Measure What You Bring to the Bottom Line
In fact, you may even be a little bit embarrassed to admit your lack of know-how in this area. Hearing almost daily about the importance of economic value, bottom-line impact and net benefit, you’re convinced colleagues are measuring their way to a higher HR plane, leaving you behind to ponder your ignorance. Are you alone in your discomfort with the measurement task? Not by a long shot.
In the real world, there are few companies that consistently measure the bottom-line results of their HR investments. Rather, most are using extensive measurement sporadically at best, and many not at all.
Even sampling a few of the organizations that made it onto Fortune magazine’s list of “100 Best Companies to Work For in America” (January 12, 1998) indicates that quantitative measure in the HR field is in its infancy. Not only does it appear that few companies measure the return on their HR investments, but in some cases, merely discussing the concept of HR measurement seems to invoke a high level of discomfort. Even a company like Ventura, California-based Patagonia Inc., a supplier of outdoor sportswear which invests heavily in employee amenities, and ranked 24th on Fortune’s list, does little to measure return in any standardized fashion.
Terri Wolfe, vice president of human resources for Patagonia -- a company known for a recreational culture, family-friendly environment and top-notch child-care centers -- is quick to admit this fact. “Oh, you’d better go somewhere else to get information on measuring results because that’s not something we do here,” Wolfe responded when asked to comment on the topic of measuring HR results.
But wait -- that’s no reason to breathe a sigh of relief. Measuring the return on HR investment is the wave of the future, and the time has come for HR to step up to a new challenge: bottom-line accountability.
Experts agree that measuring HR’s ROI is essential.
Few will argue the value of measuring results for demonstrating impact in any business or organization concerned with profitability and growth. But should this concept really apply to the HR world?
You bet it should. HR shines the light on its contributions when it can show in dollars and cents that its efforts and initiatives are moving the organization closer to its fiscal goals and objectives. If HR isn’t able to quantify its contribution to the bottom line, then it will continue to be viewed as “overhead” -- a term which implies that the HR function merely sucks up resources as opposed to adding value.
Undoubtedly, the “overhead” categorization further removes HR from the desired position of “strategic business partner,” a designation reserved for internal business units that can demonstrate the cost and value of expenditures and investments, showing linkage to a contribution to the economic health of the organization.
Dave Ulrich, professor of business administration at The University of Michigan and author of Human Resource Champions: The Next Agenda for Adding Value and Delivering Results (Harvard Business Press, 1997), is a strong advocate for measuring the results of HR’s efforts. According to Ulrich, “That which is inspected is expected. In a world of competing demands, if we don’t measure HR work, it won’t get attention.”
A recent study conducted by New York City-based HR consulting firm Tillinghast-Towers Perrin (Towers Perrin Monitor, April 1998) loudly demonstrates how measuring HR’s contributions in actual dollars can be a big attention grabber. In the study, Tillinghast-Towers Perrin looked at 17 personal lines property/casualty insurance companies as they relate to impact on employee satisfaction, motivation and retention.
The study confirms that HR policies and practices can play a vital role in customer retention, which has a huge, quantifiable impact on the bottom line. A very strong correlation was found between customer retention levels and employee turnover. Low turnover among employees and sales agents proved to be critical in maximizing customer retention levels in the personal lines insurance business (and is likely to have the same result in other service-based industries).
The research focused on the economics of enhanced customer retention and found that a personal lines company with $1 billion in annual premiums can expect to realize an added value of up to 6 percent of its current premium volume, or $60 million, by increasing its customer retention rate from 85 percent to 87 percent. Furthermore, if this same company increases its policyholder retention rate to 90 percent, it realizes an added value of up to 14 percent of its current volume -- $140 million. That’s the kind of measurement that catches senior management’s eye and demonstrates in no uncertain terms that HR’s programs can have real impact on the bottom line.
And having impact on the bottom line is something every HR organization should be concerned with today. Jack Phillips, author of Accountability in Human Resource Management (Gulf Publishing Company,1996) and president of the Performance Resources Organization, a Burlingham, Alabama-based consulting firm, says its more important than ever for HR to measure ROI. “Pressure to improve productivity and increase efficiency in a competitive environment has brought scrutiny to all functions, activities and expenditures,” says Phillips. “HR is responding with a variety of approaches to measure this contribution and ROI seems to be the best strategy to meet this important challenge.”
Phillips also points out that HR expenditures are on the increase, often making an organization’s human resources the “greatest single expenditure in most organizations.” This factor alone, Phillips says, places an even greater requirement on HR to prove to senior managers there’s a return on this investment. “The threat and extent of outsourcing is creating more emphasis on ROI. One of the most important strategies to prevent further outsourcing is to show senior management the return on investment of existing functions and processes.” Phillips also indicates that as functions are outsourced, the ROI process becomes a useful tool to measure the success of the outsourced activity.
HR is reluctant to embrace ROI measurements.
Given all of this, why aren’t more HR functions calculating the return on their investments? Phillips says he feels many HR professionals are still reluctant to accept responsibility and meet the demands of ultimate accountability. According to Phillips, many HR professionals contend that measurement and evaluation systems (particularly in ROI) are too difficult, too costly, and in some cases, impossible. Phillips is quick to respond that, in reality, ROI is possible within most budgets and can be “simplified and implemented with little cost.”
Still, it seems most companies are approaching the measurement challenge at a less-than-rigorous pace. Even high-tech leader Sun Microsystems, headquartered in Mountain View, California, and ranked 69th on Fortune’s list, hasn’t hit the ROI issue head-on, but progress is being made. Ken Alvares, vice president of human resources, explains that when dealing with HR programs, whether it be employee support services, training and development programs or quality initiatives, the measurement factor can be a difficult nut to crack.
Alvares, a self-described believer in “measuring everything you can,” says the problem lies in the fact that the end measurements are only as good as the assumptions they’re based on. “When it comes to measuring the results of some HR programs, I have a hard time trusting some of the numbers,” Alvares says. “For instance, when we’re trying to isolate revenue increase per head and start assuming those increases can be attributed to one program, I think the results are open to question.”
However, Alvares does submit that in some situations, the measurement factor can be relatively clean and easy. For instance, the Sun organization implemented a software program that allowed salary change data to be entered and calculated far more efficiently, saving hours of work and improving productivity. Alvares explains it was relatively simple to calculate the cost of completing the same amount of work before and after using the new software. However, by press time, Alvares couldn’t provide Workforce with exact costs. Measuring return on investment can be fairly simple in situations where costs and expenditures are easy to identify.
Practitioners provide how-to advice.
Calculating ROI in the above example would involve subtracting the cost of the investment (dollars spent on software, training and implementation) from the savings realized through improving productivity and reducing hours spent on the process. By dividing the net savings by the cost in dollars, you arrive at your result.
To simplify an example like this, let’s say the initial cost of an investment was $50,000 for a 12-month period (hypothetical cost of software and implementation). And let’s assume that improved productivity, reduced people hours measured in an hourly pay rate, and a reduction in temp help resulted in an overall annual savings of $75,000, or a net benefit of $25,000 ($75,000 to $50,000). Deriving the result would involve dividing the net benefits ($25,000) by the initial cost ($50,000) for a result of 50 percent. Again, this is an oversimplification of what’s typically a complex process, but it’s a framework nonetheless for measuring results in traditional financial terms.
Unfortunately, Alvares admits, not all initiatives are as easy to measure and quantify. So rather than approaching the measurement conundrum with the same old approaches, he takes a different tack by asking the HR committee to demonstrate that their investments are creating a competitive advantage in the marketplace, either through product competitiveness or people competitiveness. If a new program improves pricing, time to market or quality, Alvares believes the return will be there.
The same holds true for investments that allow the Sun organization to maintain peak productivity through people processes. “We tend to use critical incident methodology, looking at business results before and after a change initiative,” Alvares says. He cites a specific example of this process when Sun did a pilot study to see whether engineers were more productive working alone or in teams that involve a lot of interaction. The initial assumption was that engineers prefer to work in isolation on individual projects. A video camera was used to monitor a pilot group of engineers who were placed in a more integrative environment.
The findings indicated that the engineers were more productive in a group and there was a significant benefit to the sharing of knowledge that took place. Alvares said the company went forward with a restructuring in this area because key indicators led HR to believe the return would follow in dollars and cents, which the company may or may not measure down the line.
Obviously, there’s not one right way to measure HR’s ROI. The approach can vary by each initiative and its expected results. However, Phillips suggests that HR should use traditional ROI approaches because middle- and upper-level managers must support HR programs and approve additional funding. These managers prefer the same type of calculation used to evaluate investments in the plant, equipment and new products -- calculations that are somewhat unfamiliar to the HR world.
Phillips recommends HR professionals use five key measures to analyze the return on HR’s efforts:
- The investment in the HR function -- stated as the total department expense divided by operational expenses, or divided by employees to make it comparable from one organization to another
- Absence rate -- unexpected absences and number of employees who leave the organization without being asked to leave
- Turnover -- including both those who leave on their own and those who are terminated
- Job satisfaction -- the percentage of employees who feel good about their work and the company, derived from standard employee attitude survey data
- Organizational commitment -- productivity and performance statistics -- high productivity and performance reflect strong employment commitment.
Where to look for measurement opportunities.
Ulrich agrees that HR professionals aren’t doing very well in the measurement area. “When we do measure, we often look at activities, such as the number of people who had 40 hours of training this year, the number of people hired, the percentage of the workforce on variable pay and so on. Instead, we need to look at outcomes and results and ask, ‘did we do the right training, hiring and compensating to get the desired business results?’”
But, Mark Teachout, Ph.D. and executive director of learning and performance technology for USAA, a worldwide insurance and financial services company (39th on Fortune’s list) based in San Antonio, Texas, says he doesn’t believe it’s necessary to measure the results of every initiative. “If you become over-focused on the [bottom-line results], you can get to a point at which you need to do a ROI on conducting the ROI to make sure it’s worth the time spent measuring results -- it can get a little crazy.” Teachout believes HR professionals should be focused more on improving results rather than proving them, and prefers to reserve true quantitative measure for cases in which accurate measurement is possible and significant dollars are involved. USAA’s “Live Work” program for new sales members is a good example of such a case.
Teachout oversees the “Live Work” program, which involves putting new service reps through an eight-week sales and service training session. During the last phase of classroom training, trainees are on the phone with actual business prospects selling policies and financial services. The training staff is able to calculate the revenue they are generating while training is in progress. Results for 1997 indicated that new trainees generated over $1 million in sales, a ROI of 192 percent, which was calculated by dividing the cost of designing, developing and implementing the training by the net benefit (annual sales revenue).
USAA also measures the ROI for an amenity package that includes the world’s largest private office building, on-site tennis, golf and soccer areas, two fitness centers and five on-site child-care facilities.
Paul Menchen, vice president for HR policies and programs at USAA, believes that, when it is coupled with a competitive compensation and benefits package, USAA’s amenity package helps contribute to a low turnover ratio. However, Menchen admits that there are no specific quantitative measures in place to firmly support this data, other than positive feedback from employee opinion surveys and exit interviews.
Menchen explains, “We feel it’s important to treat employees well and provide them with a comfortable work environment. We believe by doing so, we keep turnover at a minimum. We may not directly measure results of those efforts, but we feel confident that if we treat our employees well, they, in turn, will show that same consideration to our members,” suggesting that lower turnover ratios and happy employees can lead to better customer retention and improved business results.
Ulrich offers this advice to HR professionals grappling with measurement: “Do it, do it now. Even if you don’t have perfect measures, involve some financial, strategic-thinking, bright types who are comfortable with creating measures, and don’t let the lack of measure keep it from happening. Also, be consistent with measures and track them over time.”
In his book, Ulrich outlines five areas HR can measure to demonstrate results:
- Productivity measures -- output per unit of input (improvements in these areas might be traced back to increased training, improved work structure and so on)
- Process measures, such as improving systems and workflow
- HR costs and/or benefits for any specific initiative
- Employee retention, morale, commitment and skills
- Capabilities of the organization, such as speed (cycle time), learning, shared mind set, and accountability
Workforce, September 1998, Vol. 77, No. 9, pp. 34-40.