Evaluating human capital

Raising people management up the business agenda

The old adage 'people are our most important asset' has been a stock phrase for many a company director and annual report. However, when we look more closely at the basis on which these same people make important business decisions, we find that often this phrase is little more than empty rhetoric. In reality few business decisions are made with any real knowledge and understanding of the contribution of people. However, as numerous studies have underlined, the economic conditions created by globalisation and the advent of new technologies have combined to make human capital and other intangible assets the major drivers of economic competitiveness. It is not surprising, therefore, that the issue of human capital is rising up the business agenda.

This bulletin summarises the findings from a six-month study, commissioned by the CIPD, investigating the ways in which ten major UK-based firms from a variety of sectors, evaluate their human capital. It aimed to relate the theoretical aspects of human capital to actual practice and identify the significant issues for managers who want to better understand their organisation's human capital. The research aimed to investigate the growing disparity between the contribution that human capital makes to business performance and the existing means of identifying and valuing that contribution. The research design recognised the lack of consensus as to what human capital means, how it is measured and how it is managed. The brief for the researchers was therefore to identify some common principles upon which the CIPD could build practical guidance for practitioners.

Key findings

Methodology

• to create a framework of shared understanding about the nature of human capital
  
• to identify some common principles for the analysis of human capital
  
• to identify how we might move forward in developing a coherent set of measures that may be applied to the impact of human capital in a variety of circumstances.
  

Since 1997, the CIPD has been investigating the link between business performance and the way in which people are managed. A wealth of evidence has been produced demonstrating that the key to competitiveness lies with the people of organisations, and particularly with the ability of the organisation to leverage the knowledge and skills of those people. However most organisations still find it difficult to produce coherent measures of the worth and contribution of their people that will be of use to their various stakeholders.

This report, therefore, complements the other studies that the CIPD has published, and forms another vital piece of the jigsaw that we are trying to put together - to offer better understanding, knowledge and information in the area of measurement. The CIPD is already making strenuous efforts to develop tools and processes to enable organisations to better evaluate their human capital and communicate this to those who make the most important decisions about the long-term performance and viability of organisations.

The virtuous human capital circle

The report found there is no single measure that can adequately reflect the richness of the employee contribution to corporate performance. The analysis suggests that measures are less important than the activity of measuring - of continuously developing and refining understanding of the productive role of human capital within particular settings. By embedding such activities in management practices, and linking them to the business strategy of the firm, firms may yet be capable of developing a more coherent and ultimately strategic approach to one of the most powerful, if elusive, drivers of competitiveness.

Another important feature human capital is that it gives us an alternative view of people management where people are assets to be deployed and managing them is a value adding activity. In a single stroke, labour moves from the cost to the asset side of the balance sheet, which redefines the employment decision-making process.

Figure 1 illustrates how to develop the human capital perspective.

Conclusions

A number of common themes and principles have been identified, as have a number of barriers and reasons why managers do not make more effort to evaluate human capital. But overall, the study found that there was no 'holy grail' in the evaluation of human capital - no single measure that was independent of context and that could accurately represent the impact of employee competencies and commitment on business performance.

This is not to suggest that metrics and other forms of information are irrelevant to the task of managing human capital. Rather, the report suggests that such information flows need to be embedded in wider processes of dialogue and exchange which, over time, enhance the knowledge of managers, employees and investors as to the value of human capital.

The increasingly critical role of these factors, however, has not been matched by advances in management and accounting practices that would allow that role to be properly reflected in management decision-making and the operation of capital markets. Without advances in the internal measurement and reporting of human capital, management are unable to fully recognise the value of their employees' competencies and commitment for business performance. Investments in training and development are viewed very narrowly as costs, and the contribution of key skills risks being lost through mergers and restructuring. Without advances in the external reporting of human capital, capital markets are unable to allocate capital efficiently to firms whose principal assets are not reflected in their balance sheets.

We were never under any illusion that it would be possible to generate a universal formula for the measurement of human capital or that this six-month exploratory study would provide all the answers. However we hoped it would be possible to define some common principles on which to move forward to develop a range of measures that would ultimately enable companies to gather better-quality information on the contribution of their human capital.