Human capital reporting: proving the value of people
The HR profession has long been concerned with demonstrating its contribution to the business strategy. With human capital reporting just around the corner, we investigate whether employers are ready for the new reporting requirement and how they can demonstrate the value of their human assets.
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Key points Within two years, the Although the Kingsmill report avoided a "one-solution-fits-all" approach for human capital reporting, it recommends that disclosure should include people data on elements such as size and composition of the workforce, retention and motivation of employees and leadership and succession planning. A key influence on developments around human capital is the increasing significance of high- performance workplaces and growing evidence that certain characteristics, such as progressive HR policies and practices, can have a positive impact on both performance and productivity levels. Research shows that many companies are ill-prepared for the reporting requirements: a study commissioned for the Kingsmill report on current human capital management practices by the top FTSE 250 companies revealed that the majority of measurement indicators - such as diversity, training spend and health and safety statistics - are not reported externally (76%). |
There is no doubt that human capital reporting (HCR) is more than just a current wave of fashion for the HR profession. Assessing the impact of an organisation's HR policies and activities through measurement techniques such as benchmarking has been a steady trend over at least the past decade, but the recommendations of the Accounting for People1 report raises the concept of HR metrics to new heights.
While there may well be growing pressure on the HR profession to justify its contribution to overall business performance, any systematic reporting of the impact of its policies, such as absence monitoring, is so far likely to be internal. The Kingsmill report - named after the chair of the Accounting for People Task Force (AFPTF), Denise Kingsmill - paves the way for the systematic disclosure of human capital data that will be available to shareholders and investors. It is intended that external reporting on such a consistent and strategic basis will also raise the prominence of the people dimension as an intangible asset at board level.
A growing number of employers are also slowly waking up to the fact that the mantra "people are our most important asset" could possibly be more than just rhetoric. With organisations finding it increasingly difficult to achieve differentiation through their products or technology, and the continuing shift from manufacturing to services, in many cases an organisation's workforce is the one definitive factor that can enhance its competitive edge.
What is human capital management?
The Accounting for People report suggests there is no rigid or agreed definition of human capital management (HCM) but describes it as "an approach to people management that treats it as a high-level strategic issue and seeks systematically to analyse, measure and evaluate how people policies and practices create value". Four consultants from Mercer Consulting flesh out a similar definition in their recently published book, Play to your strengths2. According to the authors, "human capital" is "the stock of accumulated knowledge, skills, experience, creativity and other relevant workforce attributes", while "human capital management" involves putting in place the metrics to measure the value of these attributes and using that knowledge to effectively manage the organisation.
Andrew Mayo is a programme director at the
Centre for Management Development at the
"Often the HR function is very inward-looking and forgets its prime purpose, to support people and people management," says Mayo. "Measurement is often confined to headcount data, such as changes in establishment, diversity profiles and labour turnover. These are essentially statistical. To this, many organisations would add measurements of employee opinion. Some businesses are already capturing information on the HC elements suggested in the Kingsmill report but line managers are unlikely to see much relevance unless there is a connection to performance. If we want to get some reality into the famous statement that 'people are an organisation's most important asset', then we must be better at understanding both their intrinsic value and the value they produce. My dream is that line managers receive a statement every month on what is happening to their human capital, just as they receive reports on their budgetary situation."
HCM therefore goes a big step further than merely assessing the impact of the HR function. While it certainly does involve quantifying the effectiveness of HR activity, HCM also demands the measurement of human assets and an evaluation of their overall impact on corporate performance.
It is this link
to performance and productivity that distinguishes HCM from other measurement
approaches that are common practice within most well established HR
departments. Many organisations benchmark their labour turnover rates with
competitor organisations, for example,
or compile data on the time taken to fill vacancies. Often, these statistics
are used to help inform the HR strategy and assist HR professionals and line
managers with their operational responsibilities. Sometimes, the results are
even reported externally, as is often the case with diversity data. But rarely
do organisations apply a consistent set of HR metrics to assess the value of
their intangible human assets and their impact on organisational performance,
and then report publicly on the findings.
Accounting for People
The AFPTF was set up by the government following Denise Kingsmill's prior investigation into the pay gap between men and women. Her report on pay inequality highlighted HCM as a key element in organisational performance and productivity, but said it was routinely under-reported. The AFPTF was therefore established to consider how employers could improve their HCM reporting.
The AFPTF report outlines the rationale for recommending that HCM should be reported for the benefit of external stakeholders. By prompting organisations to focus on their key drivers of value in people management through strategic analysis and measurement, it says, reporting increases the ability of organisations to evaluate the contribution of workforce policies and practices to performance and make more informed decisions on investment in workforce development. The report asserts that the effective management of people is a key value driver that high-quality reporting of HCM can be used to demonstrate, thereby assisting those investors seeking long-term performance.
The taskforce shied away from imposing what it termed a "prescriptive or legislative" approach for HCR, instead seeing the development of a universally acceptable set of HR indicators as an evolutionary approach. The many different ways in which organisations monitor various HR factors means that no single set of HCM metrics could be widely accepted as best practice. Instead, the report focuses on identifying more general principles for compiling an HCM report, and recommends that:
Reports on HCM should have a strategic focus, be balanced and objective and based on sound data. A report should clearly represent the board's current understanding of the links between HCM policies and practices and the company's business strategy and performance. This means that it should normally include details on the size and composition of the workforce; employee retention and motivation; skills, competencies and training; remuneration and fair employment practice; and leadership and succession planning. The report should follow a process that is susceptible to review by auditors, provide information in a form that enables comparison over time, and use commonly accepted terms and definitions.
Directors of companies producing Operating and Financial Reviews (OFRs), and all public and other bodies producing OFRs or reports with similar aims, should include within them information on HCM within the organisation, or explain why it is not material.
The Standards Board should invite leading employers, cooperating as appropriate with investors, professional organisations and other relevant stakeholders, to develop guidelines on key indicators and definitions.
The Standards Board should monitor the extent and depth of HCM reporting in OFRs, reporting to the trade and industry secretary within two years of its formation.
As can be
discerned from this, the Kingsmill report is just the
starting point for the future of HCM reporting in this country and has a long
way to go before it has impact across the spectrum of
Nor is this requirement restricted, in a wider sense, to private sector organisations. The Kingsmill report acknowledges that slightly different considerations apply in the public and voluntary sectors as there is generally no expectation of a financial return on investment. It makes clear, however, that taxpayers and sponsors still expect performance and value for money, as shown in an external reporting framework.
The report points out that central government, and the many agencies and bodies it supports, such as the NHS, is required to produce an OFR in line with the current advice of the Accounting Standards Board. No such requirement exists for charitable organisations, but they are required to include comparable information in their report and accounts. Local authorities are not obliged to produce an OFR, but the "explanatory forward" to local authority accounts fulfils a similar function.
Hampshire County Council, for example, is developing HR metrics that support its workforce planning, as well as measuring overall performance. Its approach is based on a balanced scorecard that is designed around core, generic competencies that reflect the council's key values and behaviours. An SAP HR management system has been installed to help collect and analyse HC data, such as absence, workforce turnover and training statistics. As Pauline Lucas, county personnel and training officer, explains: "Our measurement framework will enable the council to use HC data to inform future HR activity and carry out much more effective workforce planning. The various measurement initiatives will be integrated and translated to an individual level, for example, for use in the transparent performance and development framework that will also inform our pay policy."
The OFR
It is doubtful whether many HR professionals will have heard of an OFR - at least until recently. Indeed, there is no obvious reason for them to be familiar with the current, voluntary format that some organisations choose to produce. There is every reason, however, why HR people will soon begin to develop a close interest in the future, mandatory version of the OFR that large companies will be required to produce as part of their annual report and accounts. Nor will this interest be confined to senior HR designates by virtue of the HCM information that will need to be included in the OFR, as this document will contain a range of data that is considered to be "material" to that organisation.
The new mandatory OFR statement is one of the
measures announced following the company law review (CLR), a fundamental review
of core company law. Unlike the other main financial accounting vehicles, and
this is reflected in the Kingsmill recommendations,
an overarching principle is that there should not be a prescriptive checklist
dictating what should be in an OFR. Instead, its content should be governed by
broad guidelines that can be geared towards an organisation's unique
characteristics. The DTI has recently published its consultation document on
the OFR, which describes it as "the directors' overview of the company . . .
that will give shareholders key information on a company's objectives,
strategy, past performance and
future prospects".
From the 2006 accounting period, the OFR will require the boards of "economically significant" entities to provide a high-level, strategic commentary on the strengths and resources of the business, such as corporate reputation and brand, customer/supplier relationships, market position and research and development. The information disclosed by companies will also, of course, include the people dimension as it is hardly likely that any such organisation will be able to demonstrate that its workforce and intellectual capital are not material to its performance.
It is proposed that this new regulatory
requirement will affect the 1,290 quoted companies in the
Some
commentators, including some of the main professional accountancy bodies, are
sceptical that organisations are adequately prepared for the new reporting
responsibilities the OFR will place on them. The
Reality check
Current reporting on HCM by organisations for an external audience can be described, at best, as patchy. As part of the Accounting for People review, the taskforce commissioned a study of current practices on HC measurement and reporting by the top 250 FTSE companies in the UK4. The study notes that very few FTSE companies are actively measuring or reporting on HC, either internally or externally. The majority of measurement indicators - such as diversity, training spend and health and safety statistics - are not reported externally (76%). The 24% of indicators that are reported publicly are not necessarily published in a company's annual report and accounts or other publications directed at the investor community.
The report states that the main reason why companies do not report externally is that information is viewed as commercially sensitive. Other barriers to HCR include the belief that measurement is not the first priority for the company, with other HR activities being regarded as more important. Insufficient time and resources, a lack of conviction that there will be a clear return on investment and an absence of clear guidelines and universal practice are also mentioned.
IRS's own research (see Aligning HR and business strategy: key steps to competitive advantage) found no evidence to contradict these findings. Less than a quarter of those organisations surveyed (11 organisations) indicated that they measure HC, while 35 said they do not. Of those employers that do measure HC, only four reported that they have a consistent way of describing it, and just one organisation reports externally on its findings.
Further confirmation that organisations currently undertake very little external reporting on HC issues is provided by recent research by the Empower Group5. The consultancy surveyed the UK FTSE 500 companies and found that half do not undertake regular employee measurement activities, with only one organisation in 10 linking employee data to other business metrics, such as productivity and quality targets. Less than one company in five links employee and customer information, and only a quarter of organisations link employee survey data to financial data.
The suspicion that those large companies that
will soon be required to produce a mandatory OFR have a considerable amount of
work to do before they are ready to comply with its HCR element appears
justified: less than one-third of those FTSE 500 companies that do currently
engage in regular employee measurement stated they are totally confident that
the current measures would be appropriate for reporting. The report concludes
that the
High performance workplaces
A direct influence on HCM and its proposed
reporting framework is the current debate around the concept of high
performance workplaces. It is an issue that is high on the government's
productivity agenda on the back of a growing body of research indicating that
certain characteristics - essentially a consistent HCM policy - can be
associated with more effective and productive organisations. As Denise Kingsmill makes clear in the taskforce's final report: "We hope
that this is the beginning of a process that will lead to
The global HR consultancy firm Watson Wyatt has carried out a number of studies to demonstrate the correlation between its HC index and shareholder value6. The index is based on a range of detailed questions about the organisation's HR management practices and ranks each surveyed company from zero to 100. As the survey has developed, it has shown that the following key HC elements are connected to a significant increase in shareholder value:
excellence in recruitment and accountability;
a collegial, flexible workplace;
communications integrity; and
prudent use of resources.
Understanding how high performance can be achieved and contribute to productivity levels is also a theme that the Work Foundation has investigated. Its recent report - The missing link: from productivity to performance7 - identifies a High Performance Index (HPI), with five key areas that need to be given equal weight by firms in order to maximise performance:
customers and markets;
shareholders and governance systems (including finance and investment);
stakeholders (suppliers, customers and people but also community and corporate social responsibility objectives);
human resource practices; and
creativity and innovation management.
The research
found that those companies that successfully manage all the above areas perform
significantly better and can expect to gain 2.5% extra growth, 2.5% more sales
per employee and
1% more profitability than those firms that do not. The study identifies the
contribution of people as the key factor in executing the HPI. "Integrating the
five areas can only be achieved by a workforce that sees the big picture and is
enabled and motivated to act, with middle managers able to translate strategy
into workforce goals," the report says.
Measuring up
While the first recommendation of the AFPTF report provides a list of the areas in which an organisation would be expected to provide people data, these are quite broad headings, and provide enough scope for individual organisations to determine precisely what HR metrics should be applied to which area.
The IRS research mentioned above provides some clear indications from respondents about the human capital elements that are considered crucial to their organisation's strategic direction. An overwhelming majority cited leadership as the most important HC factor, with strategic skills and cultural awareness ranked second and third respectively. Strategic alignment and integration and learning were also seen as important, but less so.
Peter Reilly, director of HR research and consultancy at the Institute for Employment Studies (IES)8 cautions about the danger of organisations producing "meaningless statistics" and recommends that companies "develop measures that monitor the sort of human capital elements to fit their size, sector, stage of development, organisational structure and their business strategy".
The
Since HCM has increased in prominence over the last two decades, a range of methodologies have developed to assist organisations in assessing the value of their human assets. A recent study for the European Commission9 outlined 23 different valuation and assessment models that are used by organisations. Among some of the better known approaches are the balanced scorecard/HR scorecard, the European Foundation for Quality Management excellence model and the Skandia navigator/IC index.
Research undertaken jointly by Personnel Today and Deloitte & Touche Human Capital Advisory Serivces10 at the end of 2002 investigated practitioners' experiences with five common HCM methodologies: HR benchmarking and metrics; balanced scorecard; HR practice effectiveness; accountancy-based valuation models and economic value added (EVA). The study revealed three main limitations associated with all five approaches: data accessibility and collection problems; doubts as to whether the measurement technique can really identify where the value of the organisation's human capital lies; and a lack of resources to carry out the measurement work. The most popular of the methodologies used was HR benchmarking, although only 5% of respondents rated it as "highly effective". The more sophisticated approaches of EVA and accountancy-based models had low take-up by organisations but 73% of those with experience of EVA rated it as "effective" or better.
An external reporting framework
Although the wisdom and complexities of human capital measurement and reporting continue to be a source of hot debate, the main professional bodies, consultancies and experts are unanimous in their advice that companies need to start preparing now for the inevitable accounting requirement that will befall them. Nor is it only the largest UK companies that can expect to be affected in the long term; it is widely anticipated that it is only a matter of time before the majority of organisations will be required to account for their investment in people.
The Chartered Institute of Personnel and Development (CIPD) has developed a number of research programmes over the past few years to investigate the link between people management practice and business performance and has developed guidance on external reporting11. Although the suggested framework recognises that a prescriptive approach is not possible and "there is no magic formula for judging the effectiveness of HCM", it includes some key principles and provides examples of measures and statistics that could be used or adapted by organisations in their reporting.
The report advises that, because a firm's ability to support its business strategy with human capital is an important indicator of future business performance, reporting needs to be future-oriented, encompassing indicators of future capabilities, such as workforce diversity and training and development. Also, the range of metrics and frameworks applied to human capital should reflect its multi-dimensional character.
The report also warns against the potential pitfall of reporting HC simply in terms of costs rather than value creation that could lead to a narrow-minded, cost-reduction approach on the part of organisations. A more useful way forward, it says, involves applying a "balanced framework approach" to human capital. Given the characteristics of human capital identified in the report, the CIPD recommends that such a framework should be based on five categories:
human capital strategy;
acquisition and retention;
learning and development;
management; and
performance.
Further, the CIPD advises, each category should include a narrative on what activities the organisation is undertaking to address these issues, plus a menu of key and discretionary indicators.
For internal consumption
According to Andrew Mayo, it would be a mistake to confuse the external reporting requirements laid down by the AFPTF report with the internal information needed by organisations in order to manage. "The metrics set out in Kingsmill are very general and therefore not that helpful for management decisions," Mayo advises. "Those measures are there for public consumption and of course, companies will need to produce the necessary information to satisfy the regulatory requirements, but the type of internal information needed by organisations should be a management rather than a PR tool."
Andrew Mayo acknowledges that evaluating the return on investment in people is not easy, essentially because people capital is not subject to the same rules as financial capital, and certain judgments and assumptions therefore have to be made. He has developed a "human capital monitor" model that complements Kaplan and Norton's balanced scorecard and is based on linking three distinct areas of measurement: the intrinsic worth of people as individuals; their contribution to both financial and non-financial value added; and the environment in which they make that contribution.
Mayo's advice for HR practitioners just starting to develop ways of measuring the return on their HC investment is threefold: "First, think of the critical groups of people who make a difference, and not just senior employees. Consider the measures that are already in place that relate to them and your vision of what you would like to have to complete the 'monitor'. Finally, develop a plan to achieve what is needed with a realistic timescale."
The CIPD is also very aware of the importance of organisations developing internal measures for managing their HC. As Angela Baron, CIPD organisation and resourcing adviser, explains: "Internal reporting on human capital goes hand in hand with external reporting, but it is important that employers develop a consistent approach to gathering data, analysing it and reporting internally on human capital management. Organisations will find that external reporting on HC is more difficult if they do not develop robust internal reporting measures."
The CIPD has therefore set up a working party to develop guidance for internal reporting for HCM, which will be published this summer. In Baron's view, good HC data can strengthen the link between good people management principles and business performance. "The better informed line managers are about human capital issues, the more likely they are to act on the information they receive, which in turn will affect people's performance," says Baron.
Because it's worth it
HCM could be the opportunity that the HR profession has been waiting for, particularly if it is taken a step further than the forthcoming regulatory requirement for external reporting and the metrics are utilised internally to inform business strategy.
A key finding of the research study into FTSE 250 companies, commissioned by the AFPTF, was that accounting departments are not trained and do not have the experience to measure and report HC. Both HR professionals and their finance counterparts have no choice but to get to grips with HCR, and this will be achieved most effectively if they work together. HCR therefore offers a real chance for HR people to raise their game and be taken seriously in a business partner role.
This article was written by Rachel Suff, a freelance employment researcher and writer, rmsuff@dsl.pipex.com.
1.Accounting for People, available at: www.accountingforpeople.gov.uk/.
2.Play to your strengths: managing your internal labour markets for lasting competitive advantage, by Haig R Nalbantian, Richard A Guzzo, Dave Kieffer and Jay Doherty, ISBN: 0-07-142253-6, published by McGraw-Hill Trade.
3.The Operating and Financial Review and human capital reporting: is the OFR the place for human capital reporting? available at www.icaew.co.uk.
4.Human capital measurement and reporting: a British perspective, by Kee Foong and Richard Yorston, available at: www.accountingforpeople.gov.uk/.
5.Measuring up: are HR metrics doing the job? Survey of employee measurement in UK FTSE 500 companies, The Empower Group, February 2004, available at www.empowerglobal.com.
6.Linking human capital and shareholder value: human capital index -European survey report 2002, Watson Wyatt, available at www.watsonwyatt.com/research.
7.Findings of the Work and
8."Danger of confusing human capital reporting", People Management,
9.Study on the measurement of intangible assets and associated reporting practices, by the Commission of the European Communities Enterprise Directorate General, available to download at europa.eu.int/comm/enterprise/services/business_services/documents/studies/intangiblesstudy.pdf.
10.Measuring human capital, available at: www.personneltoday.com.
11.Human capital: external reporting framework, available at: www.cipd.co.uk.
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Case study:Royal Bank of Scotland Group Over the past 18 months, the Royal Bank of Scotland (RBS) Group has been developing and implementing a human capital model that links its people strategy to business performance. With more than 120,000 employees in 28 countries worldwide, human capital management (HCM) is considered a key strategic priority for the group: its chief executive was a member of the Accounting for People Task Force and the taskforce's final report featured a sample of RBS's Operating and Financial Reviews. At the heart of the RBS Group's HCM approach is its aim to become "the most admired bank" and, because it recognises that to do that it needs the full engagement of its people, to also become "the most admired employer". As Greig Aitken, RBS's head of measurement and research, explains: "It is the engagement and performance of our employees that have the potential to give the bank its competitive advantage. We therefore aim to offer a compelling employee proposition that attracts, engages and retains the best available talent." The employee proposition is an all-encompassing framework that includes elements such as total reward, work itself, performance and development and leadership. The group's HCM model evaluates the impact that its policies and practices in each of the distinct areas have on staff engagement, as well as the overall contribution to business performance. The aims of the RBS model are therefore to: support the aim of the RBS Group's chief executive, to become "the most admired bank"; measure the links between employees' behaviours and business results; measure the effectiveness of the RBS Group's offering to employees; enable clear action plans to be created to improve the effectiveness of RBS's human capital. This is done at group, divisional and local management levels. Establishing a link The model is designed to measure more than past business performance and assess current HC activity; it was developed as a "diagnostic tool", with the capacity to inform decision-making and help predict future business performance. The disparate sources of HR information are integrated by the model - on areas such as employee turnover, leaver surveys and reward preferences - and provide senior managers with the data to evaluate the relationship between employee behaviours and business results (as shown in figure 1).
"By developing the HC model, RBS has the tangible means to link its HR strategies with quantifiable improvements in business performance," says Aitken. "For example, we can now understand the factors that contribute to staff turnover and non-attendance and their effect on the bottom line. A one percentage point reduction in staff turnover would lead to an annual saving of over £20 million, for instance, while a 0.1% reduction in absence would lead to a saving of over £1 million annually." Staff engagement The concept of employee engagement is at the centre of RBS's strategy for HCM and is considered the key variable in influencing individual performance. Engagement takes satisfaction, and even commitment, a stage further; in Aitken's view, if an employee is engaged in the business, they are not only likely to remain with the company for longer but will exert discretionary effort to improve business success. RBS's human capital model has found demonstrable links between distinct parts of its employee proposition and staff engagement levels. For example, there is evidence of a strong relationship between the level of engagement by an employee and their uptake of flexible benefits. "This means not only that we need to ensure that the menu of benefits on offer is right, but that the benefits package is effectively communicated to all staff," says Aitken. This kind of detailed, statistical analysis, that compares staff engagement rates to business metrics such as customer service indices and productivity levels, enables the group to put in place detailed action planning to boost performance. A case in point is the finding that non-financial recognition has a positive impact on employee engagement. Engagement scores can also be segmented in a variety of alternative ways, such as by tenure, location, age and position to provide more detailed data sets for targeted groups of employees. Looking ahead By gathering data that establishes the
effect that staff engagement |
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Case study: British Telecom Telecommunications group British Telecom (BT) has recognised the importance of measuring human capital for some time. As Sam Hill, manager, people reporting, measurement and metrics, explains: "BT now spends more on people than it does on technology and it is therefore essential that we understand where we make this investment and why. Measured correctly, human capital management can provide a transparent link between the effectiveness of human capital deployment and the creation of superior stakeholder value and returns." BT's human capital measurement takes the following approach: define and quantify "total labour cost" (TLC) - this measure consists of basic pay, overtime, bonus plus employer's contribution to NI and pension, plus cost of contingent labour). The business is directed to use TLC as the key volume measure of BT's human resources, rather than headcount; understand the thoughts of its existing workforce through focused employee attitude surveys; understand why people join, do not join, or leave the business (through entrant, turn down and exit surveys); understand who in the workforce generates revenue (directly or indirectly) and those who administer or support; and catalogue and record the skills and competencies of employees (not just in terms of what they do, but what they could do). Storing and analysing the data BT has created a single data warehouse to house its people metrics and to cross-reference against the group's existing knowledge of people demographics and dynamics. "We also have a suite of 40 key performance indicators (KPIs) but this number will increase over the next year in order to expand our measurement of human capital," explains Hill. "A user-friendly 'front end' reporting tool delivers these KPIs to the desktops of our managers." The human capital data collected and analysed by BT is used for a range of strategic HR and corporate activities. For example, on the resourcing side, the metrics allow the group to highlight skills gaps, both now and in the future. The management information also influences BT's reward strategy by establishing the correlation between performance and pay and between performance and career advancement, for example. "In terms of organisational design, the measurement framework allows us to highlight inefficient spans of control or layers of management and to establish the ratio between the volume of professional support and their customers," explains Hill. "We can also measure the effectiveness of our equal opportunities policies that, for example, verify the fairness of our recruitment and promotion processes." Going public Currently, the majority of BT's human capital reporting is undertaken for internal purposes but the group aims to introduce a number of key HCM indicators into its external reporting framework over the coming year. Sam Hill's advice to organisations starting off on the HCR road is, firstly, to focus on measuring elements that add value to the organisation and its management, rather than simply managing activity. Secondly, it is wise to keep the measures simple - simple to calculate and simple for the audience to understand.
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