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The Business Case for Superior People Management Can a company increase its shareholder value by changing the way it manages people? The answer from Watson Wyatt's new Human Capital Index® (HCI) research is a resounding yes. In fact, the findings suggest that by adopting the right portfolio of human capital practices, a company can improve its market value by 47 percent. Two years ago, the first HCI study showed a definite link between superior HR practices and high shareholder value. Yet a crucial question remained: Do better people-management strategies create higher market value, or do financially successful companies simply have more resources to allocate to human capital? The 2001/2002 follow-up HCI study compared a group of companies at two different times. The study found that superior human capital practices are a leading indicator of superior financial results. Great people management drives financial success to a greater extent than good financial outcomes drive good HR practices. If a company wants to improve shareholder value, it can do so by focusing on human capital. Superior Human Capital Practices Drive Higher Shareholder ReturnThe HCI study used a single, composite score to represent a company's human capital approach. Companies with low HCI scores averaged a 21 percent five-year return, compared with the high-HCI companies' 64 percent return (see Figure 1). Figure 1:
The HCI study also identified which HR practices affect the bottom line. Watson Wyatt divided those practices into five key links. The research quantifies how much of an increase in a company's market value is associated with a significant improvement* in each HR practice. A company that significantly improves all 43 key HR practices could see its value jump 47 percent (see Figure 2). Figure 2:
* A note on language: All expected changes in market value discussed below are the estimated difference in the average market values for firms that were significantly better in this area than otherwise identical firms. What constitutes a "significant improvement"? A one standard deviation increase. Most answers to HCI questions are on a 1-5 scale, so a significant change is a one-scale-point movement from a 1 to a 2, a 2 to a 3, and so on. "Total Rewards & Accountability" Worth 16.5% Gain Doing a better job of rewarding employees for good work—and refusing to accept subpar performance—can earn a company a 16.5 percent higher market value. Firms that improve their selection and use of health and retirement benefits can increase shareholder value by 7.3 percent, and linking pay to performance is associated with a 6.3 percent increase. Stock programs, incentive/profit-sharing plans, pay that is linked to strategy and higher pay for top performers all focus employees on the bottom line-and the research shows it pays off. A company that recognizes variations in performance by promoting the most competent employees, helping poor performers improve and terminating chronic nonperformers can boost its market value by 2.2 percent. "Collegial, Flexible Workplace" Offers 9% Gain Great leadership and a culture that encourages employee contribution produce a collegial, flexible workplace—and a 9 percent increase in shareholder value for a company making significant advances in this area. Companies that provide more flexible work arrangements should see a 3.5 percent increase in value. Improving the trust and integrity associated with company leadership builds shareholder value by 2.3 percent. By encouraging teamwork and avoiding the use of titles or office space to designate authority, companies can increase value by 1.4 percent. And making a stronger effort to keep employees satisfied can result in a 1.3 percent increase. "Recruiting & Retention Excellence" Offers 7.9% Increase In contrast to the first HCI study two years ago, this year's research emphasizes the retention end of recruiting and retention. Keeping turnover low translates to 3.2 percent higher shareholder value. Improving the company's commitment to job security adds an additional 1.4 percent. When it comes to recruiting, the research shows that companies can achieve 2.5 percent higher market value by stepping up their efforts to use formal strategies, aligning those strategies with business plans, bringing coworkers into the hiring process and offering new hire orientation. Companies that significantly improve their record of hiring able people can achieve a 0.8 percent increase. Finally, establishing a reputation as a great place to work is rewarded with a 0.5 percent increase in shareholder value. Improved "Communications Integrity" Worth 7.1% Creating an environment where employees share their knowledge is crucial. A company that improves its communications integrity can experience a 7.1 percent growth in market value. Improving employees' access to communication technology can lead to an impressive 4.2 percent gain. But technology is only half the picture; a company culture in which employees at all levels can offer input to senior management is associated with a 0.7 percent increase in value. And when companies are more open about business plans and financial information, they are rewarded with 1.1 percent higher market value. The same 1.1 percent increase can result when more employees participate in opinion surveys and the feedback leads to action. Focused HR Services Technology" Adds 6.5% One of the most interesting findings of the HCI research involves HR service technology. Our research shows that if HR groups use new technology for the fundamentals-to improve accuracy, service and cost-effectiveness—it pays off in 6.5 percent higher shareholder value. But when HR departments use the technology with less clear, less quantifiable goals—such as enhancing communication or promoting culture—the technology is linked to a large decrease in market value. Other Actions Diminished Value by 33.9% The HCI research steers companies toward the most financially rewarding HR practices. It also throws a cautionary flag in front of some practices applauded by conventional wisdom. Three practices in particular—360-degree review, developmental training and implementing HR technologies with "softer" goals in mind—were often associated with a decrease in market value. Although there is nothing inherently wrong with these practices, many organizations implement them in misguided ways. Since companies must be careful when they turn to these practices, they are categorized as practices that require "prudent use of resources." Multisource feedback is gaining in popularity, but is linked to a 10.6 decrease in market value—most likely because it's a challenge to get this feedback right. It requires an open culture, well-trained participants and follow-up. When one or more of these elements is missing, multisource feedback can be a lengthy distraction that interferes with teamwork. The HCI research also shows that developmental training—preparing workers for their next job instead of the current one—is linked to a 5.6 percent decrease in value. We hypothesize that a company's competitors most likely recoup this type of investment, as the newly skilled workers quit when a promotion is not immediately forthcoming. Maintaining training during economic downturns may also be ill advised. Again, it may be that competitors cancel their own programs to capture the value by hiring newly knowledgeable workers away. Click here for more information on the HCI research |
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