10 Apr. 2013 | Comments (0) Share Follow @Conferenceboard
In my previous blog, Human Capital Analytics: Foundational Concepts, I suggested that the financial capital (cash) companies spend on human capital (people and HR programs) should be viewed as an investment, as opposed to an expense. It is a worthwhile investment, made to drive both revenue and profits, leading to increasing enterprise value.
Like any investment, a company will want to measure how well the human capital investment is performing. What is the return (ROI)? Is the return at an acceptable level for the business as a whole, over time and across segments? How much revenue is the investment driving for the business? What human capital strategy actions should be taken to continuously improve both the return and revenue growth rate?
Calculating the Human Capital Investment
If one is to measure the return on, and efficiency of, the human capital investment, it is vital for the denominator of that equation to be complete and accurate. To be complete, a company must include all the money it spends on human capital, and, to be accurate, the source of the data must come from the general ledger.
The money spent on human capital is contained in three buckets:
- 1) Employee costs
- 2) Costs in support of employees
- 3) Costs in lieu of employees
1) Employee Costs
Employee costs consist of wages, employee benefits, and payroll taxes. These items are easily identified in a general ledger.
2) Costs in Support of Employees
Costs in support of employees are the incremental costs companies spend to support their employees. These costs fall into the following categories:
- real estate or housing
- employee relocation
- training and development
- information technology
While also a part of the general ledger, all of these costs are not obvious. The test of whether the cost is in support of employees is whether the cost primarily supports the business or the employees. For example, while Starbucks has consumer retail locations worldwide, most of its retail locations are leased and exist for the purpose of selling its products to consumers. Its corporate office in Seattle, Washington, on the other hand, exists primarily for the purpose of housing its employees. Thus, in this example, the corporate office would be considered a cost in support of employees, while the retail outlets are not human capital costs as they exist to support the business. Another example is a payroll system. The payroll system exists to support the payment of wages/compensation to employees. Without employees, there would be no payroll system. This same process of distinguishing human capital costs from costs of doing business would also be done for the other expense categories listed above.
The amount of costs in support of employees can be quite significant. It is not unusual for them to be in the range of 15 to 25% of employee costs. They can also vary widely across business segments and over time.
3) Costs in Lieu of Employees
Costs in lieu of employees are costs associated with independent contractors and outsourcing. Economists call these substitution costs. The test of whether the expense is a cost in lieu of employees is if the expense replaces an employee that otherwise would perform the job.
These costs are also part of the general ledger, though they are not always obvious. For example, charges for legal services may all be lumped under one category in the general ledger. However, when the question is posed: What portion of the legal services performed by outside counsel need to be done by outside counsel? The answer is typically less than 100%. The difference is the portion of cost that is outsourced. This is also true for services provided by an accounting/auditing firm, an IT firm, an HR services firm, or other external vendors.
These costs can be meaningful in amount and can also vary significantly among business segments and over time. Vienna HCA has seen a range in these costs from a low of 15% to a high of 53% of employee costs.
Thus, the process of reviewing the general ledger will identify a company’s total or entire investment in human capital, the first step in measuring the ROI and productivity of the investment. Because these amounts come from the general ledger, they are updated regularly, “closed” monthly or quarterly, and scrutinized, by auditors, frequently. In short, they are trustworthy.
In the next blog, we’ll define and explore different approaches to measuring the return on the human capital investment.
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