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How HR Drives Profits

Academic research and real-world experience show how HR practices affect the bottom line. It's not about obsessive cost cutting. It's about effectively investing in human capital.

June 27, 2002
Related Topics: HR Services and Administration, The HR Profession, Latest News
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Let's say that you were given $1,900 per employee to spend on human resources for the year and your CEO wants you to spend that money in a way that generates the biggest bang for the buck. In other words: profit. Where are you going to put that money? Into compensation design? Training? A new human resources information system? And how are you going to demonstrate whether that investment did indeed produce a return for the company?

Sure, you may know in your gut that HR contributes to the bottom line, but intuition doesn't cut it in today's business world. Executives want proof that HR is a profit-maker and not just a cost center -- and they want you to design HR initiatives accordingly.

Fortunately, more and more studies are coming out that demonstrate a remarkable correlation between specific HR practices and shareholder return. Furthermore, an increasing number of individual companies are able to provide solid anecdotal evidence that HR is, if not a profit center, then at least an important contributor to their profitability goals. Together, the research and individual case studies provide significant insight into how the HR function must operate in order to drive the bottom line.

"HR has never been more uniquely situated and placed than they are right now in terms of helping organizations achieve bottom-line results," says Shirley Richard, president of the Richard Company, a consulting firm in Phoenix. Why? Because not only are executives beginning to understand that the "human" resource is the most valuable resource they have, but there's also proof available now to show that investment in human resources does pay off.

So what does the research say about HR's impact on profit? The news is good, very good. Ed Lawler and Susan Mohrman of the Center for Effective Organizations at the University of Southern California recently completed an intensive study of management practices in Fortune 1000 companies. Their study demonstrates that employee-involvement practices such as information sharing, skills training, rewards programs, and empowerment efforts -- all of which fall squarely into HR's domain -- show a significant bottom-line return.

In 1999, companies that were big users of employee-involvement practices boasted a 66 percent higher return on sales, a 20 percent higher return on assets, a 20 percent higher return on investment, and a 13 percent higher return on equity, USC investigators report.

"This study clearly suggests that the kinds of practices that HR develops and supports have an impact on the bottom line," Lawler says. "While HR doesn't directly produce revenue -- it doesn't go out and find new business or open new markets -- HR certainly improves the effectiveness of the organization, which allows the company to find new business or open new markets."

Chris Ryan, director of the People Strategy Practice for the Chicago Market Circle of Andersen's Human Capital Group, is conducting a study that is providing even more specific data about HR's contribution to the bottom line. He and his colleagues are reviewing a broad range of human capital practices and how they relate to total shareholder return. Although the study is still under way, early results clearly indicate that companies that use HR practices such as helping new hires to assimilate, letting employees know what is expected of them, and regularly pruning low performers tend to achieve higher total shareholder return over a period of three to five years than companies that don't.

"Our study, along with the work of other researchers, refutes the notion that HR is simply a cost center," Ryan says, adding that various studies have shown that 15 to 30 percent of the total value of a company can be correlated to specific human capital practices. So what does all this mean for HR professionals in the trenches? "The point is that HR professionals have a choice in terms of how they spend their money and invest in the human capital of the firm," Ryan says. "What the data makes clear is that some choices have much greater impact than others."

In order to boost corporate profitability, HR has two ways of looking at building profit: 1) cutting costs and 2) helping to generate revenue.

Cost-cutting is a quick and relatively easy way to boost profits. It is typically HR's first tactic. One of the most common ways that HR has gone about cutting costs is utilizing technology to provide employee self-service, says Alicia Main, HR analyst with Best Practices, LLC, in Chapel Hill, North Carolina. Self-service technology enables employees -- and their managers -- to do such things as pursue e-learning, change benefit options, get answers to stock and compensation questions, and manage performance without
the help of HR professionals or expensive HR handbooks.

Baxter International in Deerfield, Illinois, for example, has saved over half a million dollars by investing in employee self-service, says Karen May, vice president of human resources. Xerox Corporation, which uses a PC-based human resources management system to give employees and managers online access to personnel information, has slashed annual printing costs by $1.5 million. Although the cost of the system was $2 million, the aggregate annual savings made the investment worthwhile.

When done well, measures that utilize technology to bring efficiency to administrative processes have the potential to reduce costs an average of 30 percent, says Brian Lowenthal, benchmark director of Hackett Benchmarking & Research, a division of Answerthink, Inc., in Hudson, Ohio. Unfortunately, he says, many companies that have been focusing on cost reduction through technology "haven't been doing it very well." Despite all the focus on cost-cutting, HR costs have actually risen, on average, 16 percent since 1998. "This is because many companies have been focused on technology and cost-cutting and have not done much to
improve work processes or deal with the cultural-change issues," Lowenthal says.

Furthermore, research shows that even if companies do realize valuable savings through cost-cutting or technology, there are other, more effective ways for HR to build value over time. While these value-adding efforts go by various names, including transformational HR, strategic HR, and cultural support, they all, in essence, refer to the same thing: the ability of HR to select and retain the right employees and help them do their best work. This is where the real profit gains are to be found.

"Line and HR managers need to shift their focus from thinking of HR as a cost to be minimized and embrace the idea that investments in human capital can be a significant source of value creation for shareholders," says Mark Huselid, an associate professor of HR Strategy in the School of Management and Labor Relations at Rutgers University and author of numerous studies demonstrating the financial impact of HR. So what do these "investments in human capital" look like in practice? What is value-added HR all about in real life? Well, when you take a look at companies that continue to be profitable despite today's brutal economic conditions, you'll find that their HR departments operate in much the same way.

Workforce talked to the HR directors at three such companies to learn what they do to support the company's bottom-line goals. These companies are:

  1. Universal Technical Institute, Inc., based in Phoenix, Arizona. This 1,100-employee company is a nationwide leader in providing technical training for heating, ventilating, and air-conditioning systems. If you operated a Mercedes-Benz car dealership and needed technicians who could work on the cars' climate-control systems, you might send employees to courses sponsored by UTI. Over the last 18 months, UTI has implemented a major cultural-change initiative that boosted revenue by 17.5 percent, reduced employee turnover by 35 percent, and increased enrollment in the company's manufacturer training program by a whopping 228 percent.

  2. Whole Foods Market, Inc., based in Austin, Texas. This chain of natural foods stores has 22,500 employees in 23 states and Canada, and is adding an average of 20 stores per year, an annual growth rate of 20 percent.

  3. Valassis, a marketing services company based in Livonia, Michigan. This 1,400-person company helps other companies market their products and services, most notably through coupon inserts in Sunday newspapers around the country. Valassis posted 10 percent net growth last year and continues to grow despite the tough climate for advertisers.

There are many similarities in how the HR efforts at these companies help to strengthen the bottom line. What's important to remember when reviewing these efforts is that not any one of them, in isolation, can build profit. As Joe Buys, a partner with Crystal Clear Concepts, Inc., a management consulting firm in Detroit, says: "You can't look at any one element in isolation." HR activities must work together to create an overall culture that is conducive to profit-making. Profitable companies have the following HR initiatives in common:

  1. They communicate extensively. The vision, values, and goals of the company are regularly communicated to employees. Not only that, but bad news is routinely shared, and successes are celebrated. "There is no rule in our book that says you can over-communicate," says Marcia Hyde, vice president of human resources and the communications center at Valassis.

    At Whole Foods, the thrust for open communication is taken so seriously that all managers and executives -- including the CEO -- maintain an open-door policy. "I came in to work on Monday and had 1,000 e-mails to answer," says Cindy Strunk, vice president of team member services and human resources. The e-mails were about everything from paternal leave to a disagreement about a termination, and Strunk worked to answer each one.

    The company also discloses wages so that every employee, if interested, can learn what coworkers, managers, and executives are paid. "While this openness takes some getting used to," Strunk admits, "we're a company based on knowledge, and we don't believe in hiding any knowledge or information from our team members."

  2. Employees are involved in setting goals. About 18 months ago, UTI decided to pursue a new business model that would orient employees to a new customer. Instead of focusing solely on the students in its training programs, UTI decided that the industry -- the car manufacturers and dealerships that utilize its students -- was also a key customer base. This new strategic focus mandated a new way of thinking about the business.

    Sharon Gleeson, vice president of HR, says the company's executives did not sit down and devise a list of objectives for every employee to follow. Instead, each one of its 1,100 employees was involved in creating the new strategy and finding revenue-generating opportunities predicated on the new customer base. Employees from all divisions in the company worked together to identify the business drivers, create the strategic plan, devise the leadership principles, set the accountability measures, and roll out the communications surrounding the new strategy. Many of the employees had no previous experience with such efforts.

    Involving employees in this way has had an impact not only on profits -- gross earnings at UTI rose 44 percent in 2000 and 28 percent in 2001 -- but also on morale. According to employee surveys, between 1990 and 2001, overall employee satisfaction and morale moved from 37 to 75 percent; belief in the company's vision increased from 82 to 93 percent; and employees' understanding of how their jobs contribute to the company's business objectives soared to 96 percent.

  3. Employees understand how their jobs affect the bottom line and how the bottom line affects their paychecks. As UTI's experience demonstrates, when employees understand the impact of their work, amazing things can happen. But research proves that in addition to devising a clear line of sight between an employee's job and company success, it's vital for a company to share its success with employees. Hyde says that when employees understand the vision and how they contribute to it and benefit from it, they are much more inclined to help achieve it.

    There are a number of ways to share financial gains with employees. Whole Foods has had great success with a team-based gain-sharing program. Employees have the opportunity to receive gain-sharing payouts every four weeks, if their teams achieve certain goals related to sales and profit, Strunk says. Unlike profit-sharing, which reflects the performance of the company overall, the payout is based on a team's performance, and gain-sharing targets are determined by whatever measures are important to that team. Every four weeks, payouts are possible for the company's 1,300 teams, and in keeping with the open communication policy, all gain-sharing results are posted on the company's intranet.

  4. HR is not solely responsible for HR activities. When UTI decided to reorient the company toward a new customer, HR facilitated the process by bringing in consultants and hosting meetings. But employees themselves did the actual culture-change work. "Our measure of success is that HR does not take any claim for doing this," Gleeson says. "Companies fail if they believe any one department should handle cultural responsibilities."

    The idea that employees and executives should jointly carry the torch of culture and other HR responsibilities is an oft-repeated sentiment in profitable companies. "HR responsibilities are diffused through our organization," Strunk says. "Not only that, but if there is any such thing as an HR 'agenda,' it is driven from the stores on up. I don't determine the HR agenda. Our entire focus comes up from the team members themselves."

  5. Cost-savings are important, but not the focus of HR. HR directors agree that saving money is an ongoing concern for HR. But cost-saving, as mentioned earlier, should not be the primary focus of HR professionals who want to generate value for their companies. "I'm not constantly looking at training programs, systems, and procedures to learn how I might be able to affect the bottom line from a savings or efficiency perspective," Hyde says. "While those things are important, my focus is on maintaining a culture that can ensure our business grows and that employees are creative and innovative enough to get the job done."

  6. Employees are given what they need to be productive. It may go without saying that employees in profitable companies have the tools they need to get the job done. But those "tools" are not always obvious and may include everything from training and work/family initiatives to competitive compensation and corporate ethics programs.

    David Russo, formerly vice president of human resources for SAS Institute, a Workforce Optimas Award winner, and currently president and CEO of Empliant, Inc., an HR software company based in Raleigh, North Carolina, explains it this way: "HR adds value to the bottom line by creating an attractive workplace that helps employees stay and want to be productive. When the nickel stands on end, you want employees pushing that nickel to the company's side. If your company is a good place to work, with good policies and procedures and a good environment, productivity -- and profit -- increases."

So what's the moral of the story? It's that if you are handed $1,900 per employee to spend on human resources next year -- which is the average HR cost per employee, according to the Hackett Group -- spend that money on human capital practices that are closely associated with the business at hand and appear to have the biggest payoff: getting an employee acquainted and productive, setting goals and expectations, and having a results-oriented culture. Then sit back and watch your star rise.

Workforce, December 2001, pp. 26-31 -- Subscribe Now!

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