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Linking human capital management to business value – a worldwide view

Linking human capital management to business value – a worldwide view*

By Doug Ross who can be contacted at

www.watsonwyatt.com

1. Introduction

For investors, market conditions continue to prove difficult following three successive years of decline in the stock markets of most major economies. For many companies business is tougher than ever. With no let-up in sight, there continues to be a need for companies to focus on maximising real, sustainable value from human capital as never before. The results of our fourth year of global human research into this area show that the link between human capital management and real business value is stronger than ever.

In this article, we set out key themes that appear to add measurable shareholder value to companies:

>> Organisations with the best human capital management deliver significantly more shareholder value than those with poor people practices

>> Excellence in HR practice is similar across the world, with some interesting local variations

>> The key practices associated with higher value continue to show up in bear and flat markets, with the emphasis evolving over time, as do the HR practices that are linked with a loss of value

>> When companies tune their human capital management to focus on both employee commitment and customer satisfaction, rewards for shareholders are substantial

>> The effectiveness of the HR function itself is a key factor – to drive value from human capital, well designed practices and a highly efficient HR function closely aligned with business needs are essential.

>> The results from the research published at the end of 2002 show that links with value are stronger than in previous years. This partly reflects the wider range of financial performance within the participating companies as they have worked, to varying degrees of success, in the difficult market conditions. The research also indicates that the strengthening link is also partly due to a growing emphasis on human capital in the value of businesses and at the same time to other sources of competitive advantage proving increasingly difficult to sustain.

2. Global comparisons

Our findings are very consistent across the major trading blocks of Europe, North America, and Asia Pacific. The emphasis attached to specific practices varies from place to place reflecting different cultures and differences between high and low GDP per capita countries in Asia Pacific. In countries where the GDP per capita is low (China, India, Indonesia, Malaysia, Philippines and Thailand), companies are typically less developed in their application of human capital management practices; their prime focus is to get the basics right, ensuring for example, that accurate payroll and effective recruitment and performance management practices are in place.

In contrast, people practices in countries with higher GDP per capita figures (Australia, Hong Kong, Korea, Taiwan, Singapore and New Zealand) tend to mirror those of the more developed European and North American companies and are more strategically focused.

3. Watson Wyatt’s Human Capital Index (HCI)

The key themes of this article emanate from the research and analysis of data obtained in compiling Watson Wyatt’s Human Capital Index.

From initial research carried out in North America in 1999 into the correlation between effective people management and organisational success, this database of people management practices now captures data from over 1600 companies globally,

>> 600 from Europe

>> 500 from Asia Pacific

>> 500 from North America.

The HCI uses statistical analysis techniques to measure the correlation between published financial performance of an organisation and surveyed aspects of its human capital management.

The following six key aspects are considered in the analysis:

>> HR function effectiveness

>> Clear rewards and accountability

>> Recruiting and retention of excellence

>> Collegial flexible workplace

>> Communication integrity

>> Prudent use of resources.

Standard statistical tools are employed to identify and measure the relation between Tobin’s Q (a measure of intellectual capital developed by economist, James Tobin) and the aspects of human capital management encompassed in these survey items, while controlling for the effects of size, industry and other non-HR related aspects that can affect firm value.

# Getting the right mix of pay and benefits

More important than designing individual reward programmes is to get the overall reward design right, and provide appropriate flexibility and international co-ordination. In North America, linking pay to performance is a cornerstone for any reward strategy. In Asia Pacific, reflecting lower overall pay, a competitive guaranteed reward package appears to be more important. In countries where company sponsored benefits are limited or where there are state guaranteed benefits; it is harder to get returns from investment in a traditional benefits programmes.

Effective total rewards and performance accountability is the dimension with the strongest link to a positive value contribution in North America and Europe and the third largest in Asia.

Building the right reward framework and refusing to accept substandard performance links with value globally. Offering pay and benefits competitive with the market adds value in all regions, as does having a high eligibility for stock options and wide stock ownership amongst the workforce. However, creating an ownership interest through the use of stock options and similar plans is less common in Asia. Over 60% of Asia Pacific companies reported that they do not use employee stock plans. Where such plans are used, a noticeable increase in shareholder value arises.

# Different economies and company sizes drive different HR function effectiveness

A clear distinction exists between more and less developed economies in the role and added value to shareholders associated with the HR function itself. In developed economies, cost control is now a clear factor along with optimising HR’s effectiveness, whereas in the less developed economies the role of HR is much less strategic and the return for increased investment in HR is clearly evident. This is particularly noticeable in Asia Pacific, but it is probably not surprising that the role of HR in China is somewhat different from its role in Korea or Australia.

Recruiting and retention drives the engine that drives the business

Recruiting and retention excellence have a close correlation with added value to shareholders in all three major geographic zones and aligning recruiting efforts with business strategy is crucial everywhere. However, the emphasis between the two differs. In Asia Pacific, recruitment strategies are more powerful than retention practices, while the reverse is true in Europe and North America.

# A good work environment encourages productive behaviour

Maintaining a collegial, flexible workplace environment is intuitively a sound premise. The research indicates that not only is it a good concept, but it also links with shareholder value in organisations around the world, in multiple cultures and locations. Key practices in this area include engendering trust in senior leadership, ensuring that management ‘lives’ its company values, avoiding perquisites based on status, making and articulating clear leadership decisions, being flexible in working arrangements, and giving employees input into how work is done.

In Asia Pacific, the creation of a collegial, flexible workplace culture appears to be more important in those countries with higher GDPs. In addition, higher skill levels and a greater component of knowledge workers probably result in a benefit for organisations involving their employees in decision making by leveraging their innovative ideas and insight. It was also evident in Asia Pacific that the most successful firms are those who tune their people practices to create a focused workplace, where managers’ and employees’ prime focuses are on the customer and where employees are strong advocates of the firm’s products or services.

In Europe, a unique situation exists resulting from the influence of the EU. The adoption of the EU Social Agenda in many countries has meant risk management associated with employment regulations has grown significantly in importance. Working time restrictions, however, so far appear to have had only a limited effect on organisations.

# Two-way communications

Communication practices are linked with value globally, and associated practices include the sharing of business plans and goals with employees, acting upon the results of employee opinion surveys and publicising such action. In Europe, there appears to be a significant link to value in the communications dimension from communicating with employees’ representative bodies. Trades unions, in particular, appear to have a very different impact in Europe than in the rest of the world: they are generally a positive factor where a good relationship is maintained and only a very small number of companies surveyed felt that they had poor or very poor relationships with their unions.

Good communications implies more than information flow. It assumes that people are involved in a process that is candid, open and reflects trust and respect between managers and employees at all levels. In organisations that successfully engage their employees, creating an environment where employees are asked for honest and effective feedback, there is a demonstrable increase in shareholder value.

Significant value can be added at each stage of a survey process whilst controlling costs to maximise return on investment. This is achieved through a deep understanding of the drivers of employee engagement, clustering employees by their attitudinal characteristics, and by using advanced statistical techniques to deliver insights into the real issues.

# Paternalism or performance?

In Europe, practices such as excessive job security have been consistently identified as contributing to an overly paternalistic environment where employees become dependent on the company and cannot afford to move on, even if they are dissatisfied in their role. In the current market conditions, the research identified that providing a secure working environment, coupled with effective performance management, can be effective. However, there still remain some excessively paternal practices, such as maintaining training regardless of economic circumstances and failure to grasp the nettle of terminating employees when conditions make this the appropriate course of action.

Interestingly, paternalism is much more prevalent in Europe than North America while conversely, and possibly paradoxically, Europe does appear to be embracing the performance culture, with average CEO job tenure now lower in Europe than the US. This, coupled with reform of social security structures, means that ‘reward and accountability’ issues are becoming much more consistent across Europe, and more like those in North America.

4. The message

So, we finish where we began. The message from our global HCI studies is that great people management equals great shareholder value. Human capital management can be a source of competitive advantage for both domestic companies and those working in a regional or global arena. And if a company’s goal is to improve shareholder value, its HR practices must be a key priority.

* Reprinted by permission

Gary Watkins

Gary Watkins

Managing Director

BA LLB

C: +27 (0)82 416 7712

T: +27 (0)10 035 4185 (Office)

F: +27 (0)86 689 7862

Website: www.workinfo.com
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