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Fitz-Enz, J. (2009). Chapter 2: How to Measure Human Capital’s Contribution to Enterprise Goals, pp. 33-65. ATTACHED BOOK

Measuring the Economic Value of Employee Performance

Jac Fitz-enz

H U M A N C A P I T A L S E C O N D E D I T I O N

ROI OF

T H E

Special discounts on bulk quantities of AMACOM books are available to corporations, professional associations, and other organizations. For details, contact Special Sales Department, AMACOM, a division of American Management Association, 1601 Broadway, New York, NY 10019. Tel: 212-903-8316. Fax: 212-903-8083. E-mail: specialsls@amanet.org Website: www.amacombooks.org/go/specialsales To view all AMACOM titles go to: www.amacombooks.org

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.

Library of Congress Cataloging-in-Publication Data

The ROI of human capital : measuring the economic value of employee performance / Jac Fitz-enz.—2nd ed.

p. cm. Includes index. ISBN-13: 978-0-8144-1332-6 (hardcover) ISBN-10: 0-8144-1332-3 (hardcover) 1. Human capital. 2. Productivity accounting. 3. Labor economics.

HD4904.7.R33 2009 658.15’226—dc22

2008050809

� 2009 Jac Fitz-enz All rights reserved. Printed in the United States of America.

This publication may not be reproduced, stored in a retrieval system, or transmitted in whole or in part, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of AMACOM, a division of American Management Association, 1601 Broadway, New York, NY 10019.

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To Laura,

My love My strength

My inspiration

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Contents

P R E FAC E T O T H E S E C O N D E D I T I O N x i

Acknowledgments xv

P R E FAC E T O T H E F I R S T E D I T I O N x v i i

Acknowledgments xxii

C H A P T E R 1

Human Leverage 1

The Shift 1

The New Human Capital Management Model 4

Effects on Organizational Management 4

Data for Management 8

Making the Change 10

Data Conundrum 10

Two Aspects of Human Capital 11

What Human Resources Can Learn from Finance 13

HRP 14

People and Information 16

Data-to-Value Cycle 17

Organizational Capacity 20

Surveying the Track 25

The ROI Race 25

False Starts 27

Points of Measurement 29

Summary 30

References 31

v

vi CONTENTS

C H A P T E R 2

How to Measure Human Capital’s Contribution to Enterprise Goals 33 Constancy and Alignment 34

How to Become a Business Partner 36

The First Step 38

Human-Financial Interface 39

A Strategic View 40

Enterprise-Level Metrics: The Launch Point 44

The H in Human Capital 53

Human Capital Enterprise Scorecard 59

How to Marry Quantitative and Qualitative 60

Benchmarking’s Danger 62

The Willy Loman Syndrome 62

Summary 63

References 64

C H A P T E R 3

How to Measure Human Capital’s Impact on Processes 66 Making Money Through Process Management 66

In the Beginning 68

The Return of Reason 69

Positioning Business Unit Processes 72

Process/Talent Case 75

Supply Chain Management 76

Human Capital in Processes 78

Anatomy of a Process 82

Process Performance Matrix 86

Finding Human Capital Effects 91

A Test Problem 96

Summary 102

References 104

C H A P T E R 4

How to Measure Human Resources’ Value Added 106 Whither HR? 106

CONTENTS vii

Top Reasons for Employees Leaving 116

Human Capital Performance Evaluation 118

Change Measurement 128

Human Capital Scorecard 129

Human Capital Accounting 133

A Human Capital P&L 136

Benchmarking, Best Practices, and Other Fairy

Tales 136

Truly Effective Practices 137

Summary 141

References 143

C H A P T E R 5

End-to-End Human Capital Value Reports 144 One Sure Path to Profitability 146

Three Examples 149

Cases 154

An Integrated Reporting System 159

Leading Indicators 162

References 164

C H A P T E R 6

Human Capital Analytics: The Leading Edge of Measurement 165 A Model and System 166

Relationships and Patterns 167

Pattern Recognition 168

Fallacies in Trend Identification 168

Finding Meaning 169

Extrapolation 170

The Importance of Context 171

Charlatans 172

Business Applications 173

Performance Valuation 174

Data Sensors: Forecasting and Predicting 176

Toward a Human Capital Financial Index 181

viii CONTENTS

Index Value 185

Index Application 185

Data Sources 187

Summary 189

References 190

C H A P T E R 7

Predictive Analytics: Leading Indicators and Intangible Metrics 192 Toward Leading Indicators 192

Leading Indicator Examples 193

Enterprise Futures 195

Functional Futures 196

Be Prepared 196

Assessment 199

Employee Mind-Sets 200

Indirect Sign 201

Competitiveness 202

Indexing the Problem 204

Scoreboarding Overview 206

Summary 208

References 209

C H A P T E R 8

How to Measure and Value Improvement Initiatives Results 210 Rebirth of U.S. Business 210

The New Age 211

Measuring the New Capital 212

Restructuring: A Fading Star 214

Employee Engagement 222

Contingent Workforce Management: The New Human

Capital Challenge 226

Mergers and Acquisitions: Buy vs. Make 233

Benchmarking: A Value-Adding Approach 241

Summary 248

References 250

CONTENTS ix

C H A P T E R 9

Outsourcing: A New Operating Model? 252

Mixed Results 253

Trends in Functional Outsourcing 254

Outsourcing Life Cycle 259

Service Initiatives and Satisfaction 262

Getting It Right 263

The Future: Web 2.0 and Outsourcing 268

Beyond Cost Cutting 269

In the End 270

References 270

C H A P T E R 1 0

How to Change the Game 272

HR’s Disruptive Technology 274

Process Optimization 280

Integrated Delivery 283

Analysis 285

Predictive Metrics 286

Leading Indicators 288

The New Game 288

Summary: Learning While Doing 289

References 290

C H A P T E R 1 1

Eleven Principles, Seven Skills, and Five Metrics 291

Principle 1: People Plus Information Drive the

Knowledge Economy 292

Principle 2: Management Demands Data; Data Helps Us

Manage 292

Principle 3: Human Capital Data Shows the How, the

Why, and the Where 293

Principle 4: Validity Demands Consistency; Being

Consistent Promotes Validity 293

x CONTENTS

Principle 5: The Value Path Is Often Covered;

Analysis Uncovers the Pathway 294

Principle 6: Coincidence May Look Like Correlation but

Is Often Just Coincidence 294

Principle 7: Human Capital Leverages Other Capital to

Create Value 294

Principle 8: Success Requires Commitment;

Commitment Breeds Success 295

Principle 9: Volatility Demands Leading Indicators;

Leading Indicators Reduce Volatility 295

Principle 10: The Key Is to Supervise; the Supervisor

Is the Key 296

Principle 11: To Know the Future, Study the Past—but

Don’t Relive It 296

Seven Skills That Make It All Work 296

Five Metrics of Life 297

Conclusion 299

I N D E X 3 0 1

Preface to the Second Edition

In reviewing the first edition I found that many of the pre- dictions made in 1999 came true. This is because the funda- mentals around human performance still apply . . . and always will. The environment may change but people don’t. Specifically, my early prediction about the labor shortage came true, only now with greater urgency.1 I described the rise of outsourcing along with contingent workers as the first step in restructuring organizations. My declaration about the need to focus on leading indicators has come to be accepted. My points about the quality of work life have become mainstream topics. Other projections within the first edition also proved accurate. This edition continues to be on the leading edge with the introduction of Predictive Management, a new paradigm for managing the future today. You will see the concept in various places and the model in Chapter 10.

Business Changes Businesses are finding that they have to change the way they do business. The model that emerged after World War II has

xi

xii PREFACE TO THE SECOND EDITION

run its course. Dot-coms came and went with much fury and left behind an e-world that has profoundly affected the way everyone does business. When you change the commu- nication system, you shift power bases and you expose weaknesses. The flaws of the past that could be papered over are now more obvious. New forms are rising as a result of communication analytics and computer technology. Change is the order of the new century.

In terms of management trends, outsourcing has made quantum leaps. From the advent of the first full human re- sources process outsourcing contract in 1999 to today, the concept has exploded. According to Everest Research there are four thousand companies currently offering those ser- vices worldwide. Human development has shifted from a reliance on classroom training to a blended approach that incorporates various media and job experiences.

Globalization has come to the fore. The growth in China, India, and the Arabian Gulf countries has called forth a new power that is affecting everyone everywhere at all levels. Even managing a local small business is different today. Ever hear of pollution, global warming, health insurance, immigration, or education deficiencies? How about mega- brands like Toyota, Wal-Mart, Starbucks, Amazon, or Google?

Of course, recruitment is the main game now. In 1998 the labor shortage was a factor but it was isolated largely on technical skills related to dot-com ventures. Today, profes- sional and managerial shortfalls in many disciplines are emerging and will not be alleviated by temporary market downturns. Multigenerational workforces had barely sur- faced. Now they are the norm. Baby boomers were in charge, now they are looking for an exit strategy they can afford.

PREFACE TO THE SECOND EDITION xiii

The Good News Despite a continuing reluctance of some human resources people to address quantitative analysis, there have been major advances in the past decade. When I was writing the first edition of this book, I would have estimated that only about 5 percent of human resources departments were doing anything significant in this area. Most of those were still mired in basic measures of HR efficiency—that is, cost of hire, time to fill jobs, compensation and benefits expense, and effects such as turnover rates.

Now my estimate is that at least 30 to 35 percent of human resources departments are doing some kind of quan- titative measurement. Unfortunately, only about 10 percent have moved upscale to measure effects on the enterprise. Thanks to the work of people like Jack and Patti Phillips, John Boudreau and Pete Ramsted, Mark Huselid, Brian Becker and Dick Beatty, Dave Ulrich and Wayne Brockbank, Jesse Harriott and Jeff Quinn, Ken Scarlett, Debbie Mc- Grath, Erik Berggren, Doug Hubbard, Kent Barnett, and Jeffrey Burke, among others, the state of the art has im- proved dramatically. In Argentina Luis Maria Cravino and in Brazil Rugenia Pomi are leading the way. Software packages are coming to market from companies such as Au- thoria, KnowledgeAdvisors, Oracle, Scarlett Surveys Suc- cessFactors, and others that make quantitative analysis easier and more meaningful. We are moving from merely measuring to finding and explaining meaning.

Looking Ahead This edition updates its predecessor in several ways. In the past two years, I have collected more than three hundred

xiv PREFACE TO THE SECOND EDITION

cases, models, and survey results, many of which are merged here to replace and update those of the first edition, to give currency to the narrative.

The basic metrics in the book are now widely used and quoted around the world. In addition, I have developed leading indicators and intangible metrics that were not proven as well in 2000. Intangibles have attracted a great deal of interest since Baruch Lev’s 2001 book, Intangibles. Concurrently, benchmarking has peaked. The more ad- vanced human resources professionals are looking for something new and leading indicators and intangibles are satisfying that need. There is a new chapter (Chapter 7: Pre- dictive Analytics: Leading Indicators and Intangibles) to cover this development.

Chapter 1 reflects the changes since 2000. Chapters 2, 3, and 4 are refreshed with new material, but the structure is unchanged. In addition to new text and new graphics, the number of case studies has been increased.

Chapter 5 displays an updated reporting model. The latest balanced scorecard approach is added along with an up- dated human capital profit-and-loss model. These link HR’s reporting language more closely to the accounting system.

The structures of Chapters 6 and 7 are reworked in the light of recent developments. Chapter 6 expands and offers more details and depth to human capital valuation. It revis- its the value of indexing. Benchmarking is repositioned as a tactical rather than a strategic activity, which it was when I introduced it in 1985 with special attention paid to context as a means of understanding benchmark data.

Chapter 7 focuses on the future. It expands on predictive analytics. Leading indicators and intangibles are covered. Trending and indexing examples are shown.

PREFACE TO THE SECOND EDITION xv

Chapter 8 is the original Chapter 7 and is largely redone. Outsourcing is removed and placed in its own chapter. Restructuring, contingent management, mergers and acqui- sitions, and benchmarking are all reworked. Employee en- gagement is added.

Chapter 9 is given exclusively to outsourcing. Since 2000, outsourcing has exploded with both good and bad results. It is changing the structure of organizations.

Chapter 10 is an entirely new subject. Based on a major research program that yielded a new management model, this chapter describes how to change the game and gain competitive advantage through predictive management.

Finally, in Chapter 11, the guiding principles are updated into eleven principles for success, seven skills of valuation, and five metrics of life.

Acknowledgments A project as complex and extensive as publishing a book in- volves many people with many talents. The content people who supported and contributed ideas are acknowledged in the Preface to this edition. I want to also cite the people at AMACOM who helped get this tome out the door.

My gratitude goes out to Executive Editor Christina Parisi and her assistant, Janet Pagano; Publicity Director Irene Majuk; Managing Editor Andy Ambraziejus; especially Erika Spelman, who kept the project moving between me, the copyeditor, the proofreader, and the indexer; copyeditor Mary Miller who picked up all my typos and grammatical errors; proofreader Robin O’Dell; and Production Manager Lydia Lewis, who coordinated with the designer to get the design completed, negotiated schedules with the composi-

xvi PREFACE TO THE SECOND EDITION

tor and printer, and made sure everything got where it needed to go on time.

Thanks everyone. This is your book also.

References 1. Jac Fitz-enz, ‘‘Getting and Keeping Good Employees,’’

Personnel Journal, August 1990, pp. 25–28.

Preface to the First Edition

The Missing Piece The classic books of management have ignored, avoided, or thrown platitudes at the question of human value in the business environment. When and if the authors did give passing attention to valuing the human contribution, their comments were either gratuitous or simplistic. Nineteenth- century capital theory claimed that wealth was leveraged from investments in tangible assets such as plants and equipment. It held that workers were entitled to compensa- tion only for their labor, since the incremental values of the business came from investment in capital equipment. This type of thinking lit the fire under people like Karl Marx and Samuel Gompers. From the early work of Fayol1 and Bar- nard,2 which supported this thinking, to the more enlight- ened insights of Drucker, Peters, Handy, and others, no one has successfully taken on the challenge of detailing how to demonstrate the relative value of the human element in the profit equation. Invariably, writers attempting to do so have opted out at the last minute with weak-kneed excuses for not closing the loop with specific examples. The only excep- tion has been some of the human resources accounting

xvii

xviii PREFACE TO THE FIRST EDITION

work, and that has not been accepted as a practical manage- ment tool.

The term human capital originated with Theodore Schultz, an economist interested in the plight of the world’s underdeveloped countries. He argued correctly that tradi- tional economic concepts did not deal with this problem. His claim was that improving the welfare of poor people did not depend on land, equipment, or energy, but rather on knowledge. He called this qualitative aspect of economics ‘‘human capital.’’ Schultz, who won the Nobel Prize in 1979, offered this description:

Consider all human abilities to be either innate or acquired. Every person is born with a particular set of genes, which de- termines his innate ability. Attributes of acquired population quality, which are valuable and can be augmented by appro- priate investment, will be treated as human capital.3

In business terms, we might describe human capital as a combination of factors such as the following:

• The traits one brings to the job—intelligence, energy, a generally positive attitude, reliability, commitment

• One’s ability to learn—aptitude, imagination, creativity, and what is often called ‘‘street smarts,’’ savvy (or how to get things done)

• One’s motivation to share information and knowledge— team spirit and goal orientation

The great irony is that the only economic component that can add value in and by itself is the one that is the most difficult to evaluate. This is the human component, which is clearly the most vexatious of assets to manage. The almost infinite variability and unpredictability of human beings

PREFACE TO THE FIRST EDITION xix

make them enormously more complex to evaluate than one of the electromechanical components that comes with pre- determined operating specifications. Nevertheless, people are the only element with the inherent power to generate value. All other variables—cash and its cousin credit, mate- rials, plant and equipment, and energy—offer nothing but inert potentials. By their nature, they add nothing, and they cannot add anything until some human being, be it the lowest-level laborer, the most ingenious professional, or the loftiest executive, leverages that potential by putting it into play. The good news is that measuring the value added of human capital is possible. In fact, it has been going on in a dozen countries since the early 1990s. Why this is known by only a relatively few managers will be addressed later.

Viewed from either an economic or a philosophic per- spective, the thing that matters most is not how productive people are in organizations. That is a by-product of some- thing more fundamental. The most important issue is how fulfilled people are in their work. No amount of compensa- tion can restore the soul of a person who has spent his or her life in mindless toil. In fact, even a modicum of economic comfort cannot overcome the bitterness of that experience. Curiously, fulfilling work is truly its own reward for the indi- vidual and the enterprise. In the final analysis, there is clear and abundant evidence that an organization that makes work as fulfilling as possible will develop and retain the most productive workers and enjoy the most loyal cus- tomers.

One of the key drivers of fulfillment is knowledge. Know- ing how well we have done leads directly to job satisfaction. The only thing that is more satisfying than seeing data that show our accomplishments is having our supervisor see the results of our labor and compliment us on a job well done.

xx PREFACE TO THE FIRST EDITION

Facing the Talent Shortage For the foreseeable future, organizations in most developed countries will be faced with a talent shortfall. In the United States, the demographics are such that it will be impossible to sustain strong economic growth due to the paucity of tal- ent. Since 1965, the end of the baby boom era, the birthrate has declined by about one-third. This decline has resulted in a workforce population that is decreasing. Concurrently, the national economy as measured by the gross domestic product has nearly doubled over the same period. Obvi- ously, the economy and the working population are on diverging growth curves. Although the current robust econ- omy will surely slow to some degree, the availability of in- digenous talent is not going to reverse its course overnight. From 1996 to 2006, the percentage of workers ages 25 to 34 will shrink 9 percent, and those 35 to 44 will slip 3 percent.

Such data are available to anyone who chooses to look for them. Drucker accuses organizations of focusing data collection on the inside of the enterprise.4 These data treat only costs. Yet results are outside, and management has largely ignored demographic and customer trend data. He claims that the most important factor for planning and for strategy is whether the share of income that customers spend on an industry’s products is increasing or decreasing. On the human side, it was pointed out in an article in 1990 that the most significant problem organizations would face in the last half of the decade would be a shortage of talent.5

The economic and population data were available to man- agement and were ignored. If we want the economy to con- tinue its upward pace, something has to be done to compensate for the declining number of qualified workers at all levels.

There are several ways to accomplish that—some poten-

PREFACE TO THE FIRST EDITION xxi

tially more effective than others. The first reaction is to bring in millions of immigrants to fill jobs. This is not going to happen. Congress is under pressure to control immigra- tion by various self-interest groups such as labor unions. Immigrants will help, but they will be a very small part of the solution. Even if the gates were opened, the data show that between 1980 and 1990, 41 percent of new immigrants age 25 and older did not have a college equivalency educa- tion, compared with 23 percent of native-born Americans of the same age-group.6 This is not going to fill a knowledge economy’s talent shortage in the near term.

Outsourcing work to other countries is an increasingly popular method of coping with the shortage. Manufacturing has been doing this successfully for the past thirty years. However, managing professional workers engaged in quali- tative, judgmental designs thousands of miles across oceans and continents is a more complex matter and not so trouble free.

Another simplistic answer stems from outmoded beliefs about people. Some managers believe in their hearts that rank-and-file workers are not a whole lot smarter than Skin- ner’s pigeons who learned to peck levers to obtain food pellets. Those managers believe that providing tangible in- centives, the human equivalent of food pellets, is the an- swer. However, it doesn’t matter how tasty the incentives might be; a pigeon who doesn’t know which lever to peck is not going to get a pellet. This is a way of saying that if we don’t have people with the inherent talent, training, or work experience, along with the right tools and information to do the job, we are not going to get the results we need. All we will have is frustrated pigeons. To maintain a competitive position in the marketplace of the twenty-first century, man- agement will have to find methods for increasing the power

xxii PREFACE TO THE FIRST EDITION

of the human information lever. The availability of valid and reliable performance data is at the heart of the issue.

The most cost-effective, long-term solution to the talent shortfall lies in helping each person become more produc- tive. This charges management with the task of figuring out how to invest in human productive potential. During the In- dustrial Age, the primary production tools moved material. In the postindustrial age, the production tools move infor- mation, which in turn tells us how and when to move the appropriate materials and services. Electronic technology is just beginning to be employed to generate useful data and move them quickly. The loop of productivity begins to close when human beings learn what data are needed, where, when, in what form, and by whom. The loop is completed and productivity enhanced when people learn what the data mean. Training in data analysis and interpretation turns data into information and eventually intelligence. That is the only feasible path to solving the talent shortage. Schultz was right, decades ago.

Acknowledgments The models and methods described are the result of the col- lective insights and efforts of many people over a long time. At the beginning, in the 1970s, Bob Coon tested the earliest methods with me in the human resources department of a Silicon Valley computer company. Over the years, Bob worked with me again at the Saratoga Institute, when we went public with our first crude survey of human resources benchmarks in 1985. The staff at the institute, through their daily work of supporting clients with valid, reliable data on human capital, added immeasurably to the content of this book. The work of Eric Stanger, David Flores, and Charlotte

PREFACE TO THE FIRST EDITION xxiii

Cox was especially valuable. Clients too numerous to men- tion have tested our ideas over the past fifteen years.

Finally, I thank the thousands of indifferent and conten- tious people whose apathy and sometimes hostility spurred me to prove that it could be done.

A special word of thanks to my acquisitions editor, Adri- enne Hickey. She never let me produce anything less than the best I had to offer.

References 1. Henri Fayol (1841–1925), Administration Industrielle et

Générale (General and Industrial Management), trans. Constance Storrs, with a foreword by L. Urwick (London: Pitman, 1949).

2. Chester Irving Barnard (1886–1961), The Functions of the Executive (Cambridge, MA: Harvard University Press, 1938, 1962).

3. Theodore W. Schultz, Investing in People: The Economics of Population Quality (Berkeley, CA: University of Cali- fornia, 1981), p. 21.

4. Peter Drucker, ‘‘The Next Information Revolution,’’ Forbes ASAP, August 24, 1998, pp. 47–58.

5. Jac Fitz-enz, ‘‘Getting and Keeping Good Employees,’’ Personnel Journal, August 1990, pp. 25–28.

6. Hudson Institute, ‘‘Workforce 2020,’’ 1999.

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1C H A P T E R O N E Human Leverage

‘‘We can have facts without thinking but we cannot have

thinking without facts.’’

—JOHN DEWEY

The Shift No longer is management of the human resources depart- ment a human resources issue. When personnel and train- ing came into being during the 1930s, it was in response to the growing strength of organized labor. The main contribu- tion of personnel and industrial relations was to deal with that incursion. After World War II, as corporations ex- panded, there was a need for someone to handle the admin- istrative issues around employees. Personnel got the job. By the late 1960s, it was becoming clear that there were more complex challenges, so personnel changed its name to human resources. Today, the game is human capital man- agement. Conceptually, this is recognition that people are the bedrock of the organization as we stumble into the Intel- ligence Age. The fundamental question has become, how do we improve the return on our investment in human capital?

1

2 THE ROI OF HUMAN CAPITAL

We find ourselves in a world where yesterday is a distant memory and tomorrow is an uncertain dream. The only re- ality is now. Yet, by taking the long view of any issue, we better understand not only where we have come from and where we are now but perhaps where we might be headed. Consider how a technology such as telecommunications has evolved. It started as a box on the wall with a crank and a gizmo to talk into. Some people believed that it was a fad and that they didn’t need one. Today, it is a gizmo stuck in your ear or a pad hung somewhere on your body and don’t try to tell your teenagers that they don’t need one.

So what does this have to do with managing organiza- tions and especially with understanding how people—that is, human capital—need to be addressed within our organi- zations? Here is where it goes three-dimensional. The issue is not only the structure of organizations and the people within them. Now the external entity, the customer, has en- tered the organization in a new and as yet not clearly under- stood way. Whether we recognize the fact or not, the customer is as much a part of our companies as are our physical and human assets. The three types of capital— structural, human, and relational—are rapidly merging into just structural and human with what was the external rela- tions (the customer) now imbedded in everything we do in- ternally.

Let me try to explain it by paralleling it with the evolution of electronic technology. Computers became a reality with the production of ENIAC, which was the first truly work- able, large-scale computer. By large, I mean room size. ENIAC was born in 1945 as a mass of vacuum tubes that truly took up the space of a room. Twenty years later, IBM came out with the System/360 that brought computing into the business world in a somewhat user-friendly way. Two decades later, minicomputers were common and the micro-

HUMAN LEVERAGE 3

computer appeared. The first portable computer weighed more than 20 pounds. Today, laptops weigh less than 5 pounds. BlackBerrys and similar devices weigh only 5 ounces and provide more computing power than ENIAC. So what? Stay with me, there is an end and a point to this journey.

As the computer and lately the telephone evolved and merged capabilities, the critical challenges also advanced from hardware to software to services. The product capabil- ity has grown to the point where the customer and the prod- uct are virtually inseparable. Today’s telephone/computer is no longer in a room, on our desk, or in a purse or briefcase. It is attached to our ear. Already that gizmo is taking simple switching voice commands. Tomorrow it will do our com- puting verbally as we walk, drive, or sit on our patio. Argu- ments over any topic from who won the Stanley Cup in 1948 to where was da Vinci when he painted the Mona Lisa to what was Tonto’s pet’s name will be settled without lifting a finger.

Ten years ago, I told people at PeopleSoft that they needed to move toward services as the next natural evolu- tionary step. They told me to get lost. Lou Gerstner saw the future and had the power to shift IBM toward service. In 2007, over 60 percent of IBM revenues came from services.

The reason that the customer is now part of our organiza- tion is that we no longer sell a product or provide a service. We design, sell, and service a customer experience. We are stuck in the customer’s ear, literally and figuratively. No matter what our product, because of the customer’s emerg- ing capabilities and the expectations that are coming with them, we are selling experiences.

Steve Berkowitz, former CEO of Ask.com and later senior vice president of Microsoft’s online business group, hit it squarely in words that are paraphrased here:

4 THE ROI OF HUMAN CAPITAL

We have to deliver the basics but that isn’t going to get us to the top. Customers go where their emotions take them. We have to give the customer the richest experience they want NOW. In order to do that, I say we have to live 24/7 with the customer.

The New Human Capital Management Model The human resources function is positioned by choice or fate to lever human capital. The simple delivery of a service or processing of a transaction is a nineteenth-century con- cept. For this new mandate to work, a new vision, attitude, and set of skills are necessary to carry out a comprehensive model. Chapters 2 through 4 systematically lay out such a model. It starts at the top with the goals of the enterprise rather than at the bottom with the question of what human resources should measure. This is the first point of differen- tiation. We are not here to focus on human resources. Human resources is charged with helping people make a greater contribution to the organization’s raison d’ê. tre. So, our focus must be first on human capital and secondly on the human resources department. Once that distinction is clear, everything else falls into line. Then we can work down through operating processes to human resources service of- ferings. At the end, we have a structure on which to consider ensuing chapter applications and eventually build a per- formance measurement program.

Effects on Organizational Management Organizations are undergoing wrenching change not only due to globalization, technology advancements, and labor demographics but also because of the force that makes truly global companies competitive—information exchange. Peter

HUMAN LEVERAGE 5

Shanghai • Tokyo • Toronto • Washington, D.C.

Measuring the Economic Value of Employee Performance

Jac Fitz-enz

H U M A N C A P I T A L S E C O N D E D I T I O N

ROI OF

T H E

Special discounts on bulk quantities of AMACOM books are available to corporations, professional associations, and other organizations. For details, contact Special Sales Department, AMACOM, a division of American Management Association, 1601 Broadway, New York, NY 10019. Tel: 212-903-8316. Fax: 212-903-8083. E-mail: specialsls@amanet.org Website: www.amacombooks.org/go/specialsales To view all AMACOM titles go to: www.amacombooks.org

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.

Library of Congress Cataloging-in-Publication Data

The ROI of human capital : measuring the economic value of employee performance / Jac Fitz-enz.—2nd ed.

p. cm. Includes index. ISBN-13: 978-0-8144-1332-6 (hardcover) ISBN-10: 0-8144-1332-3 (hardcover) 1. Human capital. 2. Productivity accounting. 3. Labor economics.

HD4904.7.R33 2009 658.15’226—dc22

2008050809

� 2009 Jac Fitz-enz All rights reserved. Printed in the United States of America.

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To Laura,

My love My strength

My inspiration

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Contents

P R E FAC E T O T H E S E C O N D E D I T I O N x i

Acknowledgments xv

P R E FAC E T O T H E F I R S T E D I T I O N x v i i

Acknowledgments xxii

C H A P T E R 1

Human Leverage 1

The Shift 1

The New Human Capital Management Model 4

Effects on Organizational Management 4

Data for Management 8

Making the Change 10

Data Conundrum 10

Two Aspects of Human Capital 11

What Human Resources Can Learn from Finance 13

HRP 14

People and Information 16

Data-to-Value Cycle 17

Organizational Capacity 20

Surveying the Track 25

The ROI Race 25

False Starts 27

Points of Measurement 29

Summary 30

References 31

v

vi CONTENTS

C H A P T E R 2

How to Measure Human Capital’s Contribution to Enterprise Goals 33 Constancy and Alignment 34

How to Become a Business Partner 36

The First Step 38

Human-Financial Interface 39

A Strategic View 40

Enterprise-Level Metrics: The Launch Point 44

The H in Human Capital 53

Human Capital Enterprise Scorecard 59

How to Marry Quantitative and Qualitative 60

Benchmarking’s Danger 62

The Willy Loman Syndrome 62

Summary 63

References 64

C H A P T E R 3

How to Measure Human Capital’s Impact on Processes 66 Making Money Through Process Management 66

In the Beginning 68

The Return of Reason 69

Positioning Business Unit Processes 72

Process/Talent Case 75

Supply Chain Management 76

Human Capital in Processes 78

Anatomy of a Process 82

Process Performance Matrix 86

Finding Human Capital Effects 91

A Test Problem 96

Summary 102

References 104

C H A P T E R 4

How to Measure Human Resources’ Value Added 106 Whither HR? 106

CONTENTS vii

Top Reasons for Employees Leaving 116

Human Capital Performance Evaluation 118

Change Measurement 128

Human Capital Scorecard 129

Human Capital Accounting 133

A Human Capital P&L 136

Benchmarking, Best Practices, and Other Fairy

Tales 136

Truly Effective Practices 137

Summary 141

References 143

C H A P T E R 5

End-to-End Human Capital Value Reports 144 One Sure Path to Profitability 146

Three Examples 149

Cases 154

An Integrated Reporting System 159

Leading Indicators 162

References 164

C H A P T E R 6

Human Capital Analytics: The Leading Edge of Measurement 165 A Model and System 166

Relationships and Patterns 167

Pattern Recognition 168

Fallacies in Trend Identification 168

Finding Meaning 169

Extrapolation 170

The Importance of Context 171

Charlatans 172

Business Applications 173

Performance Valuation 174

Data Sensors: Forecasting and Predicting 176

Toward a Human Capital Financial Index 181

viii CONTENTS

Index Value 185

Index Application 185

Data Sources 187

Summary 189

References 190

C H A P T E R 7

Predictive Analytics: Leading Indicators and Intangible Metrics 192 Toward Leading Indicators 192

Leading Indicator Examples 193

Enterprise Futures 195

Functional Futures 196

Be Prepared 196

Assessment 199

Employee Mind-Sets 200

Indirect Sign 201

Competitiveness 202

Indexing the Problem 204

Scoreboarding Overview 206

Summary 208

References 209

C H A P T E R 8

How to Measure and Value Improvement Initiatives Results 210 Rebirth of U.S. Business 210

The New Age 211

Measuring the New Capital 212

Restructuring: A Fading Star 214

Employee Engagement 222

Contingent Workforce Management: The New Human

Capital Challenge 226

Mergers and Acquisitions: Buy vs. Make 233

Benchmarking: A Value-Adding Approach 241

Summary 248

References 250

CONTENTS ix

C H A P T E R 9

Outsourcing: A New Operating Model? 252

Mixed Results 253

Trends in Functional Outsourcing 254

Outsourcing Life Cycle 259

Service Initiatives and Satisfaction 262

Getting It Right 263

The Future: Web 2.0 and Outsourcing 268

Beyond Cost Cutting 269

In the End 270

References 270

C H A P T E R 1 0

How to Change the Game 272

HR’s Disruptive Technology 274

Process Optimization 280

Integrated Delivery 283

Analysis 285

Predictive Metrics 286

Leading Indicators 288

The New Game 288

Summary: Learning While Doing 289

References 290

C H A P T E R 1 1

Eleven Principles, Seven Skills, and Five Metrics 291

Principle 1: People Plus Information Drive the

Knowledge Economy 292

Principle 2: Management Demands Data; Data Helps Us

Manage 292

Principle 3: Human Capital Data Shows the How, the

Why, and the Where 293

Principle 4: Validity Demands Consistency; Being

Consistent Promotes Validity 293

x CONTENTS

Principle 5: The Value Path Is Often Covered;

Analysis Uncovers the Pathway 294

Principle 6: Coincidence May Look Like Correlation but

Is Often Just Coincidence 294

Principle 7: Human Capital Leverages Other Capital to

Create Value 294

Principle 8: Success Requires Commitment;

Commitment Breeds Success 295

Principle 9: Volatility Demands Leading Indicators;

Leading Indicators Reduce Volatility 295

Principle 10: The Key Is to Supervise; the Supervisor

Is the Key 296

Principle 11: To Know the Future, Study the Past—but

Don’t Relive It 296

Seven Skills That Make It All Work 296

Five Metrics of Life 297

Conclusion 299

I N D E X 3 0 1

Preface to the Second Edition

In reviewing the first edition I found that many of the pre- dictions made in 1999 came true. This is because the funda- mentals around human performance still apply . . . and always will. The environment may change but people don’t. Specifically, my early prediction about the labor shortage came true, only now with greater urgency.1 I described the rise of outsourcing along with contingent workers as the first step in restructuring organizations. My declaration about the need to focus on leading indicators has come to be accepted. My points about the quality of work life have become mainstream topics. Other projections within the first edition also proved accurate. This edition continues to be on the leading edge with the introduction of Predictive Management, a new paradigm for managing the future today. You will see the concept in various places and the model in Chapter 10.

Business Changes Businesses are finding that they have to change the way they do business. The model that emerged after World War II has

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xii PREFACE TO THE SECOND EDITION

run its course. Dot-coms came and went with much fury and left behind an e-world that has profoundly affected the way everyone does business. When you change the commu- nication system, you shift power bases and you expose weaknesses. The flaws of the past that could be papered over are now more obvious. New forms are rising as a result of communication analytics and computer technology. Change is the order of the new century.

In terms of management trends, outsourcing has made quantum leaps. From the advent of the first full human re- sources process outsourcing contract in 1999 to today, the concept has exploded. According to Everest Research there are four thousand companies currently offering those ser- vices worldwide. Human development has shifted from a reliance on classroom training to a blended approach that incorporates various media and job experiences.

Globalization has come to the fore. The growth in China, India, and the Arabian Gulf countries has called forth a new power that is affecting everyone everywhere at all levels. Even managing a local small business is different today. Ever hear of pollution, global warming, health insurance, immigration, or education deficiencies? How about mega- brands like Toyota, Wal-Mart, Starbucks, Amazon, or Google?

Of course, recruitment is the main game now. In 1998 the labor shortage was a factor but it was isolated largely on technical skills related to dot-com ventures. Today, profes- sional and managerial shortfalls in many disciplines are emerging and will not be alleviated by temporary market downturns. Multigenerational workforces had barely sur- faced. Now they are the norm. Baby boomers were in charge, now they are looking for an exit strategy they can afford.

PREFACE TO THE SECOND EDITION xiii

The Good News Despite a continuing reluctance of some human resources people to address quantitative analysis, there have been major advances in the past decade. When I was writing the first edition of this book, I would have estimated that only about 5 percent of human resources departments were doing anything significant in this area. Most of those were still mired in basic measures of HR efficiency—that is, cost of hire, time to fill jobs, compensation and benefits expense, and effects such as turnover rates.

Now my estimate is that at least 30 to 35 percent of human resources departments are doing some kind of quan- titative measurement. Unfortunately, only about 10 percent have moved upscale to measure effects on the enterprise. Thanks to the work of people like Jack and Patti Phillips, John Boudreau and Pete Ramsted, Mark Huselid, Brian Becker and Dick Beatty, Dave Ulrich and Wayne Brockbank, Jesse Harriott and Jeff Quinn, Ken Scarlett, Debbie Mc- Grath, Erik Berggren, Doug Hubbard, Kent Barnett, and Jeffrey Burke, among others, the state of the art has im- proved dramatically. In Argentina Luis Maria Cravino and in Brazil Rugenia Pomi are leading the way. Software packages are coming to market from companies such as Au- thoria, KnowledgeAdvisors, Oracle, Scarlett Surveys Suc- cessFactors, and others that make quantitative analysis easier and more meaningful. We are moving from merely measuring to finding and explaining meaning.

Looking Ahead This edition updates its predecessor in several ways. In the past two years, I have collected more than three hundred

xiv PREFACE TO THE SECOND EDITION

cases, models, and survey results, many of which are merged here to replace and update those of the first edition, to give currency to the narrative.

The basic metrics in the book are now widely used and quoted around the world. In addition, I have developed leading indicators and intangible metrics that were not proven as well in 2000. Intangibles have attracted a great deal of interest since Baruch Lev’s 2001 book, Intangibles. Concurrently, benchmarking has peaked. The more ad- vanced human resources professionals are looking for something new and leading indicators and intangibles are satisfying that need. There is a new chapter (Chapter 7: Pre- dictive Analytics: Leading Indicators and Intangibles) to cover this development.

Chapter 1 reflects the changes since 2000. Chapters 2, 3, and 4 are refreshed with new material, but the structure is unchanged. In addition to new text and new graphics, the number of case studies has been increased.

Chapter 5 displays an updated reporting model. The latest balanced scorecard approach is added along with an up- dated human capital profit-and-loss model. These link HR’s reporting language more closely to the accounting system.

The structures of Chapters 6 and 7 are reworked in the light of recent developments. Chapter 6 expands and offers more details and depth to human capital valuation. It revis- its the value of indexing. Benchmarking is repositioned as a tactical rather than a strategic activity, which it was when I introduced it in 1985 with special attention paid to context as a means of understanding benchmark data.

Chapter 7 focuses on the future. It expands on predictive analytics. Leading indicators and intangibles are covered. Trending and indexing examples are shown.

PREFACE TO THE SECOND EDITION xv

Chapter 8 is the original Chapter 7 and is largely redone. Outsourcing is removed and placed in its own chapter. Restructuring, contingent management, mergers and acqui- sitions, and benchmarking are all reworked. Employee en- gagement is added.

Chapter 9 is given exclusively to outsourcing. Since 2000, outsourcing has exploded with both good and bad results. It is changing the structure of organizations.

Chapter 10 is an entirely new subject. Based on a major research program that yielded a new management model, this chapter describes how to change the game and gain competitive advantage through predictive management.

Finally, in Chapter 11, the guiding principles are updated into eleven principles for success, seven skills of valuation, and five metrics of life.

Acknowledgments A project as complex and extensive as publishing a book in- volves many people with many talents. The content people who supported and contributed ideas are acknowledged in the Preface to this edition. I want to also cite the people at AMACOM who helped get this tome out the door.

My gratitude goes out to Executive Editor Christina Parisi and her assistant, Janet Pagano; Publicity Director Irene Majuk; Managing Editor Andy Ambraziejus; especially Erika Spelman, who kept the project moving between me, the copyeditor, the proofreader, and the indexer; copyeditor Mary Miller who picked up all my typos and grammatical errors; proofreader Robin O’Dell; and Production Manager Lydia Lewis, who coordinated with the designer to get the design completed, negotiated schedules with the composi-

xvi PREFACE TO THE SECOND EDITION

tor and printer, and made sure everything got where it needed to go on time.

Thanks everyone. This is your book also.

References 1. Jac Fitz-enz, ‘‘Getting and Keeping Good Employees,’’

Personnel Journal, August 1990, pp. 25–28.

Preface to the First Edition

The Missing Piece The classic books of management have ignored, avoided, or thrown platitudes at the question of human value in the business environment. When and if the authors did give passing attention to valuing the human contribution, their comments were either gratuitous or simplistic. Nineteenth- century capital theory claimed that wealth was leveraged from investments in tangible assets such as plants and equipment. It held that workers were entitled to compensa- tion only for their labor, since the incremental values of the business came from investment in capital equipment. This type of thinking lit the fire under people like Karl Marx and Samuel Gompers. From the early work of Fayol1 and Bar- nard,2 which supported this thinking, to the more enlight- ened insights of Drucker, Peters, Handy, and others, no one has successfully taken on the challenge of detailing how to demonstrate the relative value of the human element in the profit equation. Invariably, writers attempting to do so have opted out at the last minute with weak-kneed excuses for not closing the loop with specific examples. The only excep- tion has been some of the human resources accounting

xvii

xviii PREFACE TO THE FIRST EDITION

work, and that has not been accepted as a practical manage- ment tool.

The term human capital originated with Theodore Schultz, an economist interested in the plight of the world’s underdeveloped countries. He argued correctly that tradi- tional economic concepts did not deal with this problem. His claim was that improving the welfare of poor people did not depend on land, equipment, or energy, but rather on knowledge. He called this qualitative aspect of economics ‘‘human capital.’’ Schultz, who won the Nobel Prize in 1979, offered this description:

Consider all human abilities to be either innate or acquired. Every person is born with a particular set of genes, which de- termines his innate ability. Attributes of acquired population quality, which are valuable and can be augmented by appro- priate investment, will be treated as human capital.3

In business terms, we might describe human capital as a combination of factors such as the following:

• The traits one brings to the job—intelligence, energy, a generally positive attitude, reliability, commitment

• One’s ability to learn—aptitude, imagination, creativity, and what is often called ‘‘street smarts,’’ savvy (or how to get things done)

• One’s motivation to share information and knowledge— team spirit and goal orientation

The great irony is that the only economic component that can add value in and by itself is the one that is the most difficult to evaluate. This is the human component, which is clearly the most vexatious of assets to manage. The almost infinite variability and unpredictability of human beings

PREFACE TO THE FIRST EDITION xix

make them enormously more complex to evaluate than one of the electromechanical components that comes with pre- determined operating specifications. Nevertheless, people are the only element with the inherent power to generate value. All other variables—cash and its cousin credit, mate- rials, plant and equipment, and energy—offer nothing but inert potentials. By their nature, they add nothing, and they cannot add anything until some human being, be it the lowest-level laborer, the most ingenious professional, or the loftiest executive, leverages that potential by putting it into play. The good news is that measuring the value added of human capital is possible. In fact, it has been going on in a dozen countries since the early 1990s. Why this is known by only a relatively few managers will be addressed later.

Viewed from either an economic or a philosophic per- spective, the thing that matters most is not how productive people are in organizations. That is a by-product of some- thing more fundamental. The most important issue is how fulfilled people are in their work. No amount of compensa- tion can restore the soul of a person who has spent his or her life in mindless toil. In fact, even a modicum of economic comfort cannot overcome the bitterness of that experience. Curiously, fulfilling work is truly its own reward for the indi- vidual and the enterprise. In the final analysis, there is clear and abundant evidence that an organization that makes work as fulfilling as possible will develop and retain the most productive workers and enjoy the most loyal cus- tomers.

One of the key drivers of fulfillment is knowledge. Know- ing how well we have done leads directly to job satisfaction. The only thing that is more satisfying than seeing data that show our accomplishments is having our supervisor see the results of our labor and compliment us on a job well done.

xx PREFACE TO THE FIRST EDITION

Facing the Talent Shortage For the foreseeable future, organizations in most developed countries will be faced with a talent shortfall. In the United States, the demographics are such that it will be impossible to sustain strong economic growth due to the paucity of tal- ent. Since 1965, the end of the baby boom era, the birthrate has declined by about one-third. This decline has resulted in a workforce population that is decreasing. Concurrently, the national economy as measured by the gross domestic product has nearly doubled over the same period. Obvi- ously, the economy and the working population are on diverging growth curves. Although the current robust econ- omy will surely slow to some degree, the availability of in- digenous talent is not going to reverse its course overnight. From 1996 to 2006, the percentage of workers ages 25 to 34 will shrink 9 percent, and those 35 to 44 will slip 3 percent.

Such data are available to anyone who chooses to look for them. Drucker accuses organizations of focusing data collection on the inside of the enterprise.4 These data treat only costs. Yet results are outside, and management has largely ignored demographic and customer trend data. He claims that the most important factor for planning and for strategy is whether the share of income that customers spend on an industry’s products is increasing or decreasing. On the human side, it was pointed out in an article in 1990 that the most significant problem organizations would face in the last half of the decade would be a shortage of talent.5

The economic and population data were available to man- agement and were ignored. If we want the economy to con- tinue its upward pace, something has to be done to compensate for the declining number of qualified workers at all levels.

There are several ways to accomplish that—some poten-

PREFACE TO THE FIRST EDITION xxi

tially more effective than others. The first reaction is to bring in millions of immigrants to fill jobs. This is not going to happen. Congress is under pressure to control immigra- tion by various self-interest groups such as labor unions. Immigrants will help, but they will be a very small part of the solution. Even if the gates were opened, the data show that between 1980 and 1990, 41 percent of new immigrants age 25 and older did not have a college equivalency educa- tion, compared with 23 percent of native-born Americans of the same age-group.6 This is not going to fill a knowledge economy’s talent shortage in the near term.

Outsourcing work to other countries is an increasingly popular method of coping with the shortage. Manufacturing has been doing this successfully for the past thirty years. However, managing professional workers engaged in quali- tative, judgmental designs thousands of miles across oceans and continents is a more complex matter and not so trouble free.

Another simplistic answer stems from outmoded beliefs about people. Some managers believe in their hearts that rank-and-file workers are not a whole lot smarter than Skin- ner’s pigeons who learned to peck levers to obtain food pellets. Those managers believe that providing tangible in- centives, the human equivalent of food pellets, is the an- swer. However, it doesn’t matter how tasty the incentives might be; a pigeon who doesn’t know which lever to peck is not going to get a pellet. This is a way of saying that if we don’t have people with the inherent talent, training, or work experience, along with the right tools and information to do the job, we are not going to get the results we need. All we will have is frustrated pigeons. To maintain a competitive position in the marketplace of the twenty-first century, man- agement will have to find methods for increasing the power

xxii PREFACE TO THE FIRST EDITION

of the human information lever. The availability of valid and reliable performance data is at the heart of the issue.

The most cost-effective, long-term solution to the talent shortfall lies in helping each person become more produc- tive. This charges management with the task of figuring out how to invest in human productive potential. During the In- dustrial Age, the primary production tools moved material. In the postindustrial age, the production tools move infor- mation, which in turn tells us how and when to move the appropriate materials and services. Electronic technology is just beginning to be employed to generate useful data and move them quickly. The loop of productivity begins to close when human beings learn what data are needed, where, when, in what form, and by whom. The loop is completed and productivity enhanced when people learn what the data mean. Training in data analysis and interpretation turns data into information and eventually intelligence. That is the only feasible path to solving the talent shortage. Schultz was right, decades ago.

Acknowledgments The models and methods described are the result of the col- lective insights and efforts of many people over a long time. At the beginning, in the 1970s, Bob Coon tested the earliest methods with me in the human resources department of a Silicon Valley computer company. Over the years, Bob worked with me again at the Saratoga Institute, when we went public with our first crude survey of human resources benchmarks in 1985. The staff at the institute, through their daily work of supporting clients with valid, reliable data on human capital, added immeasurably to the content of this book. The work of Eric Stanger, David Flores, and Charlotte

PREFACE TO THE FIRST EDITION xxiii

Cox was especially valuable. Clients too numerous to men- tion have tested our ideas over the past fifteen years.

Finally, I thank the thousands of indifferent and conten- tious people whose apathy and sometimes hostility spurred me to prove that it could be done.

A special word of thanks to my acquisitions editor, Adri- enne Hickey. She never let me produce anything less than the best I had to offer.

References 1. Henri Fayol (1841–1925), Administration Industrielle et

Générale (General and Industrial Management), trans. Constance Storrs, with a foreword by L. Urwick (London: Pitman, 1949).

2. Chester Irving Barnard (1886–1961), The Functions of the Executive (Cambridge, MA: Harvard University Press, 1938, 1962).

3. Theodore W. Schultz, Investing in People: The Economics of Population Quality (Berkeley, CA: University of Cali- fornia, 1981), p. 21.

4. Peter Drucker, ‘‘The Next Information Revolution,’’ Forbes ASAP, August 24, 1998, pp. 47–58.

5. Jac Fitz-enz, ‘‘Getting and Keeping Good Employees,’’ Personnel Journal, August 1990, pp. 25–28.

6. Hudson Institute, ‘‘Workforce 2020,’’ 1999.

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1C H A P T E R O N E Human Leverage

‘‘We can have facts without thinking but we cannot have

thinking without facts.’’

—JOHN DEWEY

The Shift No longer is management of the human resources depart- ment a human resources issue. When personnel and train- ing came into being during the 1930s, it was in response to the growing strength of organized labor. The main contribu- tion of personnel and industrial relations was to deal with that incursion. After World War II, as corporations ex- panded, there was a need for someone to handle the admin- istrative issues around employees. Personnel got the job. By the late 1960s, it was becoming clear that there were more complex challenges, so personnel changed its name to human resources. Today, the game is human capital man- agement. Conceptually, this is recognition that people are the bedrock of the organization as we stumble into the Intel- ligence Age. The fundamental question has become, how do we improve the return on our investment in human capital?

1

2 THE ROI OF HUMAN CAPITAL

We find ourselves in a world where yesterday is a distant memory and tomorrow is an uncertain dream. The only re- ality is now. Yet, by taking the long view of any issue, we better understand not only where we have come from and where we are now but perhaps where we might be headed. Consider how a technology such as telecommunications has evolved. It started as a box on the wall with a crank and a gizmo to talk into. Some people believed that it was a fad and that they didn’t need one. Today, it is a gizmo stuck in your ear or a pad hung somewhere on your body and don’t try to tell your teenagers that they don’t need one.

So what does this have to do with managing organiza- tions and especially with understanding how people—that is, human capital—need to be addressed within our organi- zations? Here is where it goes three-dimensional. The issue is not only the structure of organizations and the people within them. Now the external entity, the customer, has en- tered the organization in a new and as yet not clearly under- stood way. Whether we recognize the fact or not, the customer is as much a part of our companies as are our physical and human assets. The three types of capital— structural, human, and relational—are rapidly merging into just structural and human with what was the external rela- tions (the customer) now imbedded in everything we do in- ternally.

Let me try to explain it by paralleling it with the evolution of electronic technology. Computers became a reality with the production of ENIAC, which was the first truly work- able, large-scale computer. By large, I mean room size. ENIAC was born in 1945 as a mass of vacuum tubes that truly took up the space of a room. Twenty years later, IBM came out with the System/360 that brought computing into the business world in a somewhat user-friendly way. Two decades later, minicomputers were common and the micro-

HUMAN LEVERAGE 3

computer appeared. The first portable computer weighed more than 20 pounds. Today, laptops weigh less than 5 pounds. BlackBerrys and similar devices weigh only 5 ounces and provide more computing power than ENIAC. So what? Stay with me, there is an end and a point to this journey.

As the computer and lately the telephone evolved and merged capabilities, the critical challenges also advanced from hardware to software to services. The product capabil- ity has grown to the point where the customer and the prod- uct are virtually inseparable. Today’s telephone/computer is no longer in a room, on our desk, or in a purse or briefcase. It is attached to our ear. Already that gizmo is taking simple switching voice commands. Tomorrow it will do our com- puting verbally as we walk, drive, or sit on our patio. Argu- ments over any topic from who won the Stanley Cup in 1948 to where was da Vinci when he painted the Mona Lisa to what was Tonto’s pet’s name will be settled without lifting a finger.

Ten years ago, I told people at PeopleSoft that they needed to move toward services as the next natural evolu- tionary step. They told me to get lost. Lou Gerstner saw the future and had the power to shift IBM toward service. In 2007, over 60 percent of IBM revenues came from services.

The reason that the customer is now part of our organiza- tion is that we no longer sell a product or provide a service. We design, sell, and service a customer experience. We are stuck in the customer’s ear, literally and figuratively. No matter what our product, because of the customer’s emerg- ing capabilities and the expectations that are coming with them, we are selling experiences.

Steve Berkowitz, former CEO of Ask.com and later senior vice president of Microsoft’s online business group, hit it squarely in words that are paraphrased here:

4 THE ROI OF HUMAN CAPITAL

We have to deliver the basics but that isn’t going to get us to the top. Customers go where their emotions take them. We have to give the customer the richest experience they want NOW. In order to do that, I say we have to live 24/7 with the customer.

The New Human Capital Management Model The human resources function is positioned by choice or fate to lever human capital. The simple delivery of a service or processing of a transaction is a nineteenth-century con- cept. For this new mandate to work, a new vision, attitude, and set of skills are necessary to carry out a comprehensive model. Chapters 2 through 4 systematically lay out such a model. It starts at the top with the goals of the enterprise rather than at the bottom with the question of what human resources should measure. This is the first point of differen- tiation. We are not here to focus on human resources. Human resources is charged with helping people make a greater contribution to the organization’s raison d’ê. tre. So, our focus must be first on human capital and secondly on the human resources department. Once that distinction is clear, everything else falls into line. Then we can work down through operating processes to human resources service of- ferings. At the end, we have a structure on which to consider ensuing chapter applications and eventually build a per- formance measurement program.

Effects on Organizational Management Organizations are undergoing wrenching change not only due to globalization, technology advancements, and labor demographics but also because of the force that makes truly global companies competitive—information exchange. Peter

HUMAN LEVERAGE 5