The Human Capital Edge

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FOREWORD BY DR. JEFFREY PFEFFER

Foreword to The Human Capital Edge by Dr. Jeffrey Pfeffer, Thomas D. Dee II Professor of Organizational Behavior, Graduate School of Business, Stanford University, and author of The Human Equation: Building Profits by Putting People First and co-author of The Knowing-Doing Gap: How Smart Companies Turn Knowledge Into Action.

WILL COMPANIES EVER LEARN?

You would think that we would get it by now. What with the "war for talent" metaphor, the many writings by pundits talking about the importance of intellectual capital, rather than physical assets, in today's economy, the fact that CEOs and even strategy consulting firms have come to realize that having a great strategy without having the requisite people to implement it won't do much-and I could go on-one might expect that companies would have done those things that are required to attract and retain people and, most importantly, develop and unleash the talent and motivation of those people. But they haven't, at least not as much as one might expect. In fact, sometimes I think not much has changed at all.

In the midst of the dot-com craze and the high-tech hysteria with the resulting severe shortage of people, I did an interview in Fast Company on toxic companies. The premise of my argument was that there was not a talent shortage for those places that knew how to treat people. But there was (and ought to be) a shortage of people at places that had created toxic work environments. The e-mails I received after the article appeared were both numerous and depressing. Professional people, managers, engineers, software programmers--the very people that many companies were supposedly struggling to find and keep--wrote me describing bosses who screamed at and threatened them, companies that did not let them make decisions or fully use their abilities, leaders who did not listen, and work environments where what was required to get ahead was mostly the ability to win in some zero-sum competition for status.

Who cares, you might think. The war for talent is over, isn't it? There are now thousands of high technology workers being laid off, and the job market for MBAs has completely reversed so that people who at one point treated recruiters from consulting firms rudely have rediscovered their manners and are praying for call backs in a labor market that has gone from feast to famine very quickly.

You should care. It turns out that, as many, many studies have demonstrated, how you manage people affects numerous organizational outcomes, ranging from quality and productivity to the survival rate of initial public offerings and the time to initial public offering for small, high technology companies. Now, Bruce Pfau and Ira Kay from Watson Wyatt Worldwide, a human resources consulting firm, have done some studies that should help to convince companies, once and for all, that people do matter and that there are some straightforward things those companies should do if they are interested in enhancing their performance. These data form the foundation for this book, The Human Capital Edge. Some of the data come from a large survey of employees. Some come from an annual survey of compensation practices. And perhaps the most important data come from a study of the connection between shareholder returns earned by 750 publicly traded companies and their people management practices.

I have to make a confession-I believe that shareholder returns should only be one of several measures of corporate performance, and maybe not even the primary one. In a world in which labor is a lot scarcer than capital, it has never been clear to me why returns to capital should be the measure of a company's value. Moreover, as Dennis Bakke, the CEO of AES, an independent power producer that operates all around the world, has pointed out, capital is nothing more than the result of past labor. When you work, you earn income. Some you spend and some you save. Those savings, for an individual or a country, become capital. In that sense, capital is the residue of past labor. Why should past labor get a higher priority than current labor? Nonetheless, most CEOs seem to be enamored with shareholder value-stock price-in no small measure because of how their compensation packages have been structured, so who am I to argue.

What the Watson Wyatt study shows is that a) there is a significant correlation between how companies manage their people-assessed by the Human Capital Index-and shareholder returns; and b) using panel (longitudinal) data, the evidence is that the HCI predicts shareholder returns much better than shareholder returns predict the HCI. These results help to address the question of causality and the comment, frequently made, that companies that are doing better financially can "afford" to use high performance management practices. These data show that no company can afford not to use such practices, because they lead to vastly superior financial performance. Although some other studies have attempted to statistically assess causality, this study is one of the few to be able to use panel data to resolve the issue.

What The Human Capital Edge does is not only present a lot of data showing how and to what extent various management practices affect shareholder return, but also provide specific, concrete examples of what these management practices look like in practice. Executives who read the book should be both convinced by the data and inspired by the examples. This study also covers some of the voluminous evidence, previously gathered, that makes the same point-there is an advantage to be gained by how companies manage their human capital, their people.

By the way, many, although certainly not all, of the findings from this study will strike most readers as common sense. This is because many of the results conform to our intuitions about human psychology and to our own experiences in organizations. For instance, the study found that people want leaders who are in touch, who communicate, who don't just have meetings for the sake of meetings, who don't surround themselves with people who tell them just what they want to hear, who communicate clearly what the company's strategy is and what the business model entails, and who tell the truth. As another example, there are data that indicate that peer recruiting is desirable, first of all because a group is likely to make a better decision than an individual, and second, because people who are involved in hiring others for their team will be more committed to those people and to helping them to ensure they succeed.

I am not troubled by this at all. When people ask me "what's new," I often respond by saying, "you should be asking what's true." Our search for new management fads and the pursuit of novelty for its own sake hasn't gotten companies very far, nor will it. Common sense isn't very common in its implementation in the business world, so companies that are anchored in a few empirically-proven, enduring practices will outperform those that institute and then cancel programs depending on the latest seminar that they have attended. I have often commented that if we practiced medicine like we practice management, based on hunch, intuition, and ideology, we would have much more malpractice and a lot of mortality and morbidity. One of the things that Pfau, Kay and others, have accomplished is to bring data and facts to the analysis of human capital management, a very worthy undertaking.

At the end, of course, even though this book offers a lot of ideas, a lot of data, and a lot of wisdom, buying, reading, and even discussing the book will not do much to enhance your company's performance. That's because there is no knowledge advantage without an action advantage. Knowing what to do and not doing it doesn't get you very far. One can hope that The Human Capital Edge will add enough information to that already in existence to motivate companies to take those actions that have been recommended in so many writings on how to achieve competitive advantage through people. One can hope that with the demonstration of the connection between people management and shareholder value, finally senior leadership will focus sufficient time and attention-and resources-on this critical dimension of managing the business. We can hope that finally we will begin to close the gap between knowing and doing in the domain of how we manage people.

But actually changing the management of human capital will not necessarily be easy. Many companies and their leaders have developed some bad habits-for instance, layoffs at the first sign of economic distress-that will be hard to change. And most importantly, even though much of what Pfau and Kay have uncovered is "common sense," it is rare in its implementation. Too many businesses try to excel through benchmarking and looking at what everyone else does. One can not earn extraordinary returns by copying everyone else. If you do what everyone else does, you will probably get about the same results. What The Human Capital Edge shows is how to achieve exceptional results. What is also required is the courage to put that knowledge into use.

© McGraw-Hill, 2002. All rights reserved. Reprint with written permission only.