The Human Capital Edge

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ABOUT THE BOOK

Companies that want to make themselves attractive to investors must take a hard look at their human capital management practices, Ira Kay, Ph.D., practice leader at global human capital consulting firm Watson Wyatt Worldwide, and Bruce Pfau, Ph.D., say in their book. They offer new data showing that specific human capital management practices can add - or subtract - millions of dollars from the bottom line. "Increasingly, investors will understand this and deploy their resources accordingly," Kay says.

In The Human Capital Edge: 21 People Management Practices Your Company Must Implement (or Avoid) to Maximize Shareholder Value (McGraw-Hill, February, 2002, $29.95), Pfau and Kay quantify the effect of specific human capital management practices on companies' total return to shareholders. They deliver conclusive evidence that companies that adopt and combine a select set of HR practices can experience up to a 47 percent jump in shareholder value.

"To put this in perspective," Pfau says, "picture two $1 billion companies that are highly similar in terms of research development levels, industry and capital structure, but very different in terms of human capital management strategies. The difference in market value between the two companies can be as much as $400 million to $500 million, based solely on variations in human capital management practices, such as compensation, work arrangements and appropriate use of HR technologies."

Superior human capital practices are lead indicators

Understanding the linkage between human capital practices and shareholder value is especially important given the current uncertainty in the global economy. Pfau and Kay’s data shows that superior human capital practices are lead, not lag, indicators of future financial results. As a result, Pfau says, “companies that act now to adopt the right human capital practices will emerge from the current slowdown faster and stronger than the competition.”

Too many companies invest in financially unsound human capital practices
In spite of this data, too many companies are investing in human capital practices that make little financial sense. Certain practices applauded by conventional wisdom - 360 degree review, developmental training and implementing human resource technologies with "softer" goals in mind - do not always add economic value, Pfau and Kay show. In fact, they often are associated with a decrease in market value. "Even when there is nothing inherently wrong with these practices, many organizations simply are implementing them in misguided ways," Pfau says.

Pfau and Kay also show that many companies fail to maximize the link between human capital management and the bottom line because they assume their human capital management practices are sound. They're not. Just ask their employees. Significant gaps exist between the perceptions of employers and those of their employees in areas such as compensation, benefits, communication and technology. "Until employers align their human capital management practices with their employees' needs, they will continue to waste resources on strategies that diminish, rather than increase, shareholder value," Kay says.

Book provides blueprint for integrating practices

To helpcompanies get the most out of their human capital investments, Pfau and Kay outline the 21 employee practices with the biggest direct financial effects. The book contains specific steps and case studies to help companies integrate these practices into their own organizations. The practices were identified through the combined research of Watson Wyatt's landmark Human Capital Index research study, the firm's Strategic Rewards® survey and its employee-focused WorkUSA 2000 report.

Which practices are critical? When Pfau and Kay looked at the various linkages between human capital practices and high shareholder value, it became clear to them that companies seeking to maximize shareholder value must focus on the following:

1. Achieving recruiting and retention excellence
2. Creating a total reward and accountability orientation
3. Establishing a collegial, flexible workplace
4. Opening up communication between management and employees
5. Implementing focused HR technology

Within these five categories, specific practices must be implemented. They range from the simple (hiring people for what they can do now, not later) to the complex (such as synchronizing pay and capitalizing on technology).

What are some of the specific practices companies must adopt? Consider the following:

• Hire people who can hit the ground running. Companies like to hire people with potential. They like to hire people who will grow into the job. They like to hire people they think may turn out to be stars. While those are good intentions, the hard economic truth is that they need to hire people who are already stars at doing the same kind of work in a similar environment. No company has the time for any other approach.



• It's not enough to be a great place to work. Make sure your company is known as a great place to work. Only 11 percent of the workforce is out seeking a job. The brightest stars are most likely in the 89 percent of the workforce that is not actively looking. Companies that focus on refining and then communicating their employer identity will not only net a higher percentage of the people they seek to hire, but they will have access to the much larger talent pool that is not actively working with recruiters or reading employment listings.



• Presume people are more alike than different. This idea seems counter-intuitive, especially when researchers use detailed data to identify the unique factors that make people tick, but Pfau and Kay suggest that companies stop looking so hard for differentiating factors. "Over and over again we have seen organizations spending phenomenal amounts of money figuring out what their target employees (say, female Generation Xers) want, and then putting special programs in place to attract them," Pfau says. "In our view, this is a serious misallocation of resources. Because what those female GenXers want the most from the workplace is exactly what everyone else wants the most: pay for performance, opportunity, strong leadership, fairness. It is very difficult for companies to get those big things right, so they should place their resources where they can do the most good."



• Synchronize pay, creating opportunities for all employees to soar. "Just as we believe stock options should be offered at all levels of the company, we believe compensation packages at all levels of the company should have a similar structure," Kay explains. "For example, if the CEO has a salary, the opportunity for a bonus and stock options, so should his division managers, his salespeople and his assistant. That way, they share risk, they share opportunity, and they share reward."



• Don't underestimate the crucial importance of senior leadership. Conventional wisdom says that when it comes to employee commitment, what counts is the employee's direct supervisor. But current research reveals that senior leadership is a fast-growing key component in employee satisfaction. And it is senior leadership - not individual managers - that can make or break a transformation effort.
In fact, the Watson Wyatt data shows that three-year total return to shareholder rates are higher at companies with strong trust and confidence in senior leadership, compared to the rates of return at companies with lower trust and confidence levels.
• Physician heal thyself. Part of successful HR service delivery is understanding the delicate balance between day-to-day operations and big picture initiatives. It's an important sequence - HR departments have to establish credibility through seamless performance of their basic operations before moving into more strategic areas. In other words, they need to get their house in order first. That means streamlining the payroll process and getting new hires seamlessly integrated before concentrating on defining the organization's strategies and building programs to attract, retain and support the right workforce. To ensure success throughout the process, HR needs to link the human capital strategies to the right technology solutions.

The Human Capital Edge also helps organizations turn practices that may actually be lowering their market value into value creators by suggesting ways to change the practices' focus or application. Take 360-degree feedback. "If it is not handled correctly, asking employees to evaluate their managers can decrease shareholder value. Similarly, asking employees to evaluate their peers can interfere with teamwork and, again, hurt shareholder value. Companies need to be very careful in implementing 360-degree feedback," Pfau warns.

From recruiting to retention to compensation to leadership, Pfau and Kay show companies what works - and what doesn't - when it comes to leveraging human capital to improve their bottom lines. The Human Capital Edge goes beyond conjecture and guesswork to explain the techniques companies must use (or avoid) to increase shareholder value.