21 Jun. 2013 | Comments (0) Share Follow @Conferenceboard
In the blog, Human Capital Investment: Driver of Enterprise Value, we posited that companies spend a portion of their limited financial resources on human capital to drive the revenue and profits of the business. The prior three blogs focused on the profits and return on the human capital investment. This blog focuses on the revenue that the human capital investment generates.
While ROI is an effectiveness measure, productivity is an efficiency measure. Productivity measures the amount of revenue generated for each dollar invested in human capital. There are a few approaches used to calculate the productivity value of the human capital investment, each having its own merit.
Simple & Straightforward
A simple and straightforward method to measuring productivity is:
Productivity = Revenue
Human Capital Investment
This formula measures the amount of revenue generated for each dollar spent on human capital. Revenue is an income statement item, and the amount can be provided by Finance. Companies have different definitions of revenue. It is important to understand these different definitions and choose the one that both HR and Finance can agree is the most appropriate for measuring productivity. It’s critical that HR and Finance agree on the definition, otherwise there will be endless bickering, distracting from the goal of determining what’s driving the productivity and what can be done to increase it.
The human capital investment consists of:
- Employee costs;
- Costs in support of employees; and
- Costs in lieu of employees
These costs are described in detail in the Human Capital Investment: Driver of Enterprise Value blog mentioned above.
Some business leaders may argue against this simple and straightforward approach because financial capital costs are ignored. After all, as the argument goes, since financial capital is the lifeblood of a business, expected to generate revenue, it should be a critical part of the productivity formula. While there are counter arguments to this line of reasoning, they will likely fall on deaf ears. Best to keep your powder dry on that issue.
A Human Capital/Financial Productivity Formula
Here is a formula that will satisfy those making a case for the inclusion of financial capital in a human capital productivity formula.
Productivity = Revenue
HCI + FCC
HCI is the human capital investment and FCC equals financial capital costs: interest, depreciation, amortization, and cost of equity. These items are also further defined in the previously mentioned blog.
This productivity formula has been vetted – and passed the muster – with GE pedigree CFOs, Wharton MBAs, investment bankers, and private equity executives.
What’s a Good Productivity Number?
This is an obvious question, indeed. The not so obvious answer can be found in the response to the following question: What level of productivity will result in the desired level of human capital ROI? While productivity is important to a business, if it isn’t driving a satisfactory level of profits or human capital ROI, human capital strategy actions to correct the deficiency are required.
Moreover, for greatest effect, companies are well served to measure the productivity level over time (monthly, quarterly, and/or annually) and across business units…irrespective of the formula used.
Our next blog will take the productivity formula to an even higher level – normalizing for different business models. We will also explore the relationship of productivity to ROI. For instance, does productivity drive ROI? You would think so.
View our complete listing of HC Analytics blogs.