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Financial "undercounting" in HR: what you don't count is hurting you!

Financial "undercounting" in HR: what you don't count is hurting you!

By by Dr. John Sullivan who can be contacted at www.drjohnsullivan.com

1. Introduction

2001 was a history-making year with regards to the climate surrounding corporate reporting of financial data. Starting in December of 2001 firm after firm was forced to make disclosures about errors in their financial statements following the aftermath of Enron and MCI WorldCom. Three years later the disclosures continue with statements from Freddie Mac and Goodyear coming in just this week. What is surprising to me is that few in HR seem to take notice of the scrutiny financial reporting is under and what that means for them. Nearly every HR department in the world is guilty of financial misreporting, and should be operating on high alert.

Apart from reporting the results of cost cutting efforts, HR is often atrocious at reporting financial performance. For example, when HR budgets or corporate headcount is reduced, HR typically reports a substantial cost savings, but does that savings actually exist? Unfortunately, it turns out that HR managers all too often under or misreport the financial impacts of HR cost cutting actions. This type of misreporting occurs when HR fails to accurately report the "hidden costs" associated with specific cost cutting actions or the "unintended consequences" that correlate with them. This is a serious problem I call "undercounting costs."

Let me state upfront that this article is not about accounting . It is an article about becoming more strategic by taking a closer look at the unintended consequences that occur when HR takes an extremely narrow view of the impact of their actions. The direct result of this "undercounting" is that HR repeatedly sustains a larger percentage of budget cuts and work load volatility than it would if the "real costs" of certain people management practices were known by top management. The goal of this article is to demonstrate to senior HR managers how to better educate senior management about the real costs associated with under funding HR programs. I promise you that if you read through it, you won't become an accountant but you will see the value of spending some time and resources on identifying the "hidden costs" of HR cost cutting efforts.


2. Stop counting only half of the real costs

When times are tight, everyone is encouraged to reduce their budget, and budget cutting is not necessarily a bad thing. Unfortunately, it can cause serious damage to an organization if the cuts reduce spending too far in one area and not enough in others. In the cases where HR budgets have been severely reduced, it is rare to find a department that has tracked and reported the increased cost and losses that are sustained as a result of reducing or eliminating important HR services. In the few cases where those left behind have tracked such details, the story is clear.

Anyone who understands how business works realizes that the firms accounting department tracks only one type of "costs," those actual or amortized costs that appear in the accounting ledger for the HR department. Accounting ledger costs represent the expenditure of funds for goods and services out of your budget. For example, if you trained 10 doctors at $1,000 apiece, the accounting ledger will show a $10,000 "cost" entry for training. These are real dollars and accounting has done its job by "counting" them and recording them in the ledger.

Following that logic, it’s only natural for HR to assume that if it eliminated the training of those 10 doctors, it can accurately "boast" that it had "saved" the company $10,000. And that is where the problem comes in. On the surface, that might appear to be true, but this narrow thinking omits several other important factors. Those factors are the "unintended consequences" or damages that occur when employees (in this case doctors) are provided with insufficient HR services (in this case training). In this example of accounting has recorded a budgetary "cost savings," but has not recorded the correlating damages caused by having under-trained doctors operating in a hospital.

The "omitted costs" are the dollar consequences or the collateral damage that can occur when you fail to provide the necessary level of services (in this example, training for doctors). It is likely that the "under-training" that occurred in this example will directly affect the quality of a doctor’s work. In fact, the action might have increased the number of deaths, accidents, lawsuits, employee turnover and probability of accreditation problems. These "unreported" costs quite often exceed the initial cost savings estimate of reducing the training. In one major healthcare chain, the cost of an under funded performance management system for doctors ended up being over $1 billion.

What has happened is that only half of the costs associated with reducing training have been reported. It’s HR’s job to ensure that the other half of the costs are recognized and recorded. I call the omission of the damages caused by under funding people management programs, HR "undercounting".

Other Examples

Let's look at another example of "undercounting" as a result of cuts in employee safety programs. "Overcutting" safety programs can result in an increase in workplace accidents, workers compensation insurance costs, and a host of costs associated with decreased workplace productivity. Even though it is likely that accounting would track both the reduction in expenditures on employee safety and the increased costs of accidents and insurance, there is little chance that accounting will ever correlate the two. This lack of correlation doesn't make the increase in accidents and insurance rates any less real, it simply doesn’t connect the two and identify the increase as preventable with a corresponding business case to make the financial argument for maintaining safety training.

Similar unintended consequences occur with machines as well as people. For example, if you eliminate or delay changing the oil in a finely tuned automobile, you will save significantly on short-term costs, however, it won’t be long before permanent damage to the engine will result in repair costs that make the original cost-cutting decision appear to be a silly one.

Real cost savings = The dollar amount of reduced HR expenditure + the added costs/ losses that occur in other departments as a consequence of having fewer HR services

3. Why collateral damage costs go unreported

Even though the added costs of errors and deaths will be real costs to the hospital, they will never be reported in the same HR accounting ledger alongside the "cost savings" of cutting the training program. The reason that no one in accounting correlates these two costs because there is a delay between the cost cutting action and the unintended impact. Another reason why the costs of doing the "wrong thing" (over cutting HR programs) may never be "counted" is the fact that the collateral damage often doesn’t occur within HR, it occurs in other operational departments.

4. Areas where HR frequently underreports real costs

HR fails to track and report costs in four key areas. They include:

A) Underreporting collateral damage and the real costs of "overcutting" HR programs

Strategic HR leaders must understand upfront that under reporting the collateral damage related to HR budget cutting has the net result of negatively impacting firm performance because senior managers never see the real costs associated with under funding HR and make decisions that hurt the bottom line. From a strategic business perspective, it's time for HR to realize that it must more accurately identify, track and report the actual dollar costs of "overcutting" HR programs.

There are many areas where collateral damage can occur. For example, spending less than "what is necessary" on people programs may lead to:

# increased error rates

# increased accidents, which may lead to a rise in insurance rates

# missed deadlines

# increased employee turnover

# increased union activity

# lower output or productivity

# delays in product development and service delivery

Each of these "unintended consequences" can occur as a result of spending "too little" on HR programs and has a measurable economic impact. In addition to the collateral damage areas mentioned above, there is one additional area that by far has the largest economic impact, that area is customer satisfaction. There are several studies that demonstrate the direct connection between employee satisfaction and customer satisfaction. Unfortunately, unless HR clearly demonstrate to senior management that overcutting HR lowers employee satisfaction, they will never make the connection between customer satisfaction and long-term sales decreases.

The "undercounted costs" can be defined as the resulting costs or collateral damages that occur in other business departments as a direct result of HR "spending less than necessary" on people management programs.

B) Underreporting "shifted" costs

A strategic professional looks after the interest of the entire corporation not just their own business unit. On occasion however, HR loses sight of that fact when it undertakes some of its "self-service" initiatives. Clearly HR portals and intranet information services provide helpful information to managers and employees and they provide a positive return on the money invested. However that return may be overstated in some cases because self-service programs may in some instances, just be "shifting" costs from HR to line managers and employees. Let’s look at an example of web-based benefit information.

HR may reduce its own headcount by requiring managers and employees to make their own personal information changes and to find the answers to their benefit questions online, however this action may actually increase the labor costs associated with benefits administration. Rather than having relatively low paid HR employees doing such work, benefits self-service may actually increasing overall costs by taking highly paid managers and employees away from the valuable "line jobs." If HR omits these shifted costs when it calculates its cost of a benefits transaction, it is not accurately reporting the actual costs associated with the initial action. In fact, the action may not have reduced costs at all, but instead shifted them elsewhere.

Just because accounting doesn't track them... doesn't make the losses associated with "doing nothing" or "the wrong thing" unreal losses!

C) Underreporting the costs resulting from failing to invest

When an organization fails to spend money on a people problem, one possibility is that the problem may go away on its own. However, it is much more likely that the problem will fester, get worse and even eventually become unsolvable because managers failed to take action early on. In this case, "doing nothing" will cost you "something". There are three cost areas related to failing to invest. They include:

The costs of doing nothing - there are distinct costs related to "doing nothing" or failing to act when you identify a problem. The consequences of doing nothing are similar to the costs of overcutting HR programs. The difference here is that there is no initial program to cut. There is however, an "opportunity" to develop a new program when HR identifies a "new" people management problem. The "cost of doing nothing" arises when HR allows the problem to "fester" and get worse over time either because of indecision or because HR was unwilling to invest money in a new program solution. The damage caused by in action could have been minimized or prevented it, if HR had just "done something" (invested in a new HR program or solution)

The cost of spending too little on maintenance -- spending insufficient funds to maintain existing programs may cause problems that cost you a great deal of money. In this case, the HR program is not actually eliminated but HR refuses to spend additional funds to maintain and update the HR program. Just as failing to do maintenance on a car's brakes can cause expensive accidents, failing to "invest" in the maintenance of people management programs can also have significant dollar consequences to the business. For example, failing to upgrade an applicant tracking system for recruiting could slow down our recruiting because recruiters had to use an antiquated system. By increasing our time to fill we might suffer the unintended consequences of losing the very best candidates by failing to act quickly.

Lost business revenues and profits as a result of failing to invest -- opportunity costs are the lost revenue and profit that never materialized because HR failed to take advantage of reasonable "profit generating opportunities" that may have resulted in increased revenues. For example, if you are presented with the opportunity to hire away a top competitor's best salesperson, most line managers would jump at the opportunity because it would both increases your ability to sell, while simultaneously hurting your competitor by decreasing their sales revenues. However, if you failed to hire the competitor’s salesperson because of a "hiring freeze", HR has an obligation to report the collateral damage caused by such a policy. Failing to spend money when reasonable opportunities arises to increase revenues have real costs to a business that, unfortunately, do not appear on any accounting spreadsheet

D) Underreporting the costs of having to replace "cut" HR programs

Frequently HR reduces its costs during a downturn by eliminating programs completely. Eliminating HR programs can have dramatic consequences but occasionally eliminating an HR program does not cause any immediate problem. However, because business runs in cycles, HR can find that if the downturn is short-lived, that it will have to rebuild or replace those "recently cut programs" as soon as growth returns. In these cases, it is not unusual for HR to find that rebuilding the "cut" program from scratch are incredibly expensive. In fact, so expensive that the startup costs clearly exceed any "cost savings" accrued during the time that the program was not in existence. In addition, it's worth noting that the slow start up and any weak initial performance of the "rebuild program" may add dramatically to the "uncounted" business costs.

5. Calculating the "real" value added of cost-cutting activities

The "real value" added to the corporation by any cost cutting programs that HR might sanction can be calculated in a formula with six elements. The formula looks like this:

The formula

The real cost-cutting value = the actual dollar value of any budget reductions

minus the dollars lost in each of these 4 areas of "collateral damage"

New problems caused by "overcutting" of existing programs

The additional costs in management and employee time as a result of "shifting" HR activities to employees and managers

The additional costs that result from HR failing to invest including "doing nothing", failing to invest in program maintenance and additional revenue that was lost because the firm did not invest in "new opportunities"

The additional costs associated with rebuilding dismantled programs

"Over cost cutting" is best characterized by the phrase "penny wise but pound foolish"

6. HR’S new role

The first lesson to be learned here is that although "cutting costs" seems relatively easy on the surface, there could be significantly higher costs associated with the "collateral damage" that can follow excessive or inappropriate cost-cutting.

The second lesson is that because professionals in accounting are not experts at "connecting the dots" (i.e. connecting the added collateral damage costs with the reduced HR spending), HR must accept its responsibility in involving and educating them in the area of "undercounting". HR must first help quantify the collateral damage and then demonstrate to accounting and senior management that these collateral damages are directly caused by the initial cut in training. If HR fails to accept this new role, the myth of classifying cutting training (and other primary HR programs) as a "cost savings" will continue. And as long as that myth continues, senior managers will be falsely encouraged to reduce training and HR costs to below the levels where the collateral damage exceeds the initial cost savings. It’s a very serious problem, and by not acting, in effect HR is encouraging senior management to continue cutting HR programs.

7. Conclusion

It's impossible to accurately measure the strategic impact of HR if you only look at the direct costs savings of cutting programs. Although most people in HR are not accounting experts, that does not prevent them from seeking outside help in ensuring that all of the costs associated with "overcutting" and "doing nothing" are calculated into every HR strategic action.

*Reprinted by permission of the author

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Gary Watkins

Gary Watkins

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