowledge," he says. That understanding is the basis for Bagby's commitment to making the firm's 15,413 employees (including nearly 7,000 financial consultants, scattered throughout some 700 branch offices in the United States and Europe) "the best-trained in the business."

Bagby joined the firm 30 years ago as a branch administrator and became its CEO in 2001. His commitment to achieving best-trained status has been most recently manifested in the building of a 200,000-square-foot corporate university on the campus of the firm's headquarters.

The 54-employee training division -- through which A.G. Edwards workers last year collectively received 813,000 hours of training -- was recently accredited by the American Council on Education to confer college credit to employees who successfully complete some of A.G. Edwards University's courses. This is a first for a broad-based training program in this field, according to the organization.

And how will Bagby know when his people are the best trained in the business? "We'll know we've achieved it when our competitors say, 'They have the best financial advice available.' "

Although all proposed human capital development initiatives are evaluated carefully at A.G. Edwards, they aren't subject to an annual budgeting process, Bagby says. While acknowledging his company has a finite number of dollars, he says, "we want to devote the dollars we need" to get the job done. "When I'm getting the best trained, I'm making the firm stronger for the future. That's what it's all about."

The HR executives charged with fulfilling Bagby's ambitious vision, while grateful for his deep commitment to the cause, do not act as if they have a blank check. Nor do they see training in itself as the sole path to leveraging human capital. "There is a lot of financial accountability when we're looking at programs," says Donnis L. Casey, the company's executive vice president and director of the staff division, which includes human resources. "It's kind of like an invisible budget."

Casey joined the firm in 1966, and is retiring in March. She spent most of her career managing the firm's training activities.

A.G. Edwards' commitment to training, she says, benefits multiple key elements in the human capital equation at the same time, including compensation, recruitment and retention. (Put another way, according to her, well-paid employees will still quit if they don't feel valued, good employees are easier to recruit and retain if they know the company invests in training, and so forth.) The firm's highly publicized commitment to employee development also routinely earns high-profile accolades, such as a regular berth in Fortune magazine's "Best Places to Work" rankings. "That helps our recruiting," Casey says, whether it can be precisely quantified or not.

Chuck Van Gronigen, Casey's successor as chief of A.G. Edwards' training effort, does feel the burden of devising valid metrics to gauge the success of key initiatives. "If we're doing training and it doesn't have an economic payoff, I don't want to do it," he says. That includes avoiding what he calls "crowd pleasers," popular courses whose economic impact-measured by comparing "before" and "after" trainee financial performance indicators (for example, for financial consultants, changes in commission revenue, assets under management and new accounts opened)-is disappointing.

Van Gronigen also measures his success in helping to achieve his CEO's goal to build the "best-trained" workforce by counting the number of workers who have earned industrywide professional credentials, such as the CFP (certified financial planner) designation. But that's not to assume that the "tail" of metrics is wagging the "dog" of human capital development.

"We start from a point of view that we're going to train. It's one of the ways we're going to grow our organization," says Van Gronigen.

Reliance on the Science

Nevertheless, in a highly complicated business environment with many categories of employees and more varied development requirements, coming to terms with building human capital may require more than a corporate leadership that's supportive largely by gut or instinct. It's time to bring on the brain trust, to lay out an intellectual framework that gives human capital a broader context that enables a more tightly calibrated style of corporate decision-making.

One academic path is through the field of financial accounting. Baruch Lev, a professor of accounting and finance at New York University's Leonard N. Stern School of Business, believes that limited financial disclosure requirements for public companies regarding "intangible assets," such as R&D and human capital, often cause companies to be undervalued (and in some cases, overvalued) in the stock market. This, despite the fact that, as an editorial in the Harvard Business Review declared last June, "the skills and esprit of individuals and groups, the strategies, methods, processes, ideas and intellectual property that are the harvest of their thinking . . . separate winning from lagging companies."

The fact that financial-accounting standards don't mandate detailed disclosures of how companies invest in people (and other "intangibles") doesn't prevent businesses from disclosing such details. On the other hand, according to Lev, most companies instinctively minimize assets reported on their balance sheets. "If they could have their way, they would strip the balance sheet of all its assets," he says, "because they don't want to be responsible if something happens."

Example: In a bankruptcy, if all of a company's tangible assets were sold off and no value remained for the intangible assets, "then [investors/shareholders] will sue managers and board members saying, 'You showed me an asset and it's not really an asset.' "

Lev says some of the corporate executives he talks to agree with his assertion that intangible assets do, indeed, represent core values of the enterprise. "They say, 'Our analysts never ask us about this.' I think that's particularly the case with human resources," he says.

"This has a very strong and negative feedback effect because, given the huge importance of capital markets in the U.S., if analysts aren't interested in something, then managers are also not interested in that thing."

Still, Lev suggests that, in certain circumstances, even without attempting to fix a dollar value on human capital, companies could benefit from some voluntary public disclosure. "If managers are really convinced that they have an unusual training program, an unusually capable workforce, that it's not currently reflected in their financial statements, it definitely makes sense to highlight this unusual capability."

Public Disclosure

One public company that takes that philosophy to heart is Accenture, a 100,000-employee management consulting, technology services and outsourcing giant. Rather than ask why a company should talk publicly about its investment in its people, Accenture's managing partner of HR, Jill Smart, turns the question around. "I would ask, 'Why would they be uncomfortable doing so?' "

Accenture invested about $400 million in employee development last year-or roughly $4,000 per capita, a figure Smart is proud of. "By all accounting rules, it's a variable cost, but we believe it's a fixed commitment we have to have. I'd liken it to our product development and R&D."

The massive human capital investment "isn't just about building specific skills," Smart says. "We have, as the end goal, characteristics of our people, the 'total person.' When you do that, you really get commitment from leadership. It's not just a cost item."

Three of the desired characteristics of Accenture employees are described as follows:

* "Understands how a business creates value and uses that understanding to drive client value";

* "Acts with purpose based on principle and sets the standard for professional excellence"; and

* "Provides innovative solutions to business problems and uses innovation in solving those problems."

Naturally, at a company whose stock and trade is analysis of business strategy, no expenditure of $400 million, no matter how you characterize it, will go "undissected." "We worked with some professors from the University of Chicago and some Ph.D.s on our staff and did a very in-depth analysis of return on investment," Smart says. "We looked at hundreds of thousands of data points."

One of the research goals was to correlate training to demand for a particular consultant's services. When the number-crunching was complete, "we found there was a 17-percent-to-20-percent greater demand for consultants who took the most training. We also found that they stay with Accenture about 14 percent longer than people who hadn't taken the highest levels of training available," Smart says. Not surprisingly, both of these factors have demonstrable direct bottom-line financial impact.

But is applying the cognitive powers of Ph.D.s more of a no-brainer when scrutinizing the human capital investments of a global professional services firm, than, say, the people investments of an industrial company, whose balance sheet is laden with tangible capital assets, such as costly manufacturing equipment? Not at all, says Matthew Brush, director of human capital planning for Corning Corp.

Brush worked with John Boudreau, a leading HR scholar and expert on the relationships between human capital, talent and sustainable competitive advantage, to develop an approach to make the most of Corning's people assets. "We found immense benefit from his thought leadership," Brush says.

Corning built upon the "HC BRidge" framework developed by Boudreau and Peter Ramstad in an attempt to optimize the company's human capital investment. The underlying principle involves "segmenting pools of talent where changing the skill level or the availability of talent in that pool will have a dramatic impact on performance," Brush says.

Boudreau points out that the corporate disciplines of finance and marketing long ago evolved to the point where each is able to base resource-allocation decisions on an objective, quantifiable basis. HR "needs to take a step back and find out how those models in finance and marketing became and remained powerful. What is it about their maturity that we might begin to emulate in HR?" he asks.

His own answer, captured in the HC BRidge model, distills three components: efficiency, effectiveness and impact. Measurements of HR efficiency, based on the most rudimentary spending analysis (e.g., "are we being frugal in our spending on HR programs and services?"), are widely used and "perhaps useful," but the story shouldn't end there, Boudreau says. Thus, for example, determining that you aren't paying a higher price for a leadership development course than one could pay to a competing vendor for an equivalent program, doesn't really assure that you're getting all the bang for your buck that you should.

Effectiveness, Boudreau says, seeks to answer the question, "When we do 'X,' does it have the effect we want on the groups we apply it to?" Sticking with the leadership development example, does the leadership training program really make better leaders? In other words, does it actually work?

Assessing Impact

The third element of the HC BRidge model-impact-"is the one that's the toughest" to assess, Boudreau says. In an analogy to the world of advertising, impact doesn't simply determine whether people are responding to advertising messages. It asks, "Are they the right ones?" In the HR context, a key impact question would be, "How much do we know about which talent areas have the biggest effect on firm performance or competitive advantage, and why." Applied to the leadership-development program example, the question becomes: "Are we putting the right people through the program?"

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The "impact question" applied to, for example, an employee-benefit program might be: "Is the big investment we're making in our generous pension plan motivating the employees who are most critical to our success to be productive and stay with the company? Is it really positively influencing overall organizational performance?"

This is one of the questions Brush is wrestling with at Corning. With some 22,000 employees worldwide toiling in the competitive realm of high-tech specialty glass, ceramics and polymers, Corning cannot afford to be haphazard about how its people are deployed. Corning's human capital planning and evaluation process, now in its second year, features four steps:

* Determine the type of talent required to execute the business strategy;

* Determine the net number of people required over the term of the strategic/business plan;

* Identify and prioritize portfolio gaps and determine the best approach for closing the gaps; and

* Identify actions necessary to align the people portfolio with the business.

"Part of what this is about," Brush says, "is helping HR understand how to live within a smaller budget. If you just try to do everything on a lower budget, you're not going to do anything well, as opposed to making prioritized decisions . . . . We're using this human capital planning process to spend HR dollars on the right stuff."

Corning's highly calibrated human capital management strategy led the company to an important decision at a facility in Taiwan that makes a specialized glass product used in liquid crystal display panels. "We figured out that our normal process of investing in R&D people was not going to be the most beneficial place to spend our HR dollars," Brush says.

"Where we needed to spend it was on hiring and keeping a specific type of engineer called a glass fusion engineer. And so we were able to invest less in [overall R&D personnel spending], and more in attracting this particular kind of engineer."

The process didn't simply end with recruiting enough of these highly specialized engineers for Corning's local staffing needs. Instead, with a human capital management process linked to Corning's broader long-term business strategy and competitive challenges, the decision was made to over-hire. "We said, 'If we hire them now, even though we don't need them now, we can set our competition back because it takes two years to train somebody up,' " Brush says.

But can he show a direct link to Corning's profitability?

"You're talking about the holy grail of HR-or any staff function," Brush says. "To show that what you actually do made a dramatic difference in the profitability of the company." While he's confident such a linkage "will be visible" in retrospect, his efforts "are too new now to have any meaningful data points."

Stock-Price Correlation

What if financial research showed a broad correlation between corporate investment in human capital (with employee training serving as the best available proxy, due to more readily available data) and stock-price performance-a subject near and dear to the hearts of CEOs? Would that be enough to support and analyze the effects of substantial investment in human capital?

Such research does exist. For example, in a study released last June, The Impact of U.S. Firms' Investments in Human Capital and Stock Prices, economist Lauri Bassi and three co-authors, using data from 388 U.S.-based public companies, concluded "that there is a relationship between a firm's training investments and its stock performance in the following year. Indeed, there appears to be a 'super-normal' return to firms' investments in human capital."

Bassi, a former research director for the American Society for Training and Development, has conducted similar research in the past and drawn the same conclusions. Armed with such data, she has put her -- and other people's -- money where her data is in launching a money management company, Bassi Investments. The firm's three stock portfolios zero in on companies determined to be in the top 5 percent to 10 percent, ranked according to training dollars invested per employee. And each portfolio has outperformed its benchmark index since inception.

Daniel McMurrer, chief research officer for the firm, declines to disclose a threshold dollar figure for inclusion in the portfolio. Amounts vary by industry, he says. (For some perspective, the average large U.S. company spends about $700 per employee annually on training, he says.)

The firm does disclose which companies meet Bassi's investment criteria (some include A.G. Edwards, Allstate, IBM, Intel and Eli Lilly); however, Bassi would be the last to suggest that parroting the training budget or human capital investment strategy of any company in her portfolios is a ticket to success. Indeed, the recent study acknowledges that, because it is based on "nonexperimental data," it was not possible to determine, definitively, that "the relationships being estimated are truly causal with no effects from confounding or omitted variables."

Bassi consults with companies such as Aligent Technologies, the 28,000-employee Palo Alto, Calif.-based business, to help them consider all their unique variables and sort through the linkages between human capital and organizational financial success. The process isn't suitable for those seeking quick fixes.

Wendy Miller, Aligent's director of learning optimization, says she has benefited from the exercise. Aligent was spun off from Hewlett-Packard in 1999 on the eve of the bursting of the technology bubble. When the bubble burst, Aligent, which considers itself a "humanitarian" (or people-oriented) company, was forced to shed thousands of employees.

"There was a lot of self-examination about how we could prevent this from happening again, what we could have done differently. It opened a window for us to start talking about knowledge assets, to think much more rigorously about human assets and what our total workforce strategy should be," Miller says.

The self-examination process led to the conclusion that Aligent is "an innovation company, and innovation comes from engaged, involved, passionate employees. Innovation doesn't just happen in R&D; we expect it from all employees, not just products, but in processes, business models, etc."

Miller's challenge is to gather elusive, far-flung data and useful measurement tools, such as a "knowledge asset index" encompassing "intellectual and emotional capital," to pull everything together. "Understanding the concepts and academic approach [to human capital management] is fabulous," Miller says. But getting from understanding to results doesn't happen overnight. "It's not something you can flip a switch on. Going from current state to future state is a multi-year effort."

The good news for Miller is that Aligent's leadership doesn't believe this multidimensional world of human capital management is the sole responsibility of HR. "There's not one person who has been chartered with, 'Go make this happen.' It's more of an organic evolution that's going on with people who are contributing different pieces."

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